Housing Megatrends 2010: Pulte-Centex May Lead Way to Less Confirmation Bias
In the previous post, we stated our goal for the next week or so: To offer a preview of 10 megatrends residential real estate and construction companies can bank on in 2010 that happen to trace from 10 leading achievements in 2009.
Yesterday we looked at a number of home building companies’ introduction of foreclosure-fighter entry-level home offerings in 2009. On the surface, lower price-tag new homes may look like a tactical adjustment to a huge and chronic price-point challenge posed by the transfer of millions of homes’ deeds to new homeowners via distressed or foreclosure deals.
That’s not incorrect, but it’s also only part of the picture. Shrinking materials costs and stripping out square footage and labor-intensive details and finishes would only get a home builder part of the way to where a home buyer spots a value advantage over existing homes sold under a white flag of capitulation.
It took a mentality make-over not only to extract materials costs and find construction-time short-cuts to reduce a home’s pricetag, but to create a new operational template that speeds up construction, gets it right the first time, and iterates the process consistently across communities, divisions, and regions so that indirect fixed costs can get focus and come out of the equation as well.
So “good enough” is the badge for a home builder strategy that began to emerge in 2009, as companies traded off what people opted for back when money was funny for what they really want when money is deadly serious and much harder to get. Good enough is what a home builder minimally needs to do to get a home buyer excited about buying new. It’s not necessarily lower quality, because new still needs to quicken the pulse compared with what a buyer might get in a buyers’ resale market, but good enough dispenses with whatever doesn’t strike the buyer as bottom line valuable to the whole.
A separate but related strategic issue with origins in a terrific achievement in 2009–Pulte’s “combination” with Centex–has ramifications as one of our 2010 Megatrends: “The End of Confirmation Bias.” We see in the previous example that for a design innovation–the foreclosure-fighter or price-winner new home–to work, a structural, operational change needed to support the new product rollout to gain financial viability.
The line in the sand we see with Pulte’s acquisition of Centex has to do with a disruptive approach to centralizing process and production that entrepreneurial-souled home building enterprises have resisted up to now. As the newly merged company Pultifies Centex, a whole new relationship will tie divisions and regions to the Bloomfield Hills, Mich., mother ship.
This new tie will test one of home building’s most sacrosanct assumptions that all of home building, like all of real estate, is local. This assumption, fed over the past 100 years or more by heaps of confirmation bias, accounts for errors and excess masquerading as local entrepreneurial cultures in multi-divisional home building companies. This is not to say that location is a less powerful factor in real estate value than it has ever been.
Home builders, however, must do better in 2010 at balancing location with process to their advantage in a marketplace that everyone knows will be riddled with foreclosure sales for the next 24 months or more.
- Is real estate and land knowledge essentially local (i.e. value and relationship to sellers are inextricably tied together)? Yes.
- Do municipalities and counties profoundly impact viability and profitability of new home communities? Yes.
- Do local trades and distribution networks structurally impact costs in materials, time, and labor? Yes, but not necessarily to the extent they need to…
- Do local design trends rule to such an extent that each market needs its own floor plans and elevations? Absolutely not.
In the Pulte-Centex strategy we see the most dramatic example yet of a top-out reorganization aimed at making what goes on under the hood of a national home building company easier to understand and manage. In our Big Builder Virtual event program, financial consultant Rob Held points to variability as one of home building’s fiercest foes. If you have a look at his seminar, he’s not saying that home building is not local; he is saying that if home builders can reduce production variability, they’ll be more profitable, and better at supplying the market what it demands.
Many national companies’ divisional structures grew out of acquisition and roll-up binges of yesteryear. The cathartic months from 2007 through now should have done nothing so much as create an opportunity to re-draw every organizational chart from a blank sheet of paper. An initiative and its champion(s) are only worth pursuing insofar as they account for and serve the interests of the whole.
When the world is stripped away of all of the excess that could be had when money cost nothing, what’s left is what makes a new home more desirable than a resale, and the process that can deliver that.
So, the 2009 achievement that is the Pulte-Centex coup has major ramifications for further consolidation in the home building landscape. Yes, we may see that the $1 billion plus in cost out could be gotten from several other big “combinations” of home builders that share market footprints and could re-rationalize land positions around respective product lines and price tiers.
But what we’ll really see more of in 2010 is headquarters power and accountability up, down, and outward of the home office. Division presidents will get to “do what they’re good at,” which is to leverage local knowledge and relationships for smart land buying. At that point, corporate comes in with the operational process and the marketing support to drive sales at a manageable, measurable level.
Hopefully, we’ll see the emergence of talented skeptics. It’s they who’ll give teeth to the ”lessons learned” bullet point in so many powerpoint presentations we’ll see in the upcoming months. Confirmation bias, clearly, kills value and decimates companies that fall prey to it.
The widely held belief that the industry had beaten the housing cycle at its own game was confirmation bias at its most harmful.
Accountability, less variability, and greater measurability can offset the instinct to get caught up in one’s own hype. That’s what’s at work in the Pulte-Centex combination, and what we’ll see lots of variants of in 2010.
