Frequent flyers know the welcome feeling of arriving ahead of schedule thanks to unexpectedly strong tail-winds. That's what it's been like for home builders, who have been enjoying rip-roaring tailwinds in the marketplace lately—especially this past year. And it's not just the biggest builders that are benefiting. While the top 10 home builders increased their revenues by 21.2 percent last year, over the year before, the next 90 U.S. home builders as a group actually grew a percentage point faster, according to the latest results released this month by our sister publication Builder magazine.
Historically low interest rates usually get all the credit for the market's gusty growth—and not undeservedly. But three other forces are also propelling housing's jet stream.
The first is the wave of innovations unleashed in recent years by mortgage lenders: More flexible terms, lower down payment requirements, and a new willingness to lend to immigrant families, whose incomes can now offset a lack of credit, all enable more households than ever before to buy into the American dream. That in turn is turbocharging a second, steady undercurrent of demand for homes arising naturally from native and immigrant population growth. The third and less obvious force, though, is the growing financial strength of big home builders, which is attracting an added burst of fuel-injected expansion capital into builders' operations.
Those forces are reflected in the recent financial results of the nation's top 10 home builders—and those of other publicly traded home builders in general—which Big Builder examines and compares in this issue (see “Public Builder Report Card,” page 32). The results reveal how big builders have not only fortified their operations and their balance sheets over the past year, but in particular, they have become better masters in managing their yields on each new home they build.
The public builders succeeded not only in dramatically increasing the number of homes they built last year over the year before (by an average of 16 percent, to 260,330) but also the prices they netted on them (up an average 5 percent, to $301,000). More importantly, builders extracted significantly better gross margins out of each home they closed, averaging 20.6 percent—a full 3 percentage points above what those same companies delivered, on average, over the past five years.
Many will quip, of course, that if a builder can't boost margins in this environment, shame on them. That's probably true; but it's also a bit disingenuous if builders don't also get credit for the progress they've made developing sophisticated design and pricing controls—to ensure that those margins are engineered into every house, not merely a matter of fair-weather fortune.
Those same disciplines are working all the way to the bottom line. The public builders produced a healthy 7.4 percent net profit margin last year—significantly above the 6.0 percent the group has averaged over the past five years. For investors, those results translated into a handsome 15 percent return on capital, and 28 percent return on shareholder equity—each running 2 percentage points better than their respective five-year average. The results also have translated into significantly more favorable terms and upgraded ratings on most of the builders' long-term debt.
Perhaps as important as how well builders did last year is how well positioned they are to sustain their growth. The public builders started 2004 having already sold 53 percent of the prior year's home sales volume. That compares to 48 percent from the year before. And for all the concerns about finding land, the public builders started this year with 1.55 million lots in the development pipeline.
All this should not suggest that Darwinian forces still aren't at work: The battle for land and management talent is growing ever more fierce. The real test of how well builders have succeeded in fortifying their companies is still to come, when the market turns down. But for now, and the next few years, it would appear builders will continue to enjoy remarkably favorable economic tailwinds.
Wyatt Kash, Editor