From his vacation home amidst snow-covered pines in Telluride, Colo., Toll Brothers CEO Bob Toll reflected on 2006, saying it was "not bad." Toll Brothers increased its revenues 5.7 percent to $6.12 billion, though its closings fell 1.9 percent to 8,601 units, placing the Horsham, Pa.-based builder 14th on the 2006 Builder 100, the same spot it has occupied three years running.
"You can't hate the year when you make $687 million [net income]," Toll says. "On the other hand, that was off a backlog that to a large extent had been built in early 2005." Toll Brothers was able to generate better revenues despite fewer closings, in part because of a product mix made up of half move-up units along with another 35 percent split between luxury/custom homes and vacation homes. Only 5 percent of Toll's closings were entry-level, with active adult housing filling in the remaining 10 percent. Toll was not the only builder to enjoy a solid or even big year despite market conditions that many builders, analysts, and economists say are signs of impending doom and gloom.
On the closings side, The Enterprise Cos., a Chicago-based builder specializing in high-rise condominiums and townhouses, led all companies with a 138.7 percent increase, moving from 143 on the Next 100 list to 64 on the Builder 100. All 1,215 units closed by Enterprise were condos in Chicago. Ron Shipka Sr., the company's chairman, says that long lead times on highrises, often two years, means that the company's great numbers for 2006 closings were built off sales from2005 and 2004.
Still, 2006, "was absolutely terrific," Shipka says. "A lot of stars lined up on these projects for us. It worked out in terms of deliveries, in terms of production, and definitelyin terms of sales."
THE WAY IT WAS
The king of the Builder 100 hill also enjoyed a very good year measured in closings and revenue. For the sixth straight year, D.R. Horton checked in atop the list, closing 3.94 percent more homes in 2006 than in 2005, the company's second year as the only 50,000-unit builder. In addition, Horton saw its revenues improve 5 percent.
Though D.R. Horton remains the biggest home builder, Lennar made the most money ($16.267 billion in revenue). Lennar finished second in closings with a 17.02 percent increase, closing 38,477 singlefamily homes, 7,191 multifamily homes, and 3,900 condos.
Pulte, with closings down 9.08 percent and its revenue off 3 percent, fell from the second spot to the third. The company saw flat sales carrying over from 2005 through February 2006 when "all of a sudden, we saw a 25 percent speed bump in March," says Richard Dugas Jr., president and CEO.
"The first half to two-thirds of the year were marked by relatively good earnings and closings, with weak sign-ups," Dugas says. "Then the lack of sign-ups, starting in March, began to catch up with us in the fourth quarter."
Centex finished fourth, after seeing its revenues fall 2 percent year over year and its sales decline each quarter over the past year by about 25 percent, Centex chairman and CEO Tim Eller says.
"The cycle peaked in the summer of 2005, so we began to see our cancellations increase in the fall of 2005, and we began to see our sales decline in spring 2006," Eller says. To adjust to a slower market, Eller says Centex is undergoing the most dramatic change in his 33 years in the industry, slashing its staff from 8,000 at the beginning of 2006 to roughly 5,500 by the end of 2007.
"Unfortunately, it's a very simple math approach," Eller says. "Because we have fewer sales per neighborhood, we need less infrastructure."
Beazer Homes CEO Ian McCarthy sees 2006 as having been "reasonably strong." He says a good backlog from 2005 sustained the company, though he notes that "sales started to really slow down in the second half." Beazer saw its closings fall 4.9 percent, allowing Hovnanian Enterprises to overtake it for the sixth spot on the Builder 100.
DOING WELL
Beazer took the opportunity in a slowing sales environment to refocus its operations, pulling out of Lafayette and Fort Wayne, Ind., due to the "suffering economy in the Midwest." The company also left suburban Memphis, Tenn., though it still has a small project in downtown Memphis, McCarthy says. Beazer instead committed to the Florida Panhandle, where it struck a deal to buy lots in a longterm commitment with The St. Joe Co., which exited the home building business in 2006. Beazer also expanded into Albuquerque, N.M.
Beazer had a good year in several markets like many diversified Builder 100 companies which, though they were exposed to more down-turning markets, also had presence in areas that did not fall off as much or at all. Beazer did well in Atlanta, Nashville, Tenn., Dallas, Houston, and Charleston, S.C., McCarthy says.