Single-family Housing 2010 Megatrends: Good Enough is the New Good, Better, Best
We’re going to give you a list as they say at the craps table–the hard way. One by one.
Per our list of 10 predictions for 2009 this time last year, we can’t be counted on for a great amount of precision in hindsight. Nevertheless, our guiding principle still holds that more of our forecasts will come true than not, but the timing of their totally vindicating our prescience may be off a bit. A decade or two in some cases, maybe.
At any rate, over the next 10 to 12 days, we’ll cobble together a series of observations that meld together what people in the home building business landscape have achieved in 2009 with what those accomplishments foretell about 2010. We figure, maybe if we slow our thought process down just a bit, the cycle of housing and business events may have a chance to keep pace.
One thing”s for sure. If “hang in there” was 2009′s mantra, 2010′s most repeated claims–true or not–may more likely fall evenly into the “I’m still here” bucket, or the “I’m back” one.
One of the stunning dawnings we had by the end of 2008 came with all the gentleness of one’s 9-year-old brother or sister waking us to get ready for school each day. This realization–compliments of one of our friends in the bankruptcy reorganization business–was that after the marathon land dance of 2003 through 2007, nary a real estate project in the nation, commercial, for-rent, or for-sale couldn’t get classified fairly as “in distress.”
Companies themselves, mind you, may not have been operating “in distress,” but their real estate projects on lots acquired during that land dance period were all hanging in loan-to-value limbo, where the loan represented a snapshot of insanity and value was doing its best imitation of a polar ice cap.
The achievement, then for 2009, was not a single product like KB Home’s Open Series, but rather a wave of initiatives across dozens of home building companies that succeeded in braking bad habits, wasteful processes, and uncoordinated operations to bring entry-level new home direct construction costs down to where monthly-payment sensitive buyers would again consider new versus a foreclosure bid and purchase.
Tim Eller, formerly CEO of the now-engulfed Centex and still a board member of Centex purchaser Pulte, talks of housing downturns as all having the same plot line. The differences from one downturn to another–from one who said he’d gone through at least four of them–are a matter of duration and severity. The story line, he’s said, is identical.
Eller said that what large volume home builders do when times are difficult is to scale back their pricing far enough and fast enough to reconnect with home buyers’ needs. With this advantage of price elasticity over sellers of existing homes, new home builders would restrike a balance in their businesses and pick up market share coming out of the lowest depths of the housing recession.
This time, with absolute housing unit vacancies so high, a consumer economy facing grave uncertainty, and a jobs picture that may slip, slide, gain, and fall choppily through the next several earnings seasons, the plot line Eller says is so consistant may get its real stress test.
High volume builders, particularly those whose capital structures allow them to use public credit and debt markets for operational financing, typically come out of downturns with more market share and greater clout, not just among buyers, but among subcontractors, distributors, and manufacturers of materials that go into building homes.
That part of the narrative plays out in the Great Recession only if companies can keep their excesses in the land dance of ’03 to ’07 from haunting them to death.
The achievement of KB Home and others who’ve borrowed liberally from the Rayco model of the S&L crisis-prompted downturn of yore (KB bought Rayco in 1996) right up through the Shea Spaces model we’ve remarked on in the past month is that they’ve neutralized the smothering effect of what a company agreed to pay for land with funny money that everyone knows is not around anymore.
Home builders need 2009 and 2010 to do two main things strategically. One is to leverage U.S. policy support for housing for all it’s worth. Second is to restore “new” as a focal point of desire among buyers of homes.
This is why the Open Series, Spaces, and all of the other monthly-payment sensitive offerings are significant looking ahead to 2010 as well as back to the past 12 months. They leverage policy in a minimum of two ways: both on the demand side with the tax credit and on the corporate tax side with a transaction that could turn into a Net Operating Loss refund.
They also turn inventory, generate cash, rid the operation of cost, and create need for a company’s operational fixed-cost structure.
Importantly, moreover, these products are essential initiatives around which companies can make themselves over. They’re a learn-by-doing tool, and the most important lesson to come out of being able to produce homes at a price and with a design customers want is the reframing of the “good, better, best” approach to positioning.
Even when it comes to the American Dream, “good enough” is where capability, cost, and aspirations meet. That buyer is not necessarily thinking of her home as a quick-return investment, but more of a buy and hold one, to grow into, enjoy, and then trade for value later.
“Good enough” may strike some as a come down from “you can have it all.” But it’s at the heart of the new normal, and good enough may just be good enough to ensure we’ll be hearing “I’m still here,” or “I’m back” from all of you in 2010.
Stay tuned for tomorrow’s 2010 Megatrend on the “Brief Life and Death of Confirmation Bias.”
Hurry Up and Don’t Wait
It’s odd that it works this way, but during these slowest of times in production home building, it’s not patience nor deliberate thinking that emerges as strategic necessity. It’s speed.
