Toll Brothers Re-Maps Itself to the New Geography of Affluence

Beginning, middle, or end, every home builder’s story comes down to one four-letter word: lots. Many plot the challenge to get a lot—or a few, or many—to build on. The rest tell of two things that predictably occur when builders get lots: they either laugh and celebrate or cry and curse. If a home builder is capable of sliding down the scale of a home site’s cost base from, say, 33 percent of a new home’s sticker price to 25 percent, it’s cause to celebrate—especially when prices exceed seven figures.

Toll Brothers got sucked into the vortex of housing’s worst recession in memory just like every other company in the new-home development, production, and sales business. Remember? McMansions were dead. Toll couldn’t escape the carnage, but it’s not the company that went into housing’s darkest days we’re looking at here.

Seemingly overnight, Toll Brothers transformed itself into a national multithreat power, with a complement of suburban, closer-in, and urban options for six-figure earners and stock portfolio types. Part of its plotline pivots into the first hint that the company could secure 5,200 primo lots by writing a single check. Before that inflection point last April, a pre-narrative centers on new ventures, joint ventures—some of them boldly urban and some drawing off new business models, almost as if Toll were trying on a new, more world-class identity for size. Toll’s urban, for-rent, and student housing projects each reflect a self-disruptive gambit that either will succeed in expanding its core of luxury housing offerings or be a costly life-lesson about projects it should leave for others.

Stars of Tolls’ signature of proficiency, discipline, and preparation appear to align, for now, to a tee with exogenous global investment flow toward yield. “Haves”—that portion of home buyers whom sellers would call “clients” rather than “prospects”—surged back into residential real estate on the heels of institutional investors who’d mopped up more distress than anyone had predicted, setting a floor upon which housing prices would build.

Toll flashed Jolly Roger opportunism across a landscape of broken or teetering deals, snatching lots as razor-thin as a pair of adjacent townhouses on New York’s Upper East Side and as expansive as 3,700 pristine acres in the Sienna Plantation south of Houston.

“When you’re hot, you’re hot,” says Bob Toll, who serves as chairman of Toll Brothers’ board and as a hands-on adviser in every land deal that hits the corporate land committee. “You fight hard, and you’re diligent when the waters are muddy, and when the waters start clearing up, you start to get to thinking that you’re pretty smart, and when you’re doing well, you feel very good about your expansions.”

Fact is, nobody at Toll could have imagined that what they were doing in 2011 and 2012 would prompt the phone call that came in April a year ago, with news that Shapell’s 5,200 entitled home sites were on the block, and that Toll had earned an inside track.

Lots, in this case, sparked an instinct to celebrate.

Alert Mode

“Cartwheels. We did cartwheels when I hung up.”

This is behavior typical of a Fortune 500–bound enterprise’s then-53-year-old impeccably appointed chief executive and his then-56-year-old president and chief operating officer of a work-a-day afternoon at headquarters.

Doug Yearley—a month or two shy of three years’ tenure at Toll Brothers’ helm—had picked up the telephone call that will no doubt seal his reputation for all Toll time as the man who reeled in California. Yearley’s right-hand man, a 34-year Toll Brothers veteran Richard Hartman, would be first to testify to the importance of Toll’s doubling its presence in a state whose economy out-GDPs all but eight countries. He was there in 1982, when Toll added central New Jersey to its footprint, the company’s first strategic expansion beyond Philadelphia’s near environs.

Still, this call was an invitation to a party—a fight-to-the-death, high-stakes poker game, the prize for which were residential assets and operations of Shapell Industries, a 60-year-old, Toll Brothers “mini-me” empire in Northern and Southern California. High-fives and chest bumps lasted all of a heartbeat. Then, reality set in, recalls Yearley. “We went into alert mode.”

Alert mode would consume a bicoastal S.W.A.T. team for the better part of seven months with discovery, analysis, relationship building, community-by-community modeling, and preparations for capital raising. It would cost well into the seven figures for research, formal filings, etc., and it would expose Toll Brothers to an infinitesimal shadow of doubt that it could triumph in the bidding for a portfolio many insiders and outsiders simply assumed was the company’s almost-familial birthright.

Nathan Shapell—who with his brother, David, and brother-in-law, Max Weber, had survived Nazi death camps Auschwitz and Birkenau and started his California empire-building in the mid-1950s—was widely rumored to have said, “If I ever sell this company, it would be to Toll.” But that never happened in Nathan’s lifetime, and even after he died in 2007 at the age of 85, leaving the company in the hands of his brother and brother-in-law and his heirs, Shapell never indicated any interest in selling anything to anybody, let alone the company’s entire residential operation. But the “If I ever sell …” rumor persisted.

