Deep Local Scale: It's What Our 'Local Leaders' Is All About

This article originally appeared on our sister site, BUILDER.

The strategic and competitive advantage of deep local scale--that is, the ability to leverage geographical marketshare primacy to better home builder profit margins--really began to come clear as D.R. Horton pounced on a fast-recovering Atlanta market in 2014 and 2016, buying two of the three biggest private operators there.

Today, Horton commands very nearly 18% of the nation's third most-active home building market, where top-10 home builders build one out of every two new homes. Of course, the granddaddy of leveraging the virtues and benefits of local market concentration is, and has been, NVR, which sells and builds almost 30% of the homes in the No. 7-ranked Washington/Arlington/Alexandria quad-state market.

Nowhere is it clearer than our own 2018 Local Leaders ranking of home building's 50 most-active markets in the United States, the importance of market penetration, not only for profits today, but for the ability to stay alive and prosper tomorrow. Our Local Leaders franchise showcases the top 10 builders in those top 50 markets by 2017 volume, where concentration and local scale are already playing out in profitability, business model strategy, and mergers and acquisitions jockeying for footprint adjustment, leverage, and advantage for the coming several years, and leading into what many believe will be a cyclical downturn in the next two to four years.

Our Local Leaders illuminates just how concentrated the new-home construction space has become. In the top 50 markets by volume, top 10 home builders' share ranges from an expected low of 28.8% in the No. 10-ranked New York-Northern New Jersey-Long Island, NY-NJ-PA market, to a high of 91.1% in the 35th-ranked Cape Coral/Fort Myers, Fla. market.

Deep local scale played a huge role as motivator in home building's two most recent public-to-public merger and acquisitions plays, last week's purchase of AV Homes by Taylor Morrison at a total deal value of $963 million, and the gi-normous Lennar $9.3 billion combination with then-No. 5-ranked CalAtlantic to create the No. 1 builder by volume.

Still, it was Horton that essentially woke everybody up to the post-Great Recession edge a builder can get by dominating market penetration, and now, as navigating the go-forward land investment marketplace becomes a trickier, more perilous pathway ahead beyond the next 24 to 36 months, its importance has risen another notch or three in intensity.

Deep local scale--which, in America's top home building markets means both higher absolute volume of permits, starts, completions, and deliveries, and a higher share of the total market's volume--confers opportunity on both the front-end, the middle construction phase, and the final return on invested equity for the builder who possesses it. Dominant builders in America's 50 leading home building markets build and deliver a minimum of 300 or so homes (Durham/Chapel Hill, N.C.), up to a maximum of upwards of 5,000 homes in the No. 1 home building market, Dallas.

The thing about deep local scale, however, is that while the strategy can and does pay off, it only does so--in a big way--when execution lives up to performance expectations.

NVR, for instance, makes little to no money on the appreciation in value of land, but remains a best-of-breed operator in driving speed, efficiency, pre-assembly, and operational excellence into the vertical development and construction phase of its business. D.R. Horton's operational excellence model marries superior sales discipline with nearly flawless construction where their "flags" fly, often matching rental and existing home refugees with a home of their dreams already awaiting them. Lennar's relatively new-found digital marketing juggernaut zeroes in on "moments of engagement" with prospects and funnels them through to homes they want faster, reducing the "carry" on the lot, as well as construction cycle time, thanks to its Everything's Included floorplan and model streamlining.

And NVR's "asset-light" model--controlling and taking down lots on an as-needed basis rather than owning, nurturing, and reaping profitable income from vertical development of a pipeline of lots--is directionally where many builders are heading, especially as housing and economic uncertainty hangs over the 2020 horizon. A "pure-play" builder's operations, investment, and business model maps more resiliently across housing cycle ups and downs when lots and land can be secured as needed but at highly favorable rates, rather than owned outright.

The post-Recession industry-wide reduction--unintended, but necessary--in force of America's skilled construction labor force accentuated the need for and benefits of deep local scale. Forward visibility, consistency, and geography allows trade subcontractors a critical factor in their own viability and ability to prosper--predictability. So, builders who have more work on a smoothed-out, consistent basis, with reliable schedules, dependable payment terms, and strong models of right-the-first-time quality and efficiency will tend to get preferential dibs on local labor crews.

As oil and gas prices go up as a consequence of the energy sector recovery and the end of the worldwide glut in oil, local scale takes on even more meaning and significance for builders trying to manage margins on their operations. Sourcing and procurement--and shipping to job sites--are a big opportunity area that comes with the turf when a builder enjoys market clout. It's worth mentioning, too, that both construction supervisors and community sales and marketing VPs also benefit from deep local scale, as the "windshield time" it takes to drive from jobsite to jobsite becomes more efficient and less wasteful, the greater the market share and concentration.

While efficiencies, access to labor, cost containment on purchasing, and cost reduction in the construction process are certainly opportunity areas at the direct costs level for home builders, the biggest rewards of a successful deep local scale strategy come at the real estate and corporate GS&A level for big, concentrated builders.

As the housing market moves into a period where the main guessing game changes--as it very likely will over the next few years--from "what inning of the recovery are we in?" to "when will the downturn begin?" followed by "when will be the moment to catch the falling knife?"--the benefit of deep local scale, as NVR proved through the last recession and emerging from it, being able to control lot take-downs and being able to manage the cost on them due to the clout they exert in a market, is a resilient, less-impairment-prone strategy that investors would prefer.

This is why we've seen a strategic move to massive alliances and alignments between builders and developers. It secures access to lots, but reduces the amount of time and cost they incur to the home builder's balance sheet and business.

Finally, and probably most importantly, deep local scale, ultimately allows a builder to close the distance in time, cost, and value lost between a home builder and its customer. Innovation's chances are better if local scale can be leveraged holistically--in land buying, investment, marketing, selling, construction, customer care and engagement, and closing--and the biggest, most sustainable strategic gain for home builders will be by reducing the time, money, materials, talent, and effort that home builders put in that doesn't convey and confer value to a firm's home buying prospect and customer.