Cost and time go together, so if you can eliminate one, you can get at the other. When it comes to the three imperatives that drive us-more, faster, better-a colleague of mine used to say, “pick two of them and be happy with that–you can’t get all three at one time.” For home builders, large and less large, faster and better will have to do for now. More may come much later. Do it fast and right the first time.
We’re living now with this realization. That feeling we got in 2003, 2004, and 2005, when we thought we were so good at building, and satisfying home buyers, and managing companies, and buying materials and services? That was euphoria. That was fantasy.
And the price of all that-as painfully we learn each time a batch of bills and payments come due-is that many of us cannibalized our future prospects to get to the heights of euphoria we felt in the middle of the decade.
Many of us over-capacitized at great cost in dollars and disregarded discipline. One of the only ways back from the brink has to be scary. But if we were willing to cannibalize our future before, now we’ll have to be more than willing to cannibalize past and present structures block our way to our future.
To get better, and do it fast, we’ll need to disencumber our businesses of deficiency and inefficiency we ourselves designed into them. We grow attached to our designs, and they feel as if they’re the bedrock of what we do. Still, we have to let them go.
As we speak, folks at Pulte–which as of August 18, 2009 became the combination of Pulte and Centex–are going through each and every land parcel they own and giving it a litmus test. If the test shows the land is best for an entry-level community, that piece will get the Centex brand. If it is first- or second move-up, it will become a Pulte community. If the tract lends itself to active adult lifestyle community development, it will get the Del Webb name.
This means that many communities currently called Centex will become Pulte, and–vice versa. This means that the parts of the combined Pulte and Centex organizations will submerge into the whole.
Few national home builders have succeeded in organizing their multi-regional, multi-divisional businesses around an operating company model. The rest are holding companies with limited ability to manage knowledge, processes, and outcomes across their roll-up of semi-autonomous regional or divisional units.
In the Pulte-Centex “combination,” as CEO Richard Dugas likes to call it, we see a story for the moment. It’s about being courageous enough to acknowledge that separately, companies can’t get the job done as well as they intend to. They need to partner. They need to disrupt the way things were, even at the risk of cannibalizing some of the pet initiatives that worked well in the bygone economic era.
Here’s what Bill Pulte says of Dugas, the man who would be king of high volume home building:
“When I first met Richard, I saw someone with high integrity, high intelligence, and someone worth keeping an eye on. Richard moved quickly through the ranks because he would win discussions by using facts, not just words, to back up his points of view. When Richard was named COO, he took that opportunity to travel the country and meet every division president in the company and build a rapport with them. After seeing his relationship-building ability and leadership skills, along with what I knew of his integrity and intelligence, I made him CEO. The fact that he was only 38 didn’t bother me at all.”
Big Builder Model Behavior
Flash. The new home business sits squarely in the consumer credit business, so should it be any surprise that those who build homes for a living are more dour in their outlook now than they were during the summer?
Until jobs and income turn tide, we’re reminded of this stunning statistic noted in this month’s Harvard Business Review:
While a little off its high point, the [consumer debt to disposable income ratio] number now stands at around 130%. In other words, it will take American consumers nearly 16 months ( 1.3 years), on average, to pay off their debt, assuming that they spend absolutely nothing on housing, clothes, or food.
The HBR provides a calculator for businesses to map their “consumer leverage exposure” ratios.
Still, home builders must use another calculator as they put together budgets for 2010 and beyond, because it’s probable that their CLEs would all be off the charts. One of the lessons learned this year–the third consecutive year of hard times for home builders–is that “waiting out the downturn” is not an option. For private builders, it’s either find cash within one’s own universe of resources to go vertical and get orders in hand to keep the trains running, or it’s give back one’s rights to the rest of the lots.
For publics, you’ll recall their CEOs making this clarification: “We didn’t say the industry was no longer cyclical, we said we were better prepared to endure and secure opportunity through the cycles.”
For them, waiting out the pain has also been a non-starter as an option. Public home builders have had a critical business model change to make as they cut costs and eliminated as many as six of every 10 employees.
They’re making this change, which some will say is a sacrifice of that “entrepreneurial spirit” and “local autonomy” that their divisions enjoyed during the halcyon days of yore, when headquarters could make money hand over fist running a holding company model.
Clearly, now, home builders public and private need to be operating companies. They need a business system that applies across regions, divisions, and communities, so that variability is taken out of the equation, so that they’re products can do battle with foreclosures. Foreclosures will likely come in measured waves, on and on, for the next few years, and increasingly, they’ll show up at every price point imaginable.
So home builders must have operational systems and product positions to battle foreclosures at every price point. Public home builders like KB Home, D.R. Horton, Meritage, MDC, and MI Homes responded strategically to the need to have foreclosure-fighters at the entry-level where monthly payments have been the story for home buyers.
Key to CEO Richard Dugas’ strategy at the newly merged Pulte-Centex is to heavy up headquarters systems and controls so that every community in its portfolio–Centex, Pulte, Del Webb, and a to-be-named luxury brand–operates according to accountability to consistency standards.