In the minds of the Toll brain trust, they simply couldn’t lose. But winning was no guarantee.

A handful of very well-capitalized, motivated, strategically congruent, and operationally able home building and financial companies—including Brookfield Residential, Standard Pacific, and SunCal—coveted this deal. It was land, and lots of it, located exactly where land was most precious, scarcest, and destined for certain growth. Perhaps Toll’s rivals looked at the Shapell prize coldly as an acquisition of assets—inventory turns—in a lot-starved market. Not Toll.

The Toll Endgame

A long journey starts with a single step, and steps in the right direction head toward a clear destination. Toll Brothers one day means to be a globally recognizable luxury housing and hospitality brand. Think Four Seasons or Ritz-Carlton.

A customer of Neiman Marcus or the Ritz or Hermes or Lexus feels on some deep level that he or she deserves it. So, too, the “Toll way” gives its clients privileges of membership. Owning a Toll property confers status, stature, and a lust-for-the-good-life refinement, just like driving a new BMW or sporting Prada for an evening. For Toll, “growth mode” coming out of the Great Recession meant needing to shrink what and where it wasn’t. It had to inhabit and thrive in an expanded core of business activity, a broader comfort zone of operational models and locales.

California was not an option.

Like its peers, Toll success stems from four key proficiencies: capital raising and investment, real estate acquisition and sales, manufacturing, and marketing. The company’s up-market price-point and lifestyle segmentation position sets it apart from competitors in production home building and development. The Toll way is to operate with “anti-rigidity,” which is to say it accounts for risk and loss as a matter of course, and yet it calculates how it will not only survive but prosper during adverse times.

“If you never lose money, you die rich,” notes Toll, whose ancestral, family, and personal wisdom are prone to sage sayings to suit any moment. Clearly, he’s passed both fire-in-the-belly and patient, calculated internal analysis to Yearley, of whom Toll says, “I hired Doug 24 years ago to be CEO of this company.” Yearley felt that the deepest depths of the recession in 2010 and 2011 were the moment to kick Toll Brothers into growth mode. So, when it learned last April that the Shapell family wanted to explore selling its residential holdings, management could hardly suppress an overriding it’s-meant-to-be sense.

That first flash of intoxication last April arrived with an over-the-transom call to Yearley from the 63rd floor Rockefeller Center offices of Alan Riffkin, a managing director at investment banker Lazard Freres & Co. Riffkin and Yearley had brushed elbows over the years in New York’s financial and investment circles, and they share—along with Toll—a Cornell University pedigree, although none of their respective terms there in Ithaca, N.Y., overlapped. This was not a social call.

“Alan said, ‘The Shapell heirs and board are exploring selling the residential business, and we’re going to go through the full process. Are you interested?’” Yearley tried to compose himself for a moment before he answered, “Yes.” Then came cartwheels.

Why elation when what would be a grueling and costly due-diligence process was just beginning? Two reasons. One is that for decades, Toll—operating in California since 1994—made no secret of hopes to venture with closely held Shapell. The Shapells paid cents and dollars for thousands of ranch acres in Northern and Southern California during the 1950s and ’60s, built and sold more than 70,000 homes over six decades, and—no offense intended—preferred to keep its business to itself.

“We’d been out there 20 years, building in the same markets, sometimes right next to them,” says Toll Brothers regional president Jim Boyd. “We tried to make inroads, but never got anywhere.”

Yet the Shapell business served a buyer similar to the well-heeled set in Toll’s crosshairs. Iconic and time-tested master plans Porter Ranch in the Los Angeles area and Gale Ranch in the Bay Area were crown jewels of the package. So, the mere notion that Shapell’s home sites were on the block was cause for joy.

“Proof of Concept”

The other reason for glee is that Toll had inadvertently given itself an edge. A year earlier, Jim Boyd and his team finally scored a coup in their decades-long courtship with Shapell, winning the privilege to pay $47 million for 113 or so lots in the Amalfi Hills neighborhood in Orange County.

Amalfi became Toll’s prototype in more ways than one. The deal allowed Toll management, and Shapell as well, a firsthand look at the delta between the value Toll could put on each lot compared with the margin Shapell Homes was deriving.

A bit of math. If Toll paid $47 million for 113 lots, it’s an average of about $416,000 per lot. At a Shapell asking price of about $1.2 million per home in the new Amalfi community, Toll’s lot costs would have averaged 35 percent. Instead, Toll sold its “contemporary-twist-on-the-traditional” 4,300-square-foot indoor-outdoor optimized units for an average of $1.6 million, which mean its lot costs averaged about 26 percent, not 35 percent. That’s several percentage points difference in gross margins.

