Infill Home Building Goes to the Back Burner
D.R. Horton made sweeping changes in its strategy recently, ones we look at for insight into how other home builders behave at this juncture in housing’s boom and bust cycle.
On both coasts, Horton divisions that focused on multifamily for-sale residences got orders to sell or opt out of their land positions and wind down. The company was “going back to its roots in entry level, single family homes… They’re getting out of the condo business,” an executive who’s familiar with Horton’s recent action plan tells us.
It was just about this time of year in 2006 that Horton’s management leaders affirmed that urban infill , multilevel, podium- and midrise style homes were a big part–a double-digit share–of the company’s future. And Horton had company in its embrace of the “inner rings” of urban areas as a rapidly emerging market for the nation’s biggest builders–the leadership at Pulte, then-Centex, Lennar, KB Home, and Hovnanian each asserted that closer-in urban home building would represent between 10% and 20% of their operations by 2010 or 2012.
This is where the market was headed, they said. Younger buyers prefer to be nearer their downtown jobs, and empty-nest Baby Boomers would downsize in droves out of the exurbs into cultural hubs for their “next phase” of being Boomers.
That was theory circa 2005-06.
That’s history now. Housing’s 2002 to 2006 boom came and went without teaching most greenfield single family home builders skills they needed to know about differences in capital management, the land and city politics game, nor construction operations to succeed with an inner-ring push.
Put it this way, $35 per square foot in direct costs may be fact for some home builders today or it may be malarkey. But it’s the standard of the moment in terms of an operating efficiency that has had to match new homes with foreclosure sales, and is going to have to continue to do that.
That means the cost per square foot metrics for urban building are a dog that won’t hunt in today’s market.
Horton, like the other publics save Beazer and Hovnanian, has amassed a cash war chest. Dry powder to pounce on opportunity or to have on hand for more rainy days.
Here are a couple of factors that could burn through those war chests in no time:
- Another year of less-than-three-absorptions-per-community-per-month operations; this is entirely possible thanks to a predictably huge ongoing wave of foreclosures and a rough double-digit unemployment rate picture;
- The onset of new costs of capital–as lenders have to set aside more capital for their risky investments, they in turn are going to require home builders to secure their borrowed money with more liquidity as well… this may take a chunk out of some of those war chests.
- Home building’s equivalent of the cash-for-clunkers program is the taxation measure under consideration that would allow them to carry current losses back beyond 36 months to a new limit of 60 months. In effect, home builders could swap out land they paid too much for but is worth very little for a tax credit that would allow them to buy new, cheaper land. If this measure fails to clear Congress–and in this environment, with all the politicking going on around health care, energy, and financial regulation, who knows?–home builders won’t get that cash-for-clunkers bump they may need as a cushion for another tough year on the sales front.
All of this means Horton and the other home builders are now under the gun on several levels.
- All their land needs to be rationalized. It must be capable of being sold for either cash purposes, or for profit.
- Their operations need speed at every turn to drive toward better margins.
- The must do what they know, and in turn, they have to sacrifice doing what they know they’ll need to do to meet the next market.
It’s an awkward time where a balance sheet strategy gets more emphasis than an operating long-term strategy. Horton knows this only too well. They know the inner-ring plan was the right one for the future. They, and almost all the other home builders who tried it with the exception maybe of Toll Brothers, didn’t have the capital runway to learn that business.
It’s going to hurt them down the road.
Home Builders Seek Housing’s Hole in the Donut
Survey says home building executives’ confidence level is inching ever so slowly upward. From horrid in January, we’ve reached tepid now. After horrid and tepid can only come torrid, but that’s still unaccounted for in the present cycle.
Clearly, economics academics are preoccupied with algorithms and the alphabet–namely the letters ”V” or “W”. Capitol Hill is obsessed with gaining grandstands for 2010 reelection bids amid debate over decisions on healthcare, energy, and financial system oversight that will bear directly not only on the welfare of our grandparents but our grandchildren.
Everybody’s polarized by impulse, ready to tussle with anybody about anything, sometimes merely for the sport of the fight. Meanwhile, home building start-ups, reduxes, subtle shoots, resurrections, and regroupings command an ever greater degree of our attention. In some cases, what appeared lifeless is showing a pulse; in others, the DNA traces to vitality that was only in hibernation, like sleeping giants.
In the past fortnight alone, you’ve seen reports here:
- KB Home will restart its operations in the D.C. metro market;
- NVR is moving on the beleagured Florida market;
- Emaar is regrouping from a near-death experience with a John Laing new co;
- Ex-TOUSA CEO Tony Mon and some ex-Beazerites have cranked up a go-vertical plan;
- Weekly, reports of imminent life after BK are filtering into the headlines;
- Builderonline.com has spotlighted startups in virtually every corner of the U.S. map.