We’re telling our local operations, ‘focus where you can add the most value,’ which is in two areas: ‘You pick the right consumer group to focus in on in your market based on the supply demand imbalance. That is not a Detroit decision. So, if you, Mr. Dallas president, want to focus exclusively on Centex and on Del Webb because you think that we’re overbuilt for the Pulte brand, fine with us. No problem. That’s one area you can add the most value.’
Number 2… how to literally put that land strategy together, because land is very local and unique to each market. So whether you’re buying developed lots or whether you’re auctioning property from the government, or buying big raw tracts and developing it yourself… all of that is the local decision.
So, consciously, instead of it being unspoken in the past, we’re going to consciously say ‘we’re focusing you, specifically at the local level, on which consumer groups to go after and the land strategy.’ And the rest of it, we’re saying, ‘leave up to experts who are really good at understanding what drives each of these local brands.’
I envision taking it down to specifying what’s inside the home, what mortgage programs we use… everything about how to operationalize that.
So, one of the bigger changes we’re likely to see coming out of the housing recession is an end to the roll-up mentality in new home building corporations, and the beginning of nationals needing to become real operating companies with success at their core, rather than as a loose confederation of independent-minded builders working under one stock symbol.
We’re seeing evidence of this in our work on the Big Builder ’09 Virtual event, where we’ve created mash-ups of big time talent working to solve a present or future land position challenge in five different markets.
In Phoenix, the team consists of:
- Kevin Egan, president & coo for T.W. Lewis Homes
- Jim Jenkins, vp, acquisitions, Shea Homes
- Michelle Mace-Basha, founder, M3B Inc.
- Kimberley Clifford, marketing director, Newland Communities
- John Fortini, principal, Silver Fern Management
- Brad Sonnenburg, principal, BSB Design
They’re working on cracking the code for Mt. Pleasant Heights, a 1,100-acre parcel, currently being marketed to potential builder/developer buyers by AmTrust Bank, in Phoenix’s Northwest Valley, in the town of Peoria, just east of the Vistancia master planned community.
The big challenge of the project is to deal with a currently overserved competitive market for new homes, not to mention some difficult topography and access issues. The flip side is that the completion of the Rte. 303 loop in the near future, as well as access routes into the Mt. Pleasant Heights community, will bring good traffic from downtown Phoenix to within a stone’s throw of the community, and that the topographical challenge translates into remarkable views of rough terrain rips and rills–a rare natural amenity.
The Big Builder Dream Team needs to strike a harmonious balance among the needs of the land, the competitive offerings of neighboring master plans, and the new economics of demand in that region, i.e. “The Who” that lies at the base of a community’s value proposition.
Going back to what Pulte CEO Dugas was saying, a Dream Team might crystallize the consumer buyer need, and bring strong local land knowledge to the party, two critical aspects of the operating company equation. After that, a big builder needs to have a system in place–construction operations, merchandising management, and selling optimization–to make a plan such as the one the Big Builder Dream Team will conceptualize work profitably in the marketplace.
Where’s evidence of that fire-in-the-belly cultural entrepreneurialism that private home building companies say is their secret sauce in finding and satisfying home buying customers?
Dugas’s answer:
If, as I predict, we’re going to be more financially successful this way, everybody wants to work for a financially successful firm. That’s the way you transition that. I’m not too worried.
Look for more forceful corporate headquarters control, and less on-site variability in the public home building model in 2010 and beyond.
Big Easy District Gets Homegrown Help
Today’s global and domestic Housing Crisis’s most eloquent metaphor formed over the Bahamas on Aug. 23, 2005. But it wasn’t just a metaphor. Six days later, early on a proverbial Stormy Monday morning, it made its second landfall. Known forevermore as Katrina, it was the costliest and one of the five deadliest hurricanes in history. At least 1,836 in New Orleans lost their lives.
Among other things, the event in hindsight serves as a bright-line moment that separates a 15-year housing boom from a bust whose duration no expert can confidently predict, and whose ravages are still being felt and dealt with.
Economics aside, Katrina marked first the exodus of investor buyers from residential real estate and, subsequently, the meltdown of mortgage finance’s international house of cards, which seemed to hiccup one moment and contract double-pneumonia the next.
Almost four years later to the month, amid a delicate balance of morale, movement forward, and memory, the wards, parishes, and neighborhoods of the Big Easy may once again serve as a metaphor–but not just a metaphor–for a painfully slow but sure show of irrepressible resiliency–more like obstinacy–that must foreshadow any noteworthy measure of re-stabilization, not to mention recovery.
Click image to access Make It Right Foundation site.
Down in the Lower 9th, the vaunted Make It Right Foundation, backed by a $5 million bump each from Brangelina and Tom Darden of Cherokee Investments as well as contributions from a number of other donors, intrepidly makes progress as it makes headlines. Some 18 homes–of an intended 150–are either done or under construction, with a number of duplexes scheduled to break ground in August. Still, at a cost of $350,000 or more per home, and a selling price at a fraction of that, the Make It Right model, while laudable in its mission, is far too expensive and time-consuming to be scaleable in its execution.