Back to the math. If you can push asking prices up by 30 percent to 35 percent, you’re lowering your land-base cost and making more money for each lot. This math synced with the Toll way.

So, too, did the overall success of Amalfi Hills, which sold through its first subdivision and took grand prize honors as the Community of the Year in the 2014 Nationals sales and marketing awards. The grand opening celebration included honors to special guests, who were on hand to see what Toll Brothers were making of the lots they’d sold.

“We invited the Shapells to our gala opening,” Boyd says. “You could tell it was an eye-opening experience for them.”

When the Shapell family and management started calculating the relative returns they could achieve from their lot portfolio, it was clear that an average of $300,000 per lot exceeded what they would earn on their own home building operation.

Ultimately, the 113-lot Amalfi Hills tipping point changed home building’s secular narrative. It started with worldwide capital investment’s awakening to the fact that housing and residential real estate’s falling knife had hit the turf. Welcome to a business climate where private home building companies were IPOing to satisfy their need to access big-time cash for a land rush that would separate the boys from the men and winners from losers. Investors bought in. Toll turned the strategy inside out; what others were buying, Toll now could sell.

Not Too Shabby

Even without the Shapell coup, 2013 would have gone into Toll’s books as a standout, even transformative, year.

On the eve of the Shapell deal, Toll completed its fiscal year Oct. 31. Management announced that year-on-year revenues jumped 45 percent to $2.73 billion with a net income of $170 million, fourth-quarter unit sales ran up to 1,485 units at an average selling price of more than $700,000—a 36 percent increase in a period whose economic claim to fame was a two-week shutdown of the U.S. government. What’s more, selling, general, and administrative expenses improved 17 percent to 12.7 percent, and the company’s backlog ending 2013 was 3,679 units and $2.63 billion, a jump of 43 percent and 57 percent, respectively, from a year earlier.

In the same 12-month stretch, Toll introduced 142 new models for its traditional home building product; its Apartment Living division started vertical work on a pipeline of 3,000 for-rent units in four projects in three markets; its high-flying City Living unit broke ground and launched marketing on its Rogers Marvel–designed five-story Pierhouse at Brooklyn Bridge Park, a joint venture with Barry Sternlicht’s Starwood Capital Group; it put a single five-bedroom penthouse at the Lucien Lagrange-designed Touraine building on the market for $20 million; it topped out at 40 stories in its joint venture with Sam Zell’s Equity Residential at 400 Park Avenue South—Pritzker Prize winner Christian de Portzamparc’s exoskeletal masterpiece; and it inked massive master planned community joint venture deals with everyone from Shea Homes in the Orange County, Calif., market, to Taylor Morrison in Austin, Texas, to GTIS in Houston, to mid-Atlantic arch-rival NVR in the Washington, D.C., metro area.

As icing on the cake, add in Toll’s Nationals Grand Prize, and it’s not a bad year. And that’s not counting the capper of them all, the one that would remap Toll into the sweet spot of the new geography of jobs.

In September, it was reported that Standard Pacific, SunCal, and Brookfield all coveted the Shapell prize, so Toll “went big,” drawing on knowledge it drew out of the Amalfi Hills deal, and its thorough study of nearly every lot in the deal. Final bids came under consideration in late October 2013.

“We made our offer clean, without a lot of ‘asks.’ We told them we’d pay cash. We made it clear that we could close,” says Yearley of the Toll $1.6 billion bid. The bids went in sealed, and then there was the agonizing wait for an answer. The final verdict, after a review of all four finalists’ respective offers with Shapell management and family members, came after a very long day on Wednesday, Oct. 30.

“I was out with my wife for dinner—at Flemings, on the Philadelphia Main Line—and as we finished, I looked at my watch,” Yearley recalls. “It hit 9 p.m. Eastern Standard Time and I thought to myself, ‘Hmmm, we didn’t get it,’ because by then it was 6 p.m. on the West Coast. I thought, ‘How could we have lost it?’ But at 9:15 p.m., my cell rang and it was Alan [Riffkin]. He said, ‘Doug, it was a long day, and we had to take the family and management through a number of very complex offers. But, after reviewing all of the opportunities thoroughly, they decided. You win.’”

By Friday that week, management was in front of the ratings agencies, and chop-chop, the company raised $600 million of five- and 10-year debt in the capital markets, issued $230 million in new equity shares, and secured a $500 million 364-day bank deal to fund the Shapell deal. But that wasn’t Yearley’s immediate reaction.

“Cartwheels.”

Learn more about markets featured in this article: Los Angeles, CA.