With Nissan Motor Corp. moving its North American headquarters to Nashville, Beazer wasn't the only builder to enjoy success there. The Drees Co.'s move-up offerings in the $360,000 range were "a perfect fit," for Nissan employees, says David Drees, president of Drees, which ranks 29th on the 2006 Builder 100.
North and South Carolina were relatively strong markets in 2006, as well, Drees says. Pulte's Dugas agrees, noting, "The Coastal Southeast had a very good year."
In a year that saw formerly hot markets such as California, Washington, D.C., Las Vegas, and Phoenix struggle, Texas may have fared the best out of any large market. From San Antonio, Austin, Dallas, and Houston, builders did big business in the Lone Star State.
"Texas is probably the one that has actually not really suffered," McCarthy says.
BIG GAINS IN MIDWEST
A builder didn't have to be big or regionally diversified to have a big year, as The Enterprise Cos. proved in Chicago. The company cannot rely solely on its one market for future success, so it is expanding into Palm Springs, Calif., where it is building single-family homes and townhomes in two projects, Shipka says. Sales on those units are going well, and he is expecting good closings from the expansion in 2007.
Another local builder, Fischer Homes, a Cincinnati-area builder, jumped 12 spots from 73 to 61 on the Builder 100. Fischer's closings improved 13.91 percent to 1,310, while its revenue increased 15 percent.
Fischer, which built a new design center and completely computerized its entire operation three years ago-moving from a company reliant on paper and mail delivery to one that conducts all its transactions electronically-now sees the cost efficiencies that come with improved technology. The company evaluated how much purchase orders cost before the new system and came up with about $12 per order, from the time the p.o. was written up until it was paid. Fischer creates about 35,000 purchase orders a month. With the computerized system, the lifecycle of a purchase order from start to finish costs a dollar or less per order, says company president Bob Hawksley.
Fischer plans to continue expanding in the Cincinnati area, where Hawksley says the market is strong for entry-level product. "We think there's a very good market for that, if you can keep the price down," he says. Entry-level makes up 32 percent of the company's product mix, with move-up at 67 percent, and luxury/custom 1 percent.
But the news in 2006 was not all positive for Fischer. The company made headlines in May when five of its supervisors were indicted in an illegal immigrant worker sting, though a federal judge later dismissed all charges against them.
Fischer took steps to have all its subcontractors recertify their workers to guard against further immigration problems and ended up cutting ties with several of them, Hawksley says. Fischer also instituted new policies allowing customers, subcontractors, and company staff to report questionable practices by the company or its subcontractors to Fischer's ethics officer who has been empowered to investigate the charges in an attempt to stem any future problems, Hawksley adds.
MARKET HEADS SOUTH
The 2004-2005 super-heated housing market, fueled by low mortgage rates and good job growth, pulled credit-risky would-be homeowners and investors chasing quick gains into a housing feeding frenzy that included regular home buyers looking to cash out the equity they had built in their existing homes. As new-home prices continued to spiral upwards in 2005 and 2006, mortgage rates rose, and housing affordability sank to lows not seen since the 1980s, says Frank Nothaft, chief economist for Freddie Mac.
To spur flagging demand (new home sales fell from 1.283 million in 2005 to 1.060 million in 2006), builders cut prices and offered big incentives. But the ever-falling, newhome prices spooked buyers who didn't want to buy into a neighborhood where values often decreased weekly, says Lance Ramella, senior managing director for Hanley Wood Market Intelligence, a sister division of BUILDER.
The housing downturn was unprecedented in that it was accompanied by otherwise good macroeconomic conditions, such as job growth of 2.2 million in 2006, according to the Economic Policy Institute. John Burns, president of John Burns Real Estate Consulting, puts the timing of the housing downturn on the Federal Reserve Board. Starting in January 2001, looking to avoid economic turbulence in the face of increasing unemployment, the Fed began decreasing the Federal Funds Rate from 6.5 percent to 1 percent by June 2003, kicking off the housing boom, Burns says.
"The Fed essentially delayed our downturn four or five years by dropping rates," Burns notes.
But until builders saw palpable signs of the downturn in the spring or summer of 2006 (depending on the market), most builders were still following 2005's game plan for growth, which would leave them in a tough spot for 2007.