Symbolically, efforts like Brad Pitt’s, and those of Branford Marsalis and Harry Connick Jr.–who’ve teamed up with Habitat for Humanity to create “Musicians’ Village” for musicians who lost their homes to the hurricane–may work to call attention of the world outside New Orleans for the continued need for help.
But they hardly serve as a self-sufficient, organic market-based approach to solving the sorry Jack-O-Lantern look of so many neighborhoods where many homes still sport FEMA search marking system badges, and others are either “scraped” to the slab or a still-standing, termite-ridden, mold hotel awaiting inevitable bull-dozing.
A middle-class, integrated neighborhood called Filmore (in New Orleans’ Gentilly 6th District), up toward Lake Pontchartrain and just east of the huge City Park, may well soon reflect a new stage of the city’s no-quit mentality.
Former JMP Securities investment group director Phil Whitcomb is working with a S.W.A.T. team of real estate development and construction operations folks on a concept that, if it gets buy-in from important neighborhood associations and local influencers, could pump the blood of life into a 52-block area bordered by Bayou St. John to the west, Robert E. Lee Boulevard to the north,the London Avenue Canal to the east, and Filmore Avenue to the south.
Pratt Park would get a Promethean make-over.
The idea–in contrast with the headline-grabbing Make It Right initiative–would be to home-grow a neighborhood transformation. It would be a mash-up of the best advantages of scaled production home building and economic redevelopment at the street-by-street level to create a sustainable extreme community make-over – jobs and affordable, energy-efficient homes where residents adopt a reinvigorated stake in their place. The neighborhood even has a built-in park, Pratt Park, which would morph into a prized playground and park facility in Whitcomb’s blueprint for Filmore’s renaissance.
The timing? Perhaps within weeks, floor plans that could fly with acceptable local architecture will be developed, even as several public-private partnership dimensions of the plan get traction. Still, it’s not a moment too soon.
With the exception of the higher ground along Gentilly Boulevard (which parallels the Bayou Sauvage Ridge) and the neighborhoods along the Lake that were built upon artificial fill, District 6 experienced some of the worst flooding as a result of Katrina. Many residential structures that were built upon slabs experienced flooding up to their roofs and are uninhabitable for the foreseeable future.
The best term to describe Whitcomb’s plan to build or renovate most of the homes in the neighborhood is “scattered urban.”
It would involve a combination of bidding for New Orleans Redevelopment Authority-owned lots, buying lots from owners who no longer intend to move back to The Big Easy from out of town, and in some cases, acquiring lots from current residents who may want to sell.
On building lots that have already been “scraped” or ones that should be bull-dozed, Whitcomb would work with a development company called Promethean Structures on building homes that would sell in the range of $150,000 to $240,000, a new-home that would comp in an acceptable range that existing homes are selling for in the community.
One of the secret-sauce operational details would be that each of the new homes would go up in 50 days, in part through the use of highly energy efficient and weather resistant structural insulated (polyurethane) panels.
A tighter envelope for air leakage, the ability to withstand high winds, non-combustible, and capable of meeting even the new, higher proposed energy conservation guidelines of the climate act, SIPs would cost about $10,000 more per home.
But, thanks to both builder and home buyer tax credits that could be obtained, the actual cost to home buyers would come down to about a $5,000 premium for a 2,000 sq. ft. home, says Whitcomb. “After the purchase, the electric bill’s going to run about 60% of what it would be for a house of that size,” says Whitcomb. So the cost of ownership winds up coming down over the years.
Whitcomb’s construction concept dives in not just on a box level, but the street and the neighborhood level as well. To start, he’s eyeing a retail site and an elementary school for redevelopment or land reuse to support the revitalization of the community. There are also several multi-family units near the new Greater Gentilly Technical High School under construction on Paris Avenue that need to be rehabilitated. Additional ideas will come forward through collaboration with the local homeowner associations.
Whitcomb won his production builder stripes in the Centex Homes academy in six years as vp of corporate development, and before that, in various management positions at Electronic Data Systems and as a corporate attorney specializing in real estate. Of critical importance to Whitcomb is that all the key management talent, community outreach, and labor supervision be homegrown New Orleans.
Whitcomb
“In various of my incarnations, I had occasion to spend time in New Orleans, and I love this city. But it’s more like a European city in the way business is conducted,” says Whitcomb. ”You work with people here, and you don’t tell them what to do; not if you want to get things done.
“We’re doing this to help, but we are a for-profit organization and want our concept to be scaleable and expandable to other areas of New Orleans and Gulf Coast communities,” says Whitcomb. “Hopefully, we can replicate the revitalization that took place in southern Dade County after Hurricane Andrew–-also called St. Andrew by some locals.”
M and A for Another Day
A piece in yesterday’s Wall Street Journal reports we’re not going to see merger and acquisition fever hit the home building sector “anytime soon.”
The story is misleading in a couple of ways.
