Mid-Summer Notes for High Production Home Builders
Double-take du jour came with this morning’s first cup of cafe. An analysis from Citi home building and building materials sector analyst Josh Levin on “private homebuilder perspectives” reports that three out of five home builders in his monthly survey say June sales were either flat with May or up.
This note will graze across three themes that have cropped up and will recur here during the summer months: 1) limbo, 2) cash, and 3) demand.
Conclude what you may about the 40% of executives surveyed by Citi who say sales worsened, this albeit early reading tells us that the destabilizing impact of The Great Expiration of April 30 may have been overstated. And why not, if it generates higher TV news ratings and a few more newsstand sales of newspapers? Being right for an instant and then wrong forever doesn’t seem to carry the clout with the press that it once did.
So, let’s look first at limbo. Fact is, if 40% of folks in the field of Josh Levin’s universe say sales didn’t get worse and 20% say they got better, we believe it’s fair to look at June as month number one in a series that already has gone some distance to dispel home builders’ worst fears–instead of a brand new cliff-dive, it’s a stabilizing, bounce-along-the-bottom month that no one could be ecstatic over, but by the same token, people can’t be too unnerved by either.
May unnerved because with the April 30 tax credit sunset came fresh flashbacks to second-derivative deterioration and a free-fall mentality that tapped into broader depressives like the Eurozone meltdown and the Gulf oil tragedy. June began to restore calm and resolve because, when you worked out the math of the tax credit demand stimulus, the numbers rightly added up to a necessary correction period of a few months.
What remains is spec to sell, incentive codes to crack, the down-and-dirty of shutting out all the noise of ideological economic psychobabble crossfire in favor of identifying, reaching, and meeting the need of “my buyer.”
In a 300,000-to-400,000 seasonally-adjusted new-home sales environment, the macro term “home buyers” is one thing: death. The CEO of a public home building company told us this with certainty: “There are enough of our buyers; we’re going to either succeed or fail on whether we get our buyers, who are out there even today.”
Surviving limbo is about your buyer. Your buyer will either lean toward continuing to rent, or toward a resale/distressed sale or not. He, she, or they, will have not just skin but flesh and bone to put in the game–see “Cash” segment below–and wants mostly to accomplish one goal with the purchase: Not to be taken for an idiot.
If you can make your buyer feel smart, you survive limbo. Operationally, of course, that means being very smart with the materials and services you pay for, which delivers your buyer more value for less. Broadly, shifting from the “funny money” to the “real money” era also means shifting from “something for nothing” expectations to a “more for less” mentality.
Private home building companies survive another day or go away based on whether they close on one or two homes regularly, vs. lots of homes across a longer time span. Public home building companies have created a lot of pre-recovery buzz in the past 14 months with cash down on finished lots wherever they operate, especially California.
That impulsive lot grab phase is done now, and things are going to work differently for a while. Plotlines that will grab headlines but wind up being less important in any real sense are comps with 2009 and mid-term elections in November. Remember, comps in September and October this year will be to year-earlier figures those months that lit up the charts in anticipation of the first home buyer tax credit deadline last November 30th. Again, the math of what got pulled forward last Fall versus baby steps toward a new-normal this September through November shouldn’t come as a shock to anyone, particularly with the kind of balance sheet work that occurred two years ago.
Strategically, what will go on will look a fair amount less dramatic than the testosterone-laced deal flow that characterized this past phase, which has now checked up. What occurred is that D.R. Horton, Meritage, M.D.C., Lennar, Toll Brothers, and to a lesser extent the other public companies availed of a generous moment in the debt markets and a generous windfall in tax-carry back refunds to build themselves a runway into the next upward run of housing’s sine curve.
Writing checks for lots at a dramatic discount to what one would have paid for them five years ago is all good. Now comes the interesting part, which is to see how what they all paid plays in the market. Each public builder, based on its overheads and leverage level has a bogie of an absorption rate to break even. Best of class is NVR, followed by Toll Brothers, who have to build and sell around one home per community per month to break even. Most of the other more competitive publics are clustered around an absorption rate of two-plus homes per community per month. The ones with the heaviest debt burden and highest SG&A need the highest rate of inventory turns to break even. Guess who: Hovnanian and Beazer.
