Private Home Builders’ Moment of Truth Approaches with 2nd Half of 2010
Arguably the most important story of the year for the big home builder community is where are many private home builders going to get money to keep their lights on.
First an explanation of what we mean, then a take on why we’re saying it now.
If private home builders don’t get that money, many, many more of them will go dark. They need that money for two reasons. One is to build through houses they’ve either sold already or can sell if they’re ready. The other is to buy some of the lots with new price tags like the national, public builders are doing.
These two reasons are precisely the reasons banks are averse to handing it over right now. They’re averse doing anything that puts more exposure on their books. It’s the last thing many of these banks can tolerate.
Big banks are now profitable, but give it five minutes and the jig will show up as a jag. Small banks–many of them anyway–have so much exposure to the X factor that is real estate valuations that one can still only guess how widespread the damage is. One running count is that 644 banks are on the “Unofficial Problem Bank” list.
Private home builders are in a fix because most of them depend heavily on banks, and banks are in a fix. The recent increase in the Fed discount rate doesn’t mean a lot to most of us, but it certainly doesn’t bode well for businesses that draw on bank capital with the intensity that home builders do. If it’s more expensive for banks to borrow, it’s going to be more expensive for their commercial customers to do so, one way or another, and it will be in shorter supply.
Private home builders are already seeing reason to clump 2009 and this year, 2010, as the two worst years of the downturn. They’re already seeing the cost of the money they draw on go into the stratosphere. They’re already seeing that the hard-won ability they had to borrow money for their home building company without personal guarantees is rapidly going by the wayside. They’re already seeing capital sources developing virtually usurious interest rate tiers as reminders of what risk the banks are going to do any business at all with home builders.
This is short-sighted, no? The health of a bank lender ultimately will depend on its community of customers, including home builders, which pay back the money owed at interest, and hire people to build, who in turn stock the foodchain of consumer demand through the economy.
We see what has happened to construction spending. It’s down 61.4% since its peak this time in 2006. We know ourselves that home builder business units are a 30% shadow of what they were this time in 2006. We know that many good, smart people are out of work. Some of them saved their personal pennies for rainy days. Many of them have been out so long they’ve just lost their unemployment benefits.
Fact is, as soon as you name one way that private home builders are superior to public home builders, you’ll get an argument–a valid one, too–from a public builder that contests that. Still, private home builders are better at some parts of this business. Why else would public companies have paid so highly for them in bygone years?
We feel that private home builders are where home building culture, home building design innovation, and home building real time supply-and-demand knowledge occur at a superior level. Private home builders, in fact, are the reason some of the public home builders are as good at what they do as they are.
Here’s what Tom Lewis, founder and owner of 20-something year-old regional home building power in Phoenix, T.W. Lewis, told us about losing his No. 2 man, Kevin Egan, this month:
“It got so that there were too many chiefs and not enough braves. Kevin created an incredible, cohesive, collaborative organization focused on excellance here. That’s what we will miss.”
The industry can ill afford to see private home builders fall into a state of credit-lock paralysis for the next year to 18 months. Just as public home builders meet a need for housing at an affordable level, using highly iterative manufacturing techniques, scaled purchase of products and labor, and negotiating muscle on land prices, private home builders meet that need on a more zeroed in basis, in smaller tracts, in trickier circumstances.
The way it’s going, though, we’re not going to see very many private home builders around to meet that need very much longer unless there’s a break in the impasse on lending to home builders.
The nation’s most afflicted local economies need jobs to jam the negative feedback loop that has jobs, home defaults, declining asset values, lower earnings, and more layoffs locked in a vicious cycle. If banks become part of the solution of loosening credit to small businesses, the negative loop will begin to flow the opposite way.
It’s an industry problem–for both public and private home builders–if private home builders play through this year with two arms tied behind their back. We’re not saying they’re not willing to try.
But smarter people might see that collaborative competition might be a notion that will speed an improved outlook for everybody.
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