It springs of a theory that a “bottoming out” in the new home market will itself precipitate a flurry of M&A deals, which may be correct. Few if any players in home building think that the dozen or so bigger public companies will remain a constant even in the next 12 months.
Still, the theory’s broad strokes don’t take one very far toward understanding what will trigger another big M&A deal, because one guy’s “bottoming out” is still another guy’s rapidly “falling knife.” One of the article’s misleading notes is that there’s concurrence about the new-home market having hit bottom. There isnt’t.
Just as many capable home buyer prospects still won’t pull the trigger to buy a home right now for fear that prices are still falling and that they’ll wind up like so many recent home buyers who are currently underwater on their mortgages because of the erosion, the same fear still rules commercial real estate acquisition and development. Buying lots at any price could and will still put some purchasers in the position of overpaying vis a vis their costs to build, market, and sell a home on the lot. There will still be losers in this game of risk.
However, the second misleading perspective in the WSJ piece is comes with its analyst quote.
“What does public-to-public M&A get you except more land and more write downs,” says Robert Stevenson, a housing analyst at Fox-Pitt Kelton. “It doesn’t make much sense.”
Analysts can talk all they want about how home builders should not be looking to add land to their portfolio right now, but that is precisely what many of them have got to do to kick-start sales. They need cash. They have land. But the land they have is not necessarily the land they need to jumpstart the market. The land they need to catalyze sales sooner than later is land that they can build for an entry-level, first-time buyer, … a non-contingency buyer.
Like Hovnanian reported yesterday, it and other companies are under lots of pressure to buy lots that were formerly selling for $220K for as little as $25K a lot. Look closer at Hovnanian’s latest absorption data. They’re averaging 7-and-a-half sales per store (community) per quarter, which is a 26% improvement quarter-on-quarter. What’s likely to be the case is that in the current home mortgage finance environment, there’s probably more first-time buyers in the mix of its current absorptions than historically.
So while the analysts note that Hovnanian is off from historical absorption rates of 40 to 50 sales per community per quarter, it’s fair to say that the company’s had to focus a disproportionate amount of effort on first-time buyer sales just to keep the volume and cash spigot flowing. In a sense, it’s probably selling better against the first-time buyer segment then it had historically, and it will continue to have to to survive its leverage and cash crisis.
Why are other home builders reporting encouraging results in the past five months compared with the fourth quarter of 2008? Most of the more sanguine reports come from home builders with a strong “monthly payment” based product for first-time buyers.
Trolling for lots at bargain basement prices enables public home builders to set up new stores–open communities–and sell homes at the “new reality” price level and still make some margin.
We’d agree that there might not be a raft of me-too M&A deals in the wake of Pulte’s acquisition of Centex. But not for the reasons and theories underlying the WSJ article.
Any company that plans to count on a cash pipeline for the next 12 to 18 months needs lots — different lots in many cases than the ones they already have. So, it’s not ludicrous to imagine another land-motivated M&A deal. Further, another huge factor in the Pulte-Centex acquisition is the elimination of a competitor. The industry could stand for one or two more take-outs to get to a more suitable capacity level.
We do know that many or all of the public home building company CEOs have been in conversations with one another about buying each other. It happens frequently, and all of them expect that the time will come when the dozen of the biggest will wind up as a handful of firms. So, while we wouldn’t call for a chain reaction of deals, we would not count out one or more in the next six months.
Home Building’s Stress Test
Ask just about anybody in real estate, construction, and design how they feel their business is going to go in the next 12 months, and our bet is that almost every one of them would say something like, ”who knows?” Unpredictability looms much more importantly as part of every market and every business, and will probably need to be baked into every kind of plan for the forseeable future.
But business plans and unpredictability don’t go together somehow. So what do you do?
Bet as Pulte CEO Richard Dugas did, on entry level and first-time home buyers. The big question is, will Centex’s kind of entry level and first-time home buyer product fit the near-term urgency bill or not. The race now is for real cash generation. At the end of the day, when they’ve taken all the cost of people, competitive cost and systems redundancy out, will Pulte-Centex be able to meet the biggest challenge of the moment, which is to get people a new-home offering that they can’t resist.
We think the philosophy’s right. But, we’d question the ability to execute. As a matter of fact, just as the government is looking under the hood of the banks, and in some cases is not liking what it sees, we’d say that most home builders who’re planning to stick around had better figure out how to get first-time buyers into their stable soon.
First a few dots that may seem random. Then, how they connect.
Let us know if this litany makes any sense to you in the next 300 words or so. Stress Test. Under water homeowners. Recovery. Walkable urbanism. High volume home builder strategy.
This afternoon at 5 pm EDT, the Federal Reserve Board will release the results of its Stress Test of the nation’s 19 largest banks. The Stress Test is called the Supervisory Capital Assessment Program, and it’s the government’s attempt to learn whether banks–and, more broadly, the private sector financial system–have enough capital to cover their losses if things go as wrong as government theorists and their trusted advisors assume they can go.
