Every time a home building division is dismantled, the reason is the same: The return on the capital investment in the division isn't good enough. Granted, different companies have different thresholds for pain, so the point at which each will cry, "Uncle!" varies. Blame it on slim margins, a competitive landscape, slow land appreciation, inflated new-home demand, or bad long-term economics, but at the end of the day, divisions are shut down because management teams think the company's capital resources are better off being deployed in another market, where returns are better.
Already a handful of management teams have committed to exit strategies in markets from Detroit to Dallas. (See "A Smaller Footprint" on page 14, for a look at who's halting operations in which markets.)
"In some respects, this is healthy because it will force builders to focus on the market with the best returns," Friedman explains. "A leading market share in smaller markets that are healthy is better than a lagging market share in a whole bunch of markets that are unhealthy."
However, determining exactly when to pull the plug is a difficult choice.
Friedman says it all comes down to looking at a company's return threshold and then doing the math. He notes that, on average, a builder needs a certain number of communities–which could be as few as 10 or as many as 30, depending on the builder–to support the division's set up, and within those communities between two and five sales per month to support the community. The tricky part is figuring how far out the horizon is when doing the financial modeling. Some industry leaders say looking at five years projected returns is a good rule of thumb.
When it's clear that a division needs to be shuttered, management needs to put together a comprehensive exit plan–and fast. As soon as the news breaks, a period of near chaos is likely; investors, employees, trade partners, and customers will be anxious about the impact of the decision on their lives, and management must reassure them with answers.
Time is the enemy when dismantling a division. Management has to shed assets and downsize operations as quickly as possible so resources can be re-deployed in more profitable markets. That is often easier said that done. Industry experts agree that an aggressive strategy would mean being completely out of the market in 12 months, with warranty lasting a year or so past that mark.
Typically among the first things management does is walk away from lot options and sell off owned parcels. Equipment also is sold, and leases on office space are evaluated. At the same time, management also assesses each existing subdivision to figure out which should be sold off and which should be built out.
In the meantime, management has to cut staff. Land people are the first to go.
Administration and sales staffs shrink as subdivisions are closed out. The warranty department is the last to leave. However, the challenge is getting the best talent to stay in place–a skeleton crew–to finish out the homes under construction. Management may need to offer outplacement services, transfers to other divisions, and "stay put" bonuses to incentive certain staffers to see operations through until the end.
Warranty issues pose the greatest obstacle to a clean exit. The long tail of the business, warranty has to be in place for at least a year after the last home is delivered to deal with any post-close issues. Outsourcing that function to a professional warranty service firm can speed an exit.
Exiting a market is a painful process for almost any builder because of the myriad of details involved, from legal issues related to layoffs and warranties to the logistics of where to store the division's paperwork. Having experienced a division shut down, Steve Nice, COO of Florida-based Vision Homes, says without a doubt closing up shop is doubly as hard as setting up shop.
"Home building companies have very little experience exiting markets. They have a lot more experience entering markets by acquisition and start up," says Nice. "And that's what makes it so difficult–they don't have the experience."
A Smaller Footprint
July was a busy month for market retreats, as the first six months of 2007 failed to produce the results builders were praying for.
Six companies pulled the emergency brake on divisional operations, citing everything from lack of demand to too thin margins as reasons to halt future investment. Here's a roundup of who's pulling back on what market and why.
Learn more about markets featured in this article: Los Angeles, CA.