What can be said, then, is that national and global economics will be what they are, and will continue to exert pressure on what bank lenders will do. What those economics won’t do, however, is stop irrepressible characters from striking at opportunity while the iron is hot, which is a moment precisely before pessimism swings to its inverse.
Here’s a closer look at one who’s been there, done that, got out, and come back, ready for another good run.
Click image to access Landon Homes Web site.
When things were really tough real estate in the 1980s, particularly in Texas, John Landon came out of Louisiana State University, Baton Rouge, with an accounting degree and a level of ignorance that set him on his road to glory.
“I was young and dumb in 1982, and they [Trammel Crow] put me in charge of lot sales–and I didn’t know any better that lots weren’t selling, so I just ran with it,” says Landon.
One-time Peoria, Ill., high school All-American swimmer John Landon knows all about going a few more laps. He left as co-CEO of Meritage Homes in May 2006, with the proverbial golden parachute: more than $60 million in severance and stock value to provide some, shall we say, oomph to his subsequent interests and efforts.
Well, he’s back in business in North Dallas’ Frisco School District with a guiding business premise that could not be simpler to think about and harder to do these days. “If we build the right product, at the right price, in the right location, we’ll do OK, even in this environment,” he says.
DEJA DO
For all of a cup of coffee, Landon thought of his post-Meritage stage as retirement, with some dabbling here and there with friends in the land banking business.
But in September 2008, as the world and its financial underpinnings seemed to come all undone, Landon jumped back in the pool for another set of laps. Lucky for him, a couple of key longtime associates like Mike Gavin plunged in with him.
“When things really started to go south on a national scale, we figured it was a pretty good time to get in, because there were entry points open to us,” says Landon. “The cost to build houses is way down-lumber, land, labor, and such-which means if you’re in a position to buy now, you’re going to get an exciting opportunity to get a lot of high quality at a very good price.”
PLUS çA CHANGE
For Landon, starting up when others are flattened out is a way to meet a need, something he learned as early as in high school, when he started his first enterprise, Crystal Clear, a swimming pool maintenance company.
Landon’s entrepreneurial DNA draws inspiration from his Irish-American dad, Lou Landon, who ran a meat-packing company near Peoria’s stock yards and had his boys working weekends and summers loading cattle onto the freight train flat cars.
Adversity, with a capital A, was literally the genesis of his first home building company, Legacy Homes, in 1987. Landon had been a vice president with Nash/Phillips Copus’ development company when it hit a wall as the late 1980s savings and loan crisis played out. Put in charge of lot sales, Landon wound up with some land and model homes, putting $60,000 of his own money into what he called Legacy Homes.
“We were profitable in five months,” says Landon; not bad for a recession. The current downturn is both deeper and longer, he adds, but there are similarities of note.
“If you go back, the similarity is there,” he says. “It’s like you’re in a card game, and the ones who are holding all the best cards [i.e., land holdings] get hit the hardest. Then the banks come in and take it all back and reshuffle. That takes the big advantage away from some of the ones who had it and re-levels the playing field in a way. That’s what makes for opportunity. The difference is that in the 1980s, the banks’ troubles were mostly confined to Texas, Arizona, California … it was more of a regional problem. This time it’s global.”
Landon’s “right product, right price, right location” conviction comes from a confidence that he can drive value into his offerings with strong controls on his operating costs. To date, Landon’s biggest investment is in, you guessed it, dirt.
“We can ultimately build out 1,000 lots, with 50 feet, 60s, 74s, and 84s,” says Landon, with flexibility for product offerings ranging from the $160s to the $300s, where the expansion of the Dallas North Tollway to Panther Creek should help drive demand for the rooftops.
Survey may say what survey may say. That doesn’t change home builder DNA.
Home Building’s 2Q: Heading to Fourth and Short
The bellwether boys–Lennar’s Stuart Miller and KB Home’s Jeff Mezger–have spoken.
The housing economy has diminished their respective companies’ businesses, their armies of associates, their empires of land holdings, etc. with the ferocity of the Judgment of Solomon. What’s not diminished a shred, though, is their will to win.
Each has spliced flickers of positives into an assessment of what’s been going on lately at their companies, and what the market looks like for the months ahead. Their measured statements echo what we hear far and wide, whether it’s from multi-regional publicly traded companies, or single-market privates. It kind of sounds like one of Mezger’s statements from his 2Q earnings call transcript:
On the brighter side, however, the existing home sales report released by the national association of realtors earlier this week confirms that the combination of historically low prices and low interest rates is having a positive impact and the new home sales data from the U.S. Census Bureau showed a sales pace that is stabilizing, albeit at low levels. Affordability is at an all-time high and inventory of available homes has trended much lower in many key markets despite the steady influx of foreclosures.