The arguable issue is whether the Stress Test tests the real life stress that could occur or not. New York University economist Nouriel Roubini asserts the stress test is not a valid reflection of real risk and real exposure of bank capital to further dramatic dislocation.
Here’s a CNBC clip of Roubini on the topic.
Whether or not you agree with Roubini may reflect how confident you are about the one-in-five home mortgage borrowers who are now said to be under water on their loans. The facts of negative equity and the theories about negative equity’s direct impact on loan defaults are roiling beneath federal bank supervisors’ assumptions at work in the Stress Test.
We can guess that people who are far under water on their home loan and undergo new challenges to their ability to make monthly payments will be most likely to default. Those who can continue to pay, but who realize they’re paying into the vat of home value deflation, we can only guess.
What we do know is that home prices are still falling and that the job and income baselines that they may need to correct to are challenged. This means that home equity, in more cases than usual, won’t be able to serve as viable currency in near term future purchases of homes. Hard cash, 20% or more in most cases, will be what it takes to buy a home, period.
This observation on residential “demand” from Todd Sullivan’s Value Plays blog:
Here is the dilemma. Falling home prices are making homes more affordable, of that there is no argument. The problem is that falling home prices also sap equity from those sellers looking to use it to afford the next purchase. When you add tighter lending and higher down payment requirements you further restrict demand as you eliminate more marginal buyers from the pool.
Contingency sales are highly challenged. Stated income purchase loans, even for professionals, are also highly challenged. The mid-to high end for production homes, and the 55+ category of active adult communities will also be highly challenged.
Why? If you can’t roll your home’s equity into that dream home, an American economic juggernaut in cars, appliances, furnishings, service companies, landscaping, etc. makes a screeching sound.
That’s the kind of Stress Test Roubini’s talking about.
The Stress Test for home builders, we think, is can they leverage their current capital structure to make new homes available to people approved under FHA, and to some with 20% down who can make monthly payments of $850 to $1300? But here’s the twist.
This can not rely entirely on swapping out land they overpaid for for land they’ll get on the cheap out in the exurbs. They have to be able to crack the code of bringing their skills of construction, engineering, financial management, community relations, and marketing into the urban core.
Here’s Nobel prize-winning economist Paul Krugman in the New York Times:
He’s in “the kind of neighborhood in which people don’t have to drive a lot, but it’s also a kind of neighborhood that barely exists in America, even in big metropolitan areas. Greater Atlanta has roughly the same population as Greater Berlin — but Berlin is a city of trains, buses and bikes, while Atlanta is a city of cars, cars and cars.
And in the face of rising oil prices, which have left many Americans stranded in suburbia — utterly dependent on their cars, yet having a hard time affording gas — it’s starting to look as if Berlin had the better idea. “
Cheap energy is gone. The fossil fuel based economy is winding down. Communities that rely excessively on car travel are a limited opportunity, even for home builders that made a living building the surburbs.
Where there is excess capacity in home building is in the suburbs and exurbs. Where there is a need for what production home builders could do is downtown and near downtown. Right now, it’s more expensive, more risky, more time-consuming, more capital intensive, and more technically difficult to do it.
Brookings Institution’s Christopher Leinberger has written:
- Real estate and infrastructure, including government buildings, accounts for 35% of wealth in the US and is the largest asset class in the economy.
- There are only two options for real estate development and the built environment (drivable sub-urbanism and walkable urbanism).
- Drivable sub-urbanism has been the defacto domestic policy of the country since the 1950s.
- Growing demand for walkable urbanism has resulted in a large gap between the current limited supply and much larger pent-up demand, boosting per square foot premiums for walkable urban residential, office and retail space from 40 to 200 percent.
- More than 80 percent of recent residents in downtown Philadelphia and Detroit are college educated.
- Recent research in selected metropolitan areas shows that 30 to 40 percent of households want to live in walkable urban communities, but only 5 to 20 percent of the housing supply is in that category.
But over time, it’s more valuable and can sustain a more predictable future. Who wouldn’t want that right now?
Pulte-Centex 101
Big Builder editor Sarah Yaussi and Hanley Wood Market Intelligence SVP for innovation and products Jonathan Smoke team up for a seven-minute seminar that will clarify “Pro-Forma” Pulte’s challenges as it tries to digest Centex in the months ahead.
Turn up the volume on your audio, and have a listen.
Pulte-Centex: Second Day Thread
On May 22, 1963, New York Yankee slugger Mickey Mantle hit The Home Run. The blast came from the left side of the plate against Kansas City [Athletics] pitcher Bill Fischer, and the ball struck Mantle’s bat and soared toward the ornate facing of the uppermost right-field reaches of the now mothballed old Yankee Stadium in New York. Fans and fellow players said the ball was still rising when it smacked the morter facade and caromed back into right field.
Tape measure home runs these days now all come with a cloud of uncertainty, given all the ways players seem to need or want to supplement their own strength.