"We were blowin' and goin'-we were trying to expand by increasing our number of communities and land under contract," Drees says.
Many companies were still going great guns (buying land, developing communities, and building more and more houses) until they finally saw visible signs of market distress. Consequently, once things turned, they were stuck with a lot of land bought at peak prices.
In the fourth quarter of 2006 alone, the top 10 builders reduced the number of lots they owned and controlled by 26 percent from their peak holdings, which occurred between the third quarter of 2005 and the first quarter of 2006, according to Margaret Whelan, managing director for home building and building products at UBS.
SITUATION CRITICAL
At the crux of the current housing downturn is low affordability, fueled by price run-ups over the last several years (from a new-home median price of $195,000 in 2003 to $245,000 in 2006) along with increasing mortgage rates, both fixed and adjustable.
"Most of the major markets in the U.S. have affordability challenges because of the run up in home prices over the last five years," Centex's Eller says.
Reed Porter, president and CEO of Phoenix-area builder Trend Homes, saw entry level home buyers priced out of even the most basic homes over the last two years. As sales lagged in 2006, Trend offered incentives, from a free pool to other free options, but buyers didn't bite, because they still couldn't afford the price, Porter says. So, in 2006, Trend cut home prices an average of $50,000-and on some models as much as $100,000. That required reworking house plans to scale back on features, as well as renegotiating with subcontractors and suppliers, Porter says.
Trend, which fell from 75 to 85 on the Builder 100, saw its closings drop from 1,108 to 926 in 2006. But with several projects delayed from last year, Trend is looking for business to pick up in 2007, and affordable, entry-level product is a big part of its plans.
"We needed to bring the price of the homes back to where our profiled buyer could afford them," Porter explains. "There's still a demand for that entry-level housing, if it's priced appropriately."
Astoria Homes, a Las Vegas-only builder, saw its closings fall 40 percent, and its Builder 100 ranking decline from 80 to 113, dropping it into the Next 100. Astoria president Tom McCormick saw first-time buyers priced out of the Las Vegas market during price run-ups over the last several years and move-up buyers wanting more house than the entry-level models being sold at move-up prices. Astoria decided to go in another direction. Instead of building more entry-level homes, Astoria is opening a luxury-home division. He doesn't expect any luxury closings before 2008, but McCormick is hoping his strategy helps carve out a niche for his company alongside the big home builders in Las Vegas.
TROUBLED WATERS AHEAD
Though Ft. Worth, Texas-based home building giant D.R. Horton predicts it will again top 50,000 closings in 2007, company CEO Don Tomnitz conceded during the Citigroup Industrial Manufacturing Conference in New York on March 7 that such a goal is "going to be really tough to achieve."
Credit Suisse analyst Ivy Zelman projects the company will see "a 25 percent-plus decline in closings" in 2007, which would drop D.R. Horton back to just over 40,000 closings.
Pulte's Dugas also foresees selling and closing fewer homes and generating less revenue in 2007 than it did last year. How much less, he's not sure, but "it won't be insignificant."
During the Citigroup conference, Tomnitz let slip his thoughts on 2007. In a moment of unguarded honesty, Tomnitz said, "I don't want to be too sophisticated here, but '07 is going to suck, all 12 months of the calendar year."
The moment after Tomnitz offered his outlook for 2007, it was plastered on plasma screens across New York, from hotel elevators to Wall Street offices, fueling all-day television news programs. The Dow Jones Industrial average, which rallied the day before, closed March 7 down 15.14 points or 0.12 percent in the wake of Tomnitz's projections.
The proclamation marked a sharp contrast to Tomnitz's previously stated views on how his company would fare in even the worst of markets. During a 2004 earnings conference call, Tomnitz boasted that the only thing that could keep D.R. Horton's earnings flat, much less force a decrease, was "the great depression."
Clearly, things have changed. The year ahead offers challenges to all segments of the home building industry, from mortgage bankers to subcontractors, suppliers, and builders of all shapes and sizes. Issues range from tightening mortgage standards that could keep some potential buyers out of the market, to a further flood of inventory that could come by way of bank foreclosures and sales by investors. And builders will have to cut costs in order to sell homes at prices buyers are willing to pay, all while maintaining margins. The year ahead promises to be challenging for even the mightiest builder.