Clearly, when you talk about home builders’ will to win in this environment, it’s not head-in-the-clouds talk. They know what they’re competing with: Paralysis brought on by fear of buying before prices have bottomed on the one hand, and foreclosures on the other.
A monthly payment for a new home, and the total cost of homeownership that that monthly payment signifies, appeal to different values in a society that has in the past 24 months increased the likelihood that a home buyer will stay in his/her home for some years longer.
If we’re no longer looking at the four walls and rooftop of the owned home as an income-producing investment that will subsidize gain in ways beyond the household earners’ take-home pay, then a new home, with its warranties, its energy savings, etc. can start to measure up on a practicality scale. Not only against a foreclosure opportunity but vs. equivalent rentals.
In the weeks ahead, earnings and operational performance of a dozen other public companies will come to light. In each case, we expect to hear emphasis on:
- the balance sheet, and the ability to improve or sustain an impressive cash trove;
- a product push, with focus in most cases–save Toll Brothers–on affordability and speed of construction time;
- improved operational disciplines for margin opportunity;
- and, opportunistic land grabs that will yield quicker upsides vs. higher priced dirt in their current lot pipelines.
Knowing as little as they do about the specific quality of lot positions big home builders currently possess–it’s their secret sauce–Wall Street investors and partners can only react with an eye toward managing their fear of risk.
So performance will need to pan out as substantially better for confidence to build up around these stocks.
The united front–actually putting private enterprise home builders, the interests of invidual home buyers and prospects, and Capital Hill on the same team, for once–should be against the brute effect of foreclosures on communities, financially, emotionally, and physically.
No matter what anybody says about home builders having overbuilt–and they did in a finite number of markets in the seven or eight states (Arizona, California, D.C.-metro, Georgia, Florida, Nevada, and Texas)–new home builders are making themselves part of the economy’s way out of a hole.
You’re doing it every time you quicken the pulse of a prospective home buyer with one of your offerings that can actually get somebody out of the waiting game and into the market.
The bellwhether boys have spoken. Stay tuned in the weeks ahead as the rest of the crowd speaks up about where they are and where they’re headed.
Meanwhile, this is our last blast to you before our Independence Day holidays. We wish you and yours a safe, joyful, celebratory official start to Summer 2009. Please keep in mind and heart those men and women in the armed services and other community initiatives who work to safeguard our sacred, one-of-a-kind independence. Here’s to your undying will to win.
Which is Better, More Sales or Less Cancellations?
If you’re a home builder, what’s going to feel like better news? (And, oh boy, what just a little good news could do going into a weekend!)
You get to choose one or the other of the two options below:
- Higher (Commerce Department) unit sales, accompanied by higher cancellation rates?
- Or fewer orders with less cancellations? (With apologies to the grammar police).
Analysts preoccupy themselves with monthly Census and Commerce Department data. Said analysts don’t run a business in the trenches that depends on turning inventory or dies.
The Census and Commerce Departments, and most of home building’s analysts, watch orders for new homes as if they were in a vacuum. They count them one time when there’s an earnest money deposit on a home, and irrespective of whether they actually flow through to the closing table and get a deal, they stay counted.
That’s not how reality works for the builders.
They report their orders as a sale, but they dont get to book the full price as a sale until they deliver the deed over to the new owner after settlement. So Commerce may already have counted a home as a sale, but a builder can’t until the Fat Lady Sings. A builder may have to sell the same house not once, not twice, but given today’s tricky credit and appraisal environment, as many as three times to get to the tail lights on the transaction.
Which makes cancellation rates significant. Higher cancellation rates mean more orders but less done deals. This rubs two ways when it comes to a fits-and-starts housing market stabilization.
A lower total on the earnest money deposits can handily be offset–on a balance sheet–by a greatly reduced number of failed or derailed deals.
Here’s a comment from Raymond James Associates housing analyst Buck Horne, on KB Home’s 2nd quarter earnings performance:
Notably, KB Home’s cancellation rate improved to 20% in the first (should say “second”) quarter from, 28% in F1Q09 and 27% in the same period a year ago.
So, KB’s total orders for 2nd quarter fell year-on-year by 31%, but the company’s cancellation rate for the reporting period improved from 27% in 2Q 2008 to 20% in 2009.