The House That Ruth built had capacity to seat 57,545 fans, but it was almost like an unwritten law that gave any fellow the right to say that he was there at the stadium in the Bronx the day of The Mick’s legendary dinger. We were eight years old, but have enjoyed the license of any New Yorker and Yankee fan to white lie about being eye witness to our idol’s feat of wonder.
Which brings us to yesterday’s Pulte-Centex mega-deal, which at the very least, has energized a nearly comatose industry with talk of possibilities.
And just like that May evening in 1963 in the Bronx, it seems suddenly to be the case that everybody in the home building industry worked at one time for either one or the other of the companies. A fair number of people have put in time at both.
None of them are surprised that the deal–whether it makes strategic sense or not–ultimately happened; the timing is the only thing that dismays who we’ll call “The Ex-ers” to describe the host of former management and operational folks we’ve canvassed to try to make more sense of the $1.3 billion take-over.
The trouble most Wall Street investors and their representatives have on a fundamental level with the home builder sector is that, even when they’re allowed to put their head under the hood of the company they don’t know what they’re looking at. Home sites, neighborhoods, management talent, manufacturing capacity, distribution skills, sales and marketing … it simply doesn’t all add up.
So it’s when home building veterans themselves look at this deal–beyond the fact that Pulte bought $1.3 billion in cash, some actual number-to-be-named later in cost savings (i.e. nobody we spoke with believes there’s $250 million annually in overhead costs that can come out unless everyone at one of the companies is fired)–there’s some insight into what’s going on and what can be expected.
Here’s some topline notes from the “Ex-ers.” We’ve seeded out malice and speciousness, but left some of the spicier speculation in for audiences to decide on how credible the observation is.
* Centex CEO Tim Eller is said to have talked over the years with Bill Pulte and, more recently, with Richard Dugas about the cultural fit of the two companies on a regular basis. Most recently, in 2004, Mr. Eller was disappointed to learn that his company would never succeed in being the “acquirer” in a deal, and therefore, until now, he’s been unmotivated to pursue it.
* Both Pulte founder Bill Pulte and current CEO Richard Dugas have long coveted greater access to what they call Targeted Consumer Group 2 and 4, which is Pulte’s segmentation designations for entry-level buyers. Pulte himself retained ownership of a brand “American Homes,” which was one of the company’s acquisitions through the years, specifically to aim at entry-level consumers. More recently, Pulte was said to have been very close to doing a deal to acquire C.P. Morgan’s Carolinas operations to give it entree with the entry-level buyer. The Centex play is simply a more grandiose execution of a plan that’s been in place for years.
* The Centex acquisition gives them a possible brand line to make more successful inroads into more affordable single-family product. One issue there is that Pulte’s insistence on higher quality behind the wall could counteract unit profitability on more affordable Centex houses, and Pulte’s purchasing team won’t be able to go toe-to-toe with subs and manufacturers on unit prices and time cost studies, now that the more experienced talent has left the building, so to speak.
* The big question is the savings. The $250 million a year number is hard to fathom, given that you can take out division presidents, payroll, marketing and sales, and a lot of other corporate headquarters people who are redundant in the organizations. But with more than 950 active communities, Pulte will still need supers, sales people, and managers in the field dealing with issues like keeping bonds current, paying the insurance, dealing with special service area zoning and other issues that require constant updated vigilance.
* Pulte has recently restructured costs out of corporate around 200 of its communities in the last year, with some attention to KB Home’s lower cost production and management system. Dugas is said to feel he has an effective corporate-directed neighborhood restructuring model now, and it will probably use this template to go through rationalizing Centex’s 490-some communities.
* Centex–and Pulte too, for that matter–have many many unprofitable markets. In its heyday in 2005, a third of Pulte markets contributed more than 90% of the company’s profitablity. Now, between Pulte and Centex, fewer than double digit markets will be expected to be profitable over the next 12 months. This means the “return to profitability” mantra for Wall Street is sheer spin.
* As for whether this deal will precipitate others, a look at companies balance sheets rules out a number of possiblities–at least as acquirers. “Ex-er” speculation is that Lennar CEO Stuart Miller would probably be the most likely of the bunch to leverage Lennar’s balance sheet strength to do something. Word is Miller came this close to a done deal with Bob Toll in 2005/06, but Mr. Toll woke up the next day and said he’d changed his mind. A Lennar/KB Home combo is also a possiblity in the minds of many.
No doubt, we’ll keep talking to people, and a lot of those people will have been “there,” which is to say Pulte and/or Centex in the the recent past. What would you like to know from them?
Home Building’s Deal Gets Wall Street Talking
Pulte-Centex deal rocks stocks.
The New York Times reports:
Homebuilding stocks tacked on significant gains early Wednesday after Pulte Homes said it would buy Centex for about $1.3 billion in stock. Investors seemed encouraged to see that, despite a severe housing slump and wildly lurching markets, two major players in the home construction business could agree to a stock-based merger.
Shares of Lennar, which builds and sells mostly single-family homes, were up 9 percent in the first hour of trading.
Here’s CNBC home building and real estate analyst Diana Olick’s take on the deal.