The housing industry's largest production home builders, rattled by how quickly buyer demand has eroded this year, have assumed a defensive posture that includes reducing overhead, renegotiating contracts with trade partners, slowing production, and all but halting land purchases. For many large builders, the current market decline has launched a waiting game, during which they hope to strengthen their balance sheets and amass cash in preparation for a rebound. This will happen, they say, only when consumers are convinced that home values and prices won't deteriorate further.
That was what executives from 14 builders—including 12 of America's 15 largest—told an audience of more than 500 investors during the Homebuilders' Symposium in New York Sept. 11–12, co-sponsored by Credit Suisse First Boston and Hanley Wood Market Intelligence (owned by PROSALES' parent company). Several builders said they've tried to hold the line on pricing and margins, even as margins have been diluted by incentives—such as lower mortgage interest rates—that ran rampant in many hot markets in their efforts to move unsold inventory.
The industry's sales in the second quarter sank 21%, and cancellation rates skyrocketed. Steve Scarborough, CEO of Standard Pacific Homes, the industry's 11th-largest builder, lamented that half of his company's cancellations were buyers who couldn't sell their own homes. In September, builder confidence hit its lowest level in 15 years, according to a survey conducted by the NAHB and Wells Fargo.
Every builder at the symposium singled out two culprits behind this downturn: excessive price hikes (often driven up by speculators) and profligate production. “This cycle is happening faster and going deeper than a lot of us thought it would,” said Tim Eller, CEO of Centex Homes, the industry's fourth-largest builder, which has been among the most aggressive in using incentives to entice buyers.
On the Defensive Many builders scaled back their construction for this year. D.R. Horton, the industry's largest builder, expects to close 50,000 homes this year, 8,000 fewer than earlier projections. WCI Communities will start only between one and three high-rise residential towers this year, down from its plan of 11 to 13. Most builders aren't expecting much relief next year, either. Beazer Homes, the industry's sixth-largest builder, projects that its starts in 2007 will recede to between 12,000 and 13,000 units, or 33% below this year's total.
With fewer homes going up, builders are reining in their operations. Most have trimmed their workforces by between 10% and 30%, and some anticipated another round of layoffs by year's end. Don Tomnitz, Horton's CEO, said his company identified $220 million in selling and general administrative expense cuts that he said were executed by Oct. 1 and included elimination of three regional COO positions. Beazer was looking to take $100 million in costs out of its operations, said its CFO, Jim O'Leary.
“We're shifting from offense to defense on almost every front,” said Bob Schottenstein, CEO of Columbus, Ohio–based M/I Homes, which serves markets that were among the hardest-hit by the current downturn. “We drank a lot of wine over the past five years, and now we're taking medicine for it.”
M/I had 1,000 fewer lots on June 30 than it did on March 30, and was like many builders that have reduced their land acquisition activities, have stopped buying land altogether, or are selling real estate. Most builders who spoke at the symposium want to mitigate their balance-sheet risks by controlling land more through options or by entering into joint ventures. And builders continue to walk away from option deals that no longer make economic sense. Builders also are re-evaluating land positions and usage in light of current demand; for example, 30% of the land being purchased by KB Home, the industry's fifth-largest builder, is for attached product, compared to 6% four or five years ago, says KB's COO Dom Cecere.
Juggling landholdings has proved to be easier than reducing inventories, even as those numbers came down a bit in the fall. Unsold existing homes declined in October from the previous month by 2.4% to 3.75 million units; and the supply of unsold new homes dropped to 6.4 months in September, from a near-record 7.2 months in July. Tom Lawler, a former Fannie Mae official and founder of Lawler Economics and Housing Consulting, noted during the symposium's luncheon that builders have been their own worst enemies by not shutting off their construction spigots: Housing completions in the first half of 2006 rose 7%, he pointed out.
While builders are still putting up houses they haven't sold, spec building has definitely subsided. Tomnitz said Horton imposed a moratorium on spec building two months before the symposium. Jim Zeumere, vice president of investor relations for Pulte Homes, the industry's second-largest builder, said specs accounted for 10% of Pulte's construction in the second quarter, compared to 25% to 30% historically. Stuart Miller, CEO of Lennar, the third-largest builder, said his company's goal is to be “inventory neutral,” so that it isn't building any more homes than it's selling.