Whether or not this data is read as downbeat or green shoots by analysts or the broader economy virtually doesn’t matter to executives who live, eat, sleep, and breathe home building.
What matters to them is that they’re doing what they need to do to make a living.
Here’s Buck Horne’s hybrid lift from the transcript from KB Home CEO Jeff Mezger’s market conditions sum-up:
CEO Jeffrey Mezger highlighted that the company is “beginning to see signs that some negative housing market trends may be moderating at both the local and national levels.” Furthermore, from management’s perspective, while it is premature to declare housing has reached the end of its severe recession, the conflicting signals it has seen could suggest the industry is “approaching a point of relative stability.”
Likewise, while not trying to betray an overly optimistic outlook, Lennar CEO Stuart Miller sprinkled positive statements among his cautious ones in talking about Lennar 2Q’s performance.
“Abject pessimism (from consumers) has given way to a sense that opportunities are available to those who qualify,” he said. “While there continue to be significant headwinds … there are some significant positive influences out there that are beginning to shape a more positive future.”
These two bellwether company CEOs know better than not to recognize another leg down isn’t entirely impossible. But they’re talking about substantive if nuanced signs of improvement.
Higher (Commerce Department) orders mean prospective buyers might be being spurred off the sidelines, but some fair number of them might not have the means to complete a home purchase.
Lower can rates mean motivated buyers and gettable credit.
When home builders can sell both the already-counted orders that fell through, and push new orders through to closing at a higher rate, they’re coming out ahead.
This is why new home inventory is headed with conviction in the right direction. Have a look at Calculated Risk’s chart and interpretation.
Click to access Calculated Risk post
There were 10.2 months of supply in May – significantly below the all time record of 12.4 months of supply set in January.
The seasonally adjusted estimate of new houses for sale at the end of May was 292,000. This represents a supply of 10.2 months at the current sales rate.
The final graph shows new home inventory.
Note that new home inventory does not include many condos (especially high rise condos), and areas with significant condo construction will have much higher inventory levels.
It appears the months-of-supply for inventory has peaked, and there is some chance that sales of new homes has bottomed for this cycle – but we won’t know for many months.
Getting inventory sold, and getting the inventory level to where it is the least cumbersome and the most flexible is the business of the home builders right now. The chasm is something they can look across if they can do this.
So which is it, higher orders per the Commerce Department or lower can rates?
Home Building’s Plot Thickens
Theory, circa 2006: Efficiently scaled home builders had enough elasticity in their systems to push their home prices down — and out ahead of — below the competing market. That would keep them in the business of sustainingtheir management, marketing, and home building infrastructures in well-oiled condition, turning inventory in a methodical manner, and generating cashflow on a virtuous time-released schedule.
Nice theory.
Circa Spring 2009, a third successive “Spring Selling Season” has turned into a third successive Hand Wringing Season. Even the best-scaled, balance sheet scrubbed public home builders are looking at every dollar in their cash till and gut-checking themselves as to whether that dollar has 2009′s name on it, or maybe 2010′s. Is that dollar “dry powder,” for opportunistic muscling for market dominance once the constipated land-transaction market finally gets moving again?
Or, just as likely, will that dollar need to try to attract other capital, get in the lengthening line of debt term renegotiation with nameless, faceless, and sometimes clueless lenders and bondholders who are beyond sweating over whether their risks have come to roost.
With KB Home’s bellwether earnings call a couple of weeks ago, the Los Angeles-based home builder’s CEO Jeff Mezger offered a ray of hope amid the brutal realism that prevails as to the difficult leg ahead. Eventually, one will finally stop saying, “It’s going to get worse before it gets better,” because despite the complex of negative feedback loops whirring us into more pain, it will finally be the worst it can get.
Second up in the bellwether home builder earnings call parade was Lennar CEO Stuart Miller. Recalling Stuart’s prognosis at this time of year since 2006, each time it was for continued deterioration in the market, with no signs of an end to the worsening. Now, at least, Mr. Miller, while not sanguine, is indicating that the bump-along-the-bottom period may be approaching.
The twist to the Circa 2006 theory above is that while the big home building companies are secularly a shadow of their former selves, they’re practically the only engine left in the barely pulsing new-home economy. They’ve morphed into quarter-sized versions of their 2006 heft, they’ve said to hell with methodical liquidation of inventory, and chewed off connections to immense land holdings like they’re coyote ugly one-night stands; they’ve scrapped and scrambled for sales; they’ve stormed Capitol Hill with bids to knock reason into the unreasoning, irrational political complex; they’ve excavated their balance sheets of huge wells of expense; and they’ve piled up cash reserves in hopes of being around for an Resolution Trust-like land reset goldrush.