Cash. Simply, cash is what separates those who can do something from those who have to wait. Waiting today may be tantamount to waiting for the grim reaper. Cash, cunning, and credibility are today what credit was yesterday. For a while, and probably a long while, cash will not only be king, but every other position of power and influence in the realm as well. With few exceptions–where cunning and credibility can stand in for hard cash for fleeting moments–cash at its present level, and the ability to generate more of it in the next 12 will shape the big builder landscape of 2012.
An X Factor under the heading of cash can cause some drama in the next few months, especially if public company share prices keep taking a beating. Call it idle cash, or cash that will expire and go back where it came from if it doesn’t get used. There’s a fair amount of that around right now, and insiders sense it could tip balances here or there in the next few months.
An example: Orleans Homebuilders’ assets might have been well on their way to becoming NVR’s but for the “idle cash” factor. Hedge funds, namely Strategic Value Partners heading up a trio that also includes Bank of America-Merrill Lynch and Anchorage Capital, bought up enough Orleans debt to take control of the company, and the hedge funds are willing parties to a restructuring plan that’s said to be gaining favor with the company’s Delaware-based bankruptcy court judge.
Strategic Value Partners is among hedge fund players, like MatlinPatterson, John Paulson, and Angelo, Gordon whose cash might work to significant effect in the next 12 months, before recovery solidly takes hold. We could see hedge funds buying up the debt of any number of public or private home builders and go so far as to precipitate combinations of some of them based on the prospective need for land assets once a rebound becomes manifest.
For private home builders, cash is what is already in their pockets or in the pockets of those with whom they enjoy a great deal of credibility. As Josh Levin’s note mentions, “the vast majority of survey participants reported that acquiring AC&D financing from banks remains difficult if not impossible to source.”
There are a few private builders around who can stomach “difficult” and are also cunning enough to take it on. Some, like WB Homes’ Bill Bonenberger, figured out a pretty solid runway for a private company to 2012 or so. He divvied up a land parcel with Richmond American, put the M.D.C. money toward what he owed his bank on the land deal, and thereby came back into within covenants to draw on vertical construction financing with other lenders. How many “wins” can you put in a row on that one, not to mention the bank’s not setting there with another REO deal to try to offload for a song?
For others, braving “difficult” is standing firm on personal guarantees, which banks have extracted mercilessly from longtime builder customers for the past few years.
Which is why cash–having it and having a way to generate it–is not optional as part of your runway to 2012.
Finally, demand. It’s amazing to us how blurred supply and demand have become. That’s nowhere clearer than in the fact that the number of jobs the economy’s shed since 2007 and the number of homes in the shadow inventory pipeline of delinquency is roughly the same, around 7.3 or 7.4 million.
Job losses and residential investment are inversely tied to one another, the economy’s dirty little chicken and egg. What the American Reinvestment and Recovery Act home buyer tax credit stimulus did accomplish was that it reduced months’ supply of existing and new homes by several months, almost down to what would be regarded as normal levels. The programs catalyzed enough sales to bring more scarcity to the market than an unstimulated environment.
Now, with industrial activity picking back up, and the global economy readjusting around who’ll buy and who’ll sell what, all the while continuing to create entire new populations of consumer classes, the biggest near-term question is this: what are the new family-supporting jobs in America, and how can this country get people in sufficient numbers to where those jobs crop up? Bureau of Labor Statistics forecasts for the next decade call for the US Economy to create 15 million new jobs, doubling the amount that it took out in since the downturn.
The biggest question is when that decade of job growth gets underway, and how many of those jobs are family supporting jobs. It’s those higher-paid workers who’ll funnel into the real demand universe of your buyer in the years ahead.
This is why home builders, if they do nothing else while recovery is still around the corner and over a bridge, need to learn as much as humanly possible about who your buyer is today. If you don’t, you risk no buyer tomorrow. That would wreck your runway.
