For America's 1,000 big home builder companies, it's been two years of rough going and it will continue to be that way–partly, because many of the things top managers believed they had to be good at don't count a lick when the supply and demand equation gets turned inside out. Home builder sentiment indices from the National Association of Home Builders/Wells Fargo Housing Market index showed a hope in the first part of the year, only to be tasered in March by subprime-itis. Builder optimism flashed hope again mid-year, but then as mortgage defaults metastasized into the farthest reaches of the anatomy of global finance. Still, at least two sources of consolation have been able to gut it out amid these ailing times. For one of them, though, you probably have to be old enough to truly appreciate it. It's that–in spite of how arrested development may be right now and for the near future–the disruption, pain, and paralysis are only temporary. Housing's correction will run its course as corrections do. Once new- and existing-home prices fall sufficiently, inventory descends to manageable levels, and starts fall back into lockstep with population and economic drivers, newly normalized demand will make home building a good business once again.
But if you haven't been a veteran of home building for at least 12–5 years, you might easily mistake the 2006 to 2009 slowdown for Armageddon. Actually, the decade ahead–fueled by the leading edge surge of Generation Y young adults into the ranks of homeownership, the transition of the Baby Boom cohort across into its third stage of being, and continued international immigration trends–makes this marke place feel like a momentary negative blip amid a host of positive fundamentals. As MDC Holding's CEO Larry Mizel has been widely quoted in saying, "The best strategy for a downturn is to survive."
So comfort certainly can come from knowing that "this too shall pass." Another reason for big builders of all ages to take heart right now is this: If you can re-size operations, take down costs, and–at least temporarily–redo your pro forma and feasibilities so divisions that were closing on 10 homes a week at peak pricing two years ago can downshift to six a week, re-price to market, and still make money for the next year or two, then there's reason enough to believe in one's viability. There are $100 billion big builder homes to sell and deliver out there, and there's $26 billion worth of materials and products to be bought from suppliers even as home sales hit their lowest ebb during the next 12 months.
Hot Buttons
Now that's a big "if," but judging from the hopes, convictions, and expectations collectively voiced by home building executive respondents to the Hanley Wood 2007 Big Builder Study, there's a pervasive willingness to reckon fully with a deeply changed business environment, and a broad re-prioritization of both strategic and operational agendas. Just 24 months ago, for instance, the business issue of most concern among those who completed our Big Builder survey was customer satisfaction. Considering the fact that there seemed to be an endless stream of customers for too few new homes, it would make sense, then, that the highest priority would be to calm down the teeming horde of demand.
Today however, the "housing market recovery" is the issue of most concern by a long shot. Customer satisfaction still ranks No. 2 on a list of hot-button issues, but in an environment where demand quite suddenly became a shadow of itself, and home buyers were all at once far overmatched by the number of homes in the already-started pipeline, business conditions, and not customers, ranked highest as the "keeps me up at night" matter at hand.
All in all, 664 company executive respondents' answers to questions about where their business, its processes, and practices would head as 2007 finally comes to a close and 2008 begins reflect what you'd expect: caution and measured optimism, depending on where you set the horizon. Immediately, companies admit to expecting less to do, fewer homes to build, more prices to squeeze lower, and more time to eliminate from the cycle.
So the "size matters" debate among volume home builders turns from the question "Is bigger better?" to the conclusion "Less is more." The ensuing challenge is in how to shrink to one's most-essential core comfort level and try as wisely as possible to bring cash generation and expenses into a livable equilibrium, and may be pay back some borrowed money along the way.
Divisions that pegged themselves to crank out 500 to 1,000 home deliveries annually now face a reality check of viability. Can they do 300 homes a year at price points that are 10–25 percent lower than they might have fetched at 2006 pricing.
Without a doubt, the overbuilding errors of home builders from 2004 to 2006 are now recycling back through the housing economy as overcorrection penance to pay until the months' supply of new- and existing-homes for sale does more than a momentary seasonal genuflection. Perhaps optimistically, the abrupt elimination of investors and unqualified buyers from the demand equation has resulted in an oversupply of at least a million new-homes, at least half of which have been built by big builders.
Hit Reset
So, with an overcompensated lower demand level for new homes in the 1.1 million units a year range, demand–after correcting for how overbuilding has supplied the national market with a million extra homes over the past three years–would be somewhere in the 700,000 or 800,000 range. Our bet is that big builders will do half of that number, and that as has been the case of every housing downturn on record, the largest builders will surface from the turmoil and struggle with an even more dominating share of the new-home marketplace. Right now, while the vaunted slash-and-burn discount programs and land impairment charges of the public builders are grabbing the headlines, three out of four in our 664-person respondent base say that it's become a strategic linchpin to "re-price to the market" to try to crack the code of slow absorptions.
As the word "growth" gets exorcised from enterprise home builders' vernacular at least for the present, so too does that most-fun of big-time home builder disciplines, land acquisition, fall out of favor as prosperity strategies shift into survival tactics. A leaner, meaner home builder must undergo an almost total personality change to tolerate the fierce head winds. Instead of funding growth via the largesse of appreciating lot values, builders instead need to sandbag whatever turf is not going to contribute to hard cash generation and concentrate fully on squeezing costs out of their home building operations–starting yesterday. They literally have to come up with new ways to do what they do, so "value engineering" has emerged as an anchor strategy, especially as tighter, more expensive credit up and down the financial food chain means cash harvesting hits both the revenue generation and expense lines of every profit and loss statement.
The data shows that our respondent set plans to operate in 7 percent fewer communities in 2008, four out of five companies are implementing sales and marketing process improvements, and seven in 10 are working through construction process improvements. Instead of modeling an ongoing business around order-taking and fulfillment of quarter-of-a-million-plus dollar commodities, production home builders have had to remake themselves in short order to become smarter, faster, more efficient, and more relationship-driven organizations. Transactions made for big bonuses in the boom days of yore, but relationships will make for a company's ongoing viability through the spare months. Those relationships need to occur not only with prospective home buyers who'll need more hand-holding and maintenance than ever, but also with lenders and vendors whose interests and fortunes intersect with home builders' through good times and bad. Consolidation's forces seemed two years ago to impel production builders toward greater headquarter control of the costs side of the business, as the revenue side–sales–was left largely out in the field.
Market conditions' 180-degree turn has dialed back on some of those inexorable forces. Enterprise builders' headquarters are ferociously trying to get their arms around what it will take to sell more, market by market, so market intelligence and sales programs are gravitating toward the home office. Meanwhile, they're tending to leave more construction and operational issues up to their field generals, in hopes they might find tactical ways to get costs lower while volumes are slower.
Change for change's sake will find currency in such an environment for the year ahead. Strategies look more like tactical maneuvers, and quick-hit solutions look pretty good on all accounts as selling down the overhang becomes everybody's business.
