By Isaac Heimbinder. Experts note that with the largest builders now approaching 30,000 units, it won't be long before public builders announce goals of delivering 50,000 homes.

However, a quick review of projections for housing makes it clear that growth by one housing producer will generally come at the expense of a competitor or to the benefit of a seller. The result? The competition is about to heat up.

Top of the stretch

The current decade is projected to be an excellent period for housing production. Growth in the industry will continue to occur in the largest metropolitan areas where large builders are increasing their market penetration by opening additional subdivisions and broadening product offerings.

However, expansion is just one aspect of builders' growth plans and can't by itself give these builders the growth rates they need. Nor can it accomplish the geographic diversity the stock market has applauded. Growth by acquiring other builders as well as by entering new markets is the more dramatic way for larger builders to bulk up their unit count and geographic mix. So the big guys are doing the only thing they can: gobbling up smaller entities.

But adding a new builder to a market (or becoming bigger within a market) does not increase market demand; it simply divides market share.

Photo: Simone Tieber

Consider these housing statistics: The NAHB projects housing demand in the current decade, excluding manufactured housing units, to be approximately 15.5 million new housing units. While this is an exceptionally good number, the activity--when compared with the average of the last five years of the '90s--demonstrates that housing, in stock market parlance, will not be a growth industry. In fact, housing actually appears to be pretty close to a zero sum game for participants. Unit increases by one industry participant generally will mean a loss of units by another.

Wagering favorites

To better understand the growth trends, take a look at the players: At the end of 2001, 16 of the 25 largest builders in the United States were publicly traded home builders. Three others in the top 25 were subsidiaries of publicly traded companies. Eight of the top 10 builders, all of which are public, acquired one or more home builders in 2001, and there have been additional announcements this year. Though there will always be a top 25 list of home builders, it appears certain that a number of the bottom 15 companies listed will disappear regularly, and the top 10 will continue to jockey for position up the list.

It's pretty clear why this is happening: The stock market in the last few years has rewarded larger capitalized public home builders with higher earnings multiples than smaller market capitalized public builders.

This phenomenon alone has been reason enough for the larger public builders to consider getting even larger--sooner rather than later.

The differential developed from the desire of mutual funds and other investors to place their investments principally in companies with the greatest market liquidity. The stock market, in addition, has recently accorded increased earnings multiple differentials to the larger public builders because of the sustained strength of the housing market and the belief that the earnings and growth rates of this group of builders will continue.

This vote of confidence has provided an even greater impetus for public builders to grow, using stock to pay for at least a portion of the purchase price, and gain even greater market attention.

Control of the stretch

Questions regarding which builders will be acquired next abound. A number of scenarios exist:

The most visible targets for acquisition will be public companies that are smaller, whose shareholders may be interested in increasing their stock market value by being acquired. Next will be the larger private companies whose ownership has an interest in being acquired.

Smaller companies, even if well run, might not be as high on the list for acquisition because larger acquisitions produce bigger unit and revenue increases and are more easily integrated. However, smaller builders might be attractive in situations where a larger builder, who is already in the same market, is looking to increase market share quickly and needs to control additional land positions to grow, or if no larger builder is available or reasonably priced.

Custom home builders or builders building in small housing markets, even if they are the largest builder in their market, will most likely not be targets in the current consolidation trend.

Even the No. 1 builders in small markets who build fewer than 100 homes in a market that produces under 2,000 homes a year, will in all likelihood not be an acquisition target for a larger home builder. One caveat relates to builders who are in markets near an area where a larger builder is presently building (for example, the cities up and down the east and west coasts of Florida or the cities comprising the bedroom communities of Southern and Northern California).

Win the mile

The good news for local builders comes when a large builder acquires another builder, absorbing the existing business without expanding it. The bad news for the same group comes when a big builder chooses to expand internally to get growth, creating a much more competitive market for resources.

The hunt for big acquisitions to satisfy the need for growth by the bigger builders will in fact get more difficult each year in order to add enough additional housing units to maintain the growth momentum percentage rates established in the previous years.

Though selling to another builder has not often been an option for a home builder, the next few years will continue to be an active time in the restructuring of the housing industry and could provide a unique period for smaller builders to create matchless value for their business. The choices may not be all that bad.

Isaac Heimbinder is a Houston-based housing consultant and former co-CEO of U.S Home.