2010 is that one more year to eke out, and 2011 will be a year you can get some of it back. But not if you don’t learn who your buyer is today.
Home Building CFO Pay By The Numbers
Even as public home building companies loosen their purse strings to invest in land they hope will turn into tomorrow’s cash flow, most of them are still cutting costs to their operations and overheads.
Where strategy focuses as much on cash preservation as it does on driving topline sales and revenue growth, the honcho who wields both the axe and the gift bag tends to be the chief financial officer.
CFOs as a group performed heroics in doing their part to retrieve a collective $2.3 billion in tax benefits traced to net operating losses in 2009.
Here’s a chart from SNL Financial that maps out how each builder did in its most recent financial reporting period:
Courtesy of SNL Financial
In 2010, a big issue for public home builders will be retaining the services of talents who provide credibility and integrity behind fairly complex financial performance reporting. Trust is in short supply at the nexus of Wall Street and Main Street, and a good CFO is often the only thing between keeping the trains running and total chaos.
Still, most CFOs compensation in 2009 reflected red ink performance of their respective mother ships, with few bonuses (in cash, especially), and stock and option awards blistered by the performance of stock prices that have taken major hits.
Still, in all, they’re not doing too badly. All in all, CFOs across our 9-company universe earned an average of $1.9 million in total compensation, versus $2.6 million in 2008, a plummet of about 26%
Base pay in most cases, held at 2007 and 2008 levels, with D.R. Horton CFO Bill Wheat’s $250,000 representing the low, and Joel Rassman at Toll Brothers the high at $1 million.
Consistent with the fact that its CEO Paul Saville ranked lowest in his peer group, NVR principal financial officer Dennis Seremet had the most modest total comp package of the pack.
Here’s the way they rank (note: we only have nine due to the fact that other public company proxy statements with information on the compensation of their named executives are still forthcoming).
Click twice on the table for a larger view.
Source: Big Builder analysis of company proxies.
Public Home Building CEO Pay — Comp and Circumstance
Compensation committees of public company industry sectors in the cross hairs of the economic crisis–housing being one of them–had their work cut out for them in 2009.
Home building company comp panels were no exception. With all but two of the companies in the sector losing money last year–NVR and M.D.C. Holdings recorded profits–what score card could be used to fairly and appropriately pay chief executives for the job they’re doing?
The “tally sheets” for chief executives among home building enterprises continued last year’s trend, for the most part, of greater emphasis on pay for individual vs. company performance. Comp committees needed to tread a fine line on CEO packages: 1) they needed to reality check them against a broader backdrop of industry decline and shareholder disillusionment; 2) they needed to reward leaders for steadying the course for the previous year; and 3) they needed to “incentivize” chief strategists to do what’s needed to position his company and stakeholders for recovery in the months ahead.
Few companies met earnings criteria to trigger targeted or maximum incentives; but in most cases, individual hurdles that recognized CEO’s capacity to improve balance sheets, retain talent, stabilize operations, and set the tone for recovery were eclipsed.
By and large, our sampling of 10 home building company company executive packages (some of the companies’ proxies post later in the year due to varying fiscal year dates), saw total comp down by 26% versus the same metric last year.
It should be noted that totals in many cases factor in stock and options awards whose face value may be at risk depending on stock price performance during the respective vesting periods, ranging in most cases from three to five years.
Bonuses, per se, were scarce, as only one–well deserving, we may add–CEO got a cash bonus to bring his lowest-of-class base pay up a bit. Interestingly, Paul Saville, CEO of the world-beating NVR, came in with the lowest total comp package, which may explain how NVR stays profitable no matter what.
“Negative discretion” was a term that came up more than once in comp committee comments. In these cases, a CEO either fully or partially validated an incentive or bonus, but, given the broader conditions and micro company performance, had his extra cash either axed or reexpressed in future payouts.
The comp committee goals for 2010 focus increasingly on business unit profitability benchmarks torward restoring total corporate earnings and shareholder return on equity.
