September, 2007

Smackdown

As megabuilders tried to shake nickels and dimes out of the channel, independent production builders focused on real efficiencies.

By Greg Brooks

If there was any question that the bloom is off the megabuilder rose, the past two months answered it in spades.

One trade magazine called publicly held builders’ latest quarterly results nothing less than “apocalyptic.” The top five earned a combined $1.52 million in the same quarter of 2006; this time they lost $2.49 million. By July, public builders had lost $7 billion in land impairments and the bloodbath isn’t over yet.

BusinessWeek blamed megabuilders’ mortgage operations for helping to cause the crash in an August 13th story titled “Bonfire of the Builders,” a play on Tom Wolfe’s 1987 bestseller about Wall Street greed. BW says some were smack in the middle of the subprime mêlée, making risky loans, misleading borrowers, and rigging appraisals. Shady mortgage brokers are going belly-up faster than you can say, “Cayman Islands.” Megabuilders are standing tall—and holding the bag.

Speaking of Wall Street, July also saw venerable investment bank Bear Sterns declare two of its mortgage-backed hedge funds worthless, to the tune of $1.5 billion in losses. Oops. Bear’s CFO says the subprime meltdown is worse than the dot-com crash. And just as big a surprise, I’m sure.

Last but not least, NAHB is no longer predicting that the housing market will recover in the first half of 2008. Or recover in the second half, or in ’09 for that matter. The next boom is now scheduled for 2010.

So is there any good news out there? Actually there is, and here’s a hint: Don’t sell that wall panel plant if you can avoid it.

Almost exactly five years ago, Andersen Corporate Finance predicted that by 2010, the top 20 builders would capture 75% market share due to “superiority in land, capital, and operating costs.” Two out of three ain’t bad.

Megabuilders held an edge in land because of their access to equity capital. But operating efficiencies were a myth from start to finish. Megabuilders were more profitable than average simply because they were concentrated in bubble markets where they could build homes at the same square-foot cost and sell them for twice the price.

But while megabuilders were marshaling their resources to shake nickels and dimes out of the channel, a few independent production builders have been coordinating suppliers and subs to achieve dramatic reductions in cycle time and waste. Turnkey is sometimes part of the mix, but components always are.

Will Patience Pay?

The ability to build homes better, faster, and cheaper will come in handy in the next boom. The crash of 1979-82 occurred because mortgage rates spiked to 16%. That’s a software glitch; as soon as the Federal Reserve Board downloaded the patch, everyone was online again.

This time we’ve got a fried motherboard. For more than 30 years, the median price of an existing home—a first-time buyer’s entry point into the market—has hovered between 3.0 and 3.5 times median income. Now it’s 4.7 times income, a 47% increase.

To return to normal, one of three things has to happen:

1)         Wages rise 47%,

2)         Home prices drop 32%,

3)         Builders figure out how to lower their square-foot costs 32% and still make money.

Dealers who had put their heart, soul, and net worth into a component plant are hurting right now. But by 2010,

baby boomers will start retiring and the next generation will be ready to start buying. Green building, urban infill,

and aging in place will all be hot niches.

 But the hottest of all will be affordable housing, and you can’t get there with equity capital or mortgage scams.

The only way to do it is to build smarter, and that should make for a very healthy housing market.