Builder 100 Over The Years

After the record-setting highs and equally historic lows of the last 36 months, builders must take away one lesson: The housing market is still cyclical. Despite the quotable stylings of D.R. Horton CEO Don Tomnitz and others during the peak of the housing boom, averring that the nation’s large public builders were recession-proof, they proved not to be.

The large public companies, it was argued by the builders as well as by some industry experts and observers, had expanded their product lines to hit more corners of the ­market, and had broadened their reach through geographic expansion into new and different types of markets, making them impervious to fluctuations in local markets and in the greater economy.

But a quick look at this year’s Builder 100 numbers clearly demonstrates that builders both large and small, and public and private alike, remain subject to industry and economic cycles. Nobody is bigger than the cycle.

The Builder 100 struggled through what everyone is euphemistically calling a “difficult” year, with sales down 23.96 percent nationally. That sales were off was predictable, and that Builder 100 companies also saw a slowdown was no surprise. But Builder 100 companies saw a greater drop in closings (28.16 percent) than the overall market, with the Next 100 (down 32.60 percent) and the 10 largest builders (down 28.50 percent) feeling the biggest losses in closings year-over-year.

In the last housing downturn, which hit its nadir in 1991, Builder 100 companies saw their revenues shrink from $34.2 billion in 1989, to $30.7 billion in 1990, to a low of $24.2 billion in 1991. But the 21.17 percent decrease in total Builder 100 revenue from 1990 to 1991 pales in comparison to the 34.99 percent revenue ­decline the Builder 100 felt between 2006–2007. (Up to 1990, Builder calculated the Builder 100 based on housing starts, not ­closings. There is no way to tell how large of a closings decrease the Builder 100 saw at its last trough.)

Overall, the housing market saw new-home starts shrink 14.92 percent from 1.193 million in 1990 to 1.015 million units in 1991. In the ­current recession, total new-home starts shrank 24.74 percent from 1.80 million in 2006 to 1.35 million in 2007, according to the NAHB.

As Builder celebrates its 30th birthday, it’s time for some historical perspective on the Builder 100, ­using Builder 100 data and the evolving philosophies of some Builder 100 regulars.

Land Gluttons

Big builders that had seen multiple housing cycles ebb and flow knew to be more cautious buying land during the recent boom. David Weekley, chairman of Houston-based David Weekley Homes, saw builders with large land positions go ­belly-up during the 1980s in Texas and pushed his company to go slower this time. (See “Last Word,” page 192, for more on Weekley.)

But not everyone took a judicious approach to land acquisition. Builders of all sizes were promoting their long land positions in 2005 and 2006 as major positives, thinking that land would only continue to increase in value, and that they were smart to lock in as much as they could at ­whatever price they could get before it got even more expensive. It turned out they were buying at the crest of the wave. The land they acquired was worth less than they paid for it almost instantly.

The fact that builders bought too much land for too much money is not the reason for the downturn. In most cases, though, land is the root cause of builders’ most pressing financial problems. The costs associated with buying, developing, and holding on to land are enormous, and the amount ­borrowed for it and still owed is preventing the builders from being able to borrow more money to keep their companies afloat.

Research by Zelman & Associates (see “Public Builder Land Holdings,” left, and online at www.builder online.com/B100) illustrates the astronomical 2,284 percent increase in lots controlled by 12 public builders between 1990 (90,614 lots) and 2005 (2.16 ­million). The subsequent wholesale disposal of oversupply is shown by the 57.2 percent decrease in lots ­controlled from 2005 to 2008, when the same builders entered the year holding 923,149 lots.

Years’ supply of land among the 12 big builders has gone down over the last year as builders let go of options and sold off owned lots to try and cut costs. Despite all of the land that has changed hands, though, the calculated years’ supply of land at the current rate of sales has not dropped nearly as much as the total count of lots controlled because home sales have decreased considerably. The median years’ supply of land in 2005 among the 12 builders was 7.1 years; in 2008 it was 6.5.

Buy or Option?

Many builders and home building consultants are now talking up the benefit of optioning land and limiting the risk associated with buying it outright, because so many builders holding large positions of owned land are struggling to unload it and are giving much of it back to their creditors.

Reston, Va.–based NVR options 100 percent of its land. ­Hovnanian Enterprises of Red Bank, N.J., ranks next with the second-highest percentage of land optioned among the 12 builders studied by Zelman & Associates in 2005, with a total of 74 percent of its 116,083 lots optioned. Lennar Corp. of Miami, has optioned 63 percent or more of its land ­holdings since 2003, according to Zelman.

You can count Centex, of Dallas, as another of the builders favoring options to major land purchases, says CEO Tim Eller. According to Zelman’s research, in 2005 Centex ­optioned 63 percent of its land (186,893 lots optioned versus 108,828 lots owned). And it intends to keep going down that path.