Here’s the ranking for 2009 among the 10 home building chieftains whose proxies have posted so far (notes on each individual’s performance follow the chart). . We’ve included three company data points to show the respective peformance on cash generation, debt reduction, and return on beginning year equity from a change in basis points from 2008 to 2009:
Source: Big Builder analysis of company proxy data
Here are some “notes” we compiled regarding each CEO’s tally sheet guidelines:
Ian McCarthy, Beazer
• Base salary freeze, … no base salary increase since 2005… remain frozen in 2010
• Incentive compensation, “2006 Bonus Plan” invoked for Merrill & Khoury, but not Ian, altho Comp Committee lauded “McCarthy’s leadership and decisive action, during an extraordinarily tough business environment”
• $4.6 million stock & option comp at risk, tied to stock performance
• McCarthy elected not to receive equity-based longterm incentive
• 2010… balance sheet improvement & economic profit account
Ian Cockwell, Brookfield
• Brookfield pegs lower-than-peers base salary, and less difference between Cockwell comp and his management team
• Key performance: generated net cash from operating activity of $137 million, acquired 3,200 lots, completed entitlements for 1061 lots, completed $250 million equity rights offering and ended year with net debt to cap ratio of 42% vs 71% at dec 31, 2008
• Awarded 1 million options, Feb. 2, 2009 with a grant date fair value of $1.6 million… Options vest at 20% per year over a five year period.
Don Tomnitz, D.R. Horton
• Performance noted includes top of class market cap, leadership in home closings, cash flow generation of $1.1 billion in 09, reduction of $471 million in debt, and reduction of $269 million in SG&A expense
• Due for a big bump in 2010 base salary from $300,00 to $900,000, first salary increase since 2001
• $2.3 million in non-equity annual incentive based on meeting partial pre-tax income and full operating cash flow and SG&A containment hurdles
• SG&A was tier one – 14.5%… “negative discretion” tempered bonus from possible $4 million to $2 million
• For long term comp… Tomnitz gets “performance units” based on stock price, return on investment, and net sales gains percentage relative to peer group performance…
Ara Hovnanian, Hovnanian Enterprises
• Potential bonus – pegged to net debt amount component – limited to less than 50% of fiscal 2008 bonus…Ara met criterium for max $699,500 bonus, based on HOV net debt being $1.8 billion or less.
• 750,000 stock option grant, representing 10% increase in grant date fair value from stock option award in 2008 ($1,380,000 vs. $1,256,250)
• $250k perqs in the “All Other”
• Pearl Meyer & Partners – comp analysts — $2,059,121 is total comp, less at-risk stock price performance based grants…
Jeffrey Mezger, KB Home
• Comp committee says of Mezger: “Unique and critical role in setting and directly overseeing the implementation of our overall operating strategy and significant related strategic initiatives, his broader responsibilities for driving our overall financial and operational performance, and his wide-ranging internal and external duties across all areas of our business.”
• Performance metrics: 09 pretax loss, excluding inventory impairments and other non-recurring items, of $67.2 million and 09 operating cash flow of $349.9 million. i.e. Maximum payout… Mezger’s $4 million reduced to $2,750,000.
• Rolled out Open Series, improved profit margins, maintained balance sheet strength and flexibility, positioned KB to achieve future growth.
• Stock and option awards are stock price performance based, $4.4 million.
Stuart Miller, Lennar
• Achievement metrics: reduced number of associates by more than 70%, reduced Company’s maximum recourse exposure related to indebtedness of unconsolidated JVs by more than 80%, changed product to reduce cost, accumulated more than $1.3 billion of cash.
• Stuart got 500,000 restricted stock awards, 25% of which were vested, worth $1.6 million in 2009 cash.
Larry Mizel, M.D.C. Holdings
• Missed on lofty Stockholders’ Equity Goal, but easily achieved performance goal, achieving a positive EBITDA for the fiscal year ending Dec. 31, 2009, netting a $2.5 million cash bonus and 60,000 shares of restricted common shares (with a grant date fair value of $1,996,800.