Still, each percentage point of unemployment–coming as they do torturously on ladder-steps of months and quarters, and half-years–represents a new spread of distance between now and a recovery horizon.
We’re out on a limb, of course, but we believe we’re in the middle of the last non-starter spring selling season of the current cycle. Another tough eight month stretch and the rare rays of light that have sparked up the gloom will start adding up.
Meanwhile, we continue to be amazed at the fortitude, or maybe its just stubborn resolve of those who’ve stayed in the game with every trick in the Book of Housing Cycles. You must be in it more than for the money; it must be part of the DNA. Former U.S. Secretary of Housing and Urban Development Henry Cisneros, calls you “housers,” which is not a pretty word.
But what it means–he describes a young mother coming home to one of your homes with a newborn who’ll one day be going off to college–is why you continue to fight to be here.
That’s Fact, Circa 2009.
Ten Set for the Task of Survival
Here’s the Builder magazine Top 10 list of its annual intelligence franchise on the nation’s leading new residential construction organizations. Now, go have a look at how and why who’s here and who’s missing from the list by checking out “Revealed: The Top 10 Builders for 2008” on builderonline.com.
Top 10 Builders for 2008
|
Rank |
Company |
2008 closings |
% change |
2007 closings |
2007 ranking |
|
10. |
Meritage Homes Corp. |
5,627 |
-51 |
7,687 |
12 |
|
9. |
Beazer Homes USA |
6,642 |
-42 |
11,366 |
8 |
|
8. |
The Ryland Group |
7,352 |
-29 |
10,319 |
9 |
|
7. |
NVR |
10,741 |
-21 |
13,513 |
7 |
|
6. |
Hovnanian Enterprises |
11,281 |
-25 |
14,928 |
6 |
|
5. |
KB Home |
12, 438 |
-48 |
23,743 |
5 |
|
4. |
Lennar Corp. |
15,735 |
-53 |
33,283 |
2 |
|
3. |
Centex Corp. |
18,241 |
-41 |
30,684 |
3 |
|
2. |
Pulte Homes |
21,022 |
-24 |
27,540 |
4 |
|
1. |
D.R. Horton |
23,915 |
-37 |
37,717 |
1 |
|
|
Total |
132,994 |
-37 |
210,780 |
|
Credit: Builder magazine, Hanley Wood, parent company of Housingcrisis.com.
Here’s one of editor Boyce Thompson’s key take-away observations:
The top 10 worked overtime to generate cash flow and allay investor concerns that they could not meet debt obligations. Unlike many builders in the second tier of the Builder 100, the top 10 all managed to stay in business thanks to long-term debt financing. Even companies reporting the biggest losses stockpiled large cash reserves that they hope to one day deploy to fuel growth.
Publicly held home building companies have a capital structure that may give them an advantage through protracted difficult times, but their unwieldy, decentralized manufacturing, distribution, and marketing operations and their profligate real estate strategies could make casualties of one or two of the above during the next leg of the crisis.
Who’ll be on this list a year from now? We’d guess at least two other names, possibly one or more of them an M&A combo.
Bruce Karatz, Ex-KB Home CEO, Indicted
The Wall Street Journal reports:
Bruce Karatz, by the 2007 Numbers
WASHINGTON — Former KB Home Chief Executive Bruce Karatz was indicted Thursday on criminal charges that he engaged in a stock-options backdating scheme that allowed him and other executives to take in millions of dollars in undisclosed compensation.
Mr. Karatz was indicted in a Los Angeles federal court on 20 criminal counts, including mail fraud, wire fraud, securities fraud and making false statements in reports filed with the Securities and Exchange Commission.
Prosecutors allege Mr. Karatz caused KB Home to grant millions of backdated stock options that were pinned to a date when KB’s stock price was at a low point, without reporting the transaction.
Mr. Karatz made millions of dollars in misappropriated KB Home funds by exercising the options, prosecutors said. (more)
Fortune Still Shines on Some Home Builders
|
Most Admired
Contenders
|
Of course, it’s who this list leaves off that causes intrigue, even to the point of second-guessing our friends at Fortune’s methodology. Where are M.D.C. Holdings and Meritage, companies we admire more than some on these lists above?
KB 3rd-QTR Loss Is $144.7 Million
From BIG BULDER, this staff report: KB Home early Friday reported a net loss of $144.7 million, or $1.87 per diluted share, for its fiscal third quarter as revenues declined 56% to$668.3 million on a 51% decrease in homes delivered, to 2,788, and a 10% decrease in the average selling price, to $239,700. Analysts were expecting a loss of $1.22 per share. Read the complete article.