“Typically, during this stage of the cycle, we can tie up a lot of land through options, and that’s what we’re looking to do now,” Eller says. “There are so many lots available that we’ll be able to tie up a lot of property with options and won’t have to invest that much in owned positions.”

That is likely to be the most popular strategy for dealing with land in coming years, though current data on the percentage of land owned versus optioned is thrown off because so many builders released options held on land parcels over the last year. That causes their percentage of owned land to look artificially high right now, says Mark Zandi, chief economist for Moody’s Economy.com.

“It’s a matter of which is the best way to get my balance sheet back in order,” Zandi says of current builder thinking about land.

But there is a contrarian play that might succeed, and for good reason, Zandi says.

“It’s going to be a relative evaluation, but if everyone’s thinking the same way, then options are going to cost a lot relative to land acquisitions,” he says.

Counter Play

One builder holding that contrarian mindset is Pulte Homes, based in Bloomfield Hills, Mich. Pulte had 52 percent of its lots optioned in 2005, but began 2008 with just 14 percent optioned, according to ­Zelman’s research. Pulte has moved to offload its land to cut costs over the last two years, reducing options held from 188,800 lots to 19,950, but only cutting its owned land count from 173,800 lots to 120,888 over the same period.

“If you get rid of all your land, you don’t have the ability to earn on it,” says Pulte CEO Richard Dugas. “If you hold your land, and you have the financial strength to hold it, and you rightsize the value of it, like we have through the write-off process, you can still benefit from that land.”

Dugas says Pulte has too much land today and that the market slowdown is to blame. But Dugas believes Pulte has the financial strength to hold the land it chooses to and will benefit later.

“We are not looking to sell our valuable land at 10 or 20 cents on the dollar, which is the asking price from these vulture funds that want to take advantage of opportunities,” he says. “Any piece of land we walk away from through a preac-­quisition write-off of those option lots, are those we can never recapture any value from unless we buy them back in the future. The land we write down in value is still there. And we still have the ability to get value for that when the market improves.”

Chief economist Mark Fleming of Santa Ana, Calif.–based First American CoreLogic backs the strategy of holding land.

“It is possible to identify those land parcels that, while maybe there’s volatility around the market value, you can be pretty certain about the long-term value,” Fleming says. “To own and to go after owning more land at this juncture requires taking some risk and charting into the ­unknown, but it can be done.”

A company has to have financial backing to be able to hold onto land and wait for the market to come back, but very few companies have that luxury. The real lesson to be learned on land is the lesson Weekley learned in Texas in the 1980s, not to overextend your land purchases, Ara Hovnanian, CEO of Hovnanian ­Enterprises, based in Red Bank, N.J, still contends.

“Whether it’s deposits or price or quantity of land, it’s a time to be cautious,” he says. “It was a difficult call to make at that time, because the housing industry seemed so immune to what would normally have caused a slowdown.”

Too Much, Too Fast

It seemed everyone believed the market had outgrown its cyclical nature and would only keep going up.

As the market took off, the combined revenues of the top 10 Builder 100 companies shot up from $21.6 billion in 1998, to $92.9 billion in 2005 (see breakdown by company in “Top 10 Builders’ Revenue,” left). As the overall market for homes increased, America’s largest builders grew to accommodate the demand. The same top 10 builders increased their share of the overall new-home market (see “Top 10 Builders’ Market Share,” left) from 9.40 percent (of 941,000 units) in 1998 to 20.97 ­percent (of 1.38 million units) in 2005. Their market share increased again in 2006 to 25.70 percent.

But how did those companies grow, and did that growth leave them weakened with massive debt accumulated through many acquisitions, asks Gopal Ahluwalia, staff vice president of research for the NAHB, Economics Group?

“Those who did organic [growth], they chose a better way to grow,” Ahluwalia says. “But if I have ­money, I can grow overnight.”

And so they did. But as the market for new homes began cooling in 2005, builders fought to keep activity heated, getting more into the mortgage and financing side of the business, and “that exacerbated their current problems,” Zandi says.

In a scenario similar to what ­happened to technology companies, which were infused with huge amounts of investor cash during the dot-com boom of the 1990s, home builders had to show growth to appease Wall Street analysts, and buying other companies accomplished that in the quickest amount of time. Many of the acquired companies were in the ­hottest markets in the country. The builders thought it was a sure thing since land and home values in those areas kept going up.

And they were wrong.

“There were lots of arguments that this [market] is different and reasons why, demographics and so forth and so on, but obviously that wasn’t the case,” Zandi says. “There was a thinking that because the industry was becoming increasingly dominated by publicly traded builders, that they would, in theory, be more disciplined than the smaller private builders that came before them; that we wouldn’t have these big swings in activity up and down. But that certainly did not hold true.”