• Other performance-based metrics included: minimum operating revenues or sales of homes of $950 million, establishing a land options and/or purchase program with 3rd parties, net operating profit for HomeAmerican Mortgage Corp., and cumulative positive cash flow.
Paul Saville, NVR
• Froze his own base salary at 2006 level for third year running
• Sees “retention risk” as a possibility, so seeks new equity incentive plan
• Annual $400,000 bonus based 80% on consolidated pre-tax profit, and 20% on new orders (net of cancellations)… 50% of his base salary.
Larry Nicholson, Ryland
• Promotion from president to CEO worth $150,000 base salary raise
• Met annual bonus incentive program hurdle of $200 million or greater in net cash provided by operating activities in 2009, worth $1,500,000
• Received 116,482 shares of restricted stock at promotion, and 106,000 stock options at promotion
• Met long-term incentive goal relative to home builder peer group stock price performance.
Bob Toll, Toll Brothers
• Met condition for full “plan year individual performance” bonus at full $5.2 million amount—which was hitting greater than $1.2 billion in consolidated revenue for 2009—but comp committee nixed bonus in favor of long-term incentive compensation.
• Other performance notes: increase in net contracts during 2nd half 2009, maintenance of strong balance sheet, selection by Institutional Investor as top CEO in the home building industry
• Stay tuned for a Toll compensation recovery in 2010 and beyond.
Florida’s CDD Mess Gets Forbes’ Attention
A reader sent us a link to Forbes’ analysis of Florida’s Community Development District bond debacle.
It’s a must-read if you’re a bond investor. If you’re a real estate speculator, it’ll ping the salivary glands, but don’t get too excited. Getting at the actual dirt will be like trying to claw a home loan out of a CMBS.
Interesting that Forbes’ reporter Matthew Schifren should adapt structure, sources, and even phrases from a story we posted here in July, but with no attribution to that story.
For example, here’s a line we wrote in our July 11 post, “Ground Under Repair–Florida’s CDD Comeuppance:”
For more than a year, Tern Bay has been slogging through foreclosure proceedings, and the legal complexities are too numerous to go into. Now, multiply the Tern Bay case by say 120 or 130 times, with upwards of $2 billion in bond debt at risk, collateralizing land that may be worthless or at least far less than the face-value of the bonds outstanding.
Now, have a look at how the Forbes story moves from the Tern Bay example to its thesis on Florida’s CDD woes:
Multiply this scenario by 100 and you get a picture of recently issued community development bonds in Florida.
I guess Shifren liked what he read enough to borrow a fair amount of it.
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.
Some Stocks Hammered, Some Nailed
This from CNBC’s stock market reporter Bob Pisani.
Home builders this week:
- Standard Pacific down 23% [SPF 3.25
-0.05 (-1.52%)
]
- Hovnanian down 16% [HOV 4.61
- Masco down 10% [MAS 12.76
- Lennar down 10% [LEN 14.06
- Ryland down 10% [RYL 21.11
On the surface, the decline may not seem logical. The housing market seems to be stabilizing, with sales improving and inventory levels declining.
If shareholders can protect any gains they achieved during the summer rallies of these stocks, it’ll be a surprise. The real rally in home building stocks that will pre-date housing’s volume and price recovery, is still ahead.
Monday Housing Crisis at a Glance
The the topline focus for the week will be macroeconomic trends–including producer and consumer price indices, housing starts and building permits, and home builder sentiment from the NAHB home builder market index due Thursday.
Here’s JP Morgan housing sector analyst on the “Street” expectations for the various housing economy benchmarks due this week.
This week features the July NAHB Survey (Street: 16; Prior: 15) on Thursday, June Housing Starts (Street: 530K Prior: 532K), and Building Permits (Street: 523K; Prior: 518K) on Friday.
Here’s the sum-up of last week in the housing sector from Citi housing analyst Josh Levin.
Although there were no housing market data releases, and despite the fact that mortgage rates continued to drop, the homebuilding stocks sold off ~6.5% w-o-w versus the broader market’s ~1.9% decline w-o-w. Our sense is that the underperformance of the homebuilding space was less homebuilding/housing market specific and more a result of overall risk reduction in the market. We also note that trading volumes were on the light side. Our coverage universe now trades at ~1.0x current TBV. According to Bankrate.com, 30-year mortgage rates now stand at 5.29% versus the prior week’s 5.34%.
Speaking of loans, young professionals–doctors, lawyers, dentists opening up new practices–are being shut out of the risk-averse market for mortgages, reports The New York Times this past weekend.
The denials are occurring for a wide array of reasons: the buyers’ incomes are adequate but irregular; they are self-employed and take many deductions, reducing the taxable income on which lenders focus; their credit scores are below the cut-off point, which has been raised drastically; their down payments are less than 20 percent.
Housing usually leads the country into a recession, which certainly happened this time, and also leads it out — which will not happen in 2010, the real estate industry contends, without stronger efforts to thaw the market.
The piece goes on to note that Congress is considering not one, not two, but three separate proposals to extend, expand, and increase the $8,000 tax credit available to first-time home buyers through Dec. 1, 2009. The existence of these proposals is the occasion for Housing Crisis’s sound bite of the week, spoken by one of the housing industry’s beloved analysts Ivy Zelman.
Some economists, noting that tax incentives helped stoke the boom, say these proposals should be shunned. “When do you decide enough is enough?” said the housing consultant Ivy Zelman. “I don’t want to feed the drug addict with more drugs.”
Zelman is not known as one who minces words, and she’s never eaten her own either. Lest she lose sleep over whether Capitol Hill policy should make the addict go Cold Turkey or try a Methadone plan, another observer, Yale economist Robert Shiller, offers a 40k-foot perspective that should calm agitated nerves a bit over what to do.
Housing markets are very inefficient – and that is why it takes several years for prices to fall to a market clearing price. Even if the rate of price declines has slowed, there will probably be a long tail of real price declines in many areas.
“My more probable scenario is languishing of the housing market for years.”
Robert Shiller
Beneath the glare of the macroeconomic and “Animal Spirits” surface–although not too far–the festering Chinese dry wall story is quickly oozing into public scrutiny in a big way. The Wall Street Journal reports this a.m.
Lennar Corp. has identified 400 homes in Florida that have confirmed problems with defective Chinese drywall, and it has set aside $39.8 million to repair the homes, the Miami-based home builder said in a securities filing Friday.
The figures are as of May 31, Lennar said.
Complaints about odors and corrosion linked to defective drywall have been increasing for months.
The U.S. Consumer Product Safety Commission said in a letter to four U.S. Senators last week that it has received more than 600 complaints related to the drywall issue from 21 states and the District of Columbia. Most of the reports are from Florida, Louisiana and Virginia.
Housing, clearly, has become a perilous occupation, not just on the job site, but in the office, the field, the bank, and the planning board.
That’s a mid-July Monday morning for you.
A Case for Dr. Shiller
Big Builder senior online editor Bill Gloede previews tomorrow’s monthly release of the S&P/Case-Shiller index. But Gloede does so in inimitable and unexpected fashion.
In a fit of apparently propitious timing, MacroMarkets, LLC, the developer and seller of structured financial products co-founded by Dr. Robert Shiller, on Tuesday will introduce its new MacroShares Major Metro Housing Shares to trading on the New York Stock Exchange.
Why propitious? Well, in California at least, it looks like prices are starting to firm up and even rise. The early second-quarter view from Lennar and KB Home earnings ;last week also seems to indicate better news, or at least market movement, ahead.
The new housing shares will trade under the symbols UMM, for housing market up, and DMM, for housing market down. The shares will track the S&P/Case Shiller Composite 10 home price index, a value-weighted average of the 10 original Case-Shiller metro area indices, which include Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington.
Dr. Shiller’s aim is to generate liquidity and stability around residential real estate, outcomes he says will occur if there’s a natural futures market for it.
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?