The prospects for America's housing industry look bleak in 2009, especially if Congress doesn't include tax credits and interest-rate buydowns in the next economic stimulus package.
That's was the message eight public builders conveyed to an audience of fund managers, analysts, and investors at Credit Suisse's homebuilding conference in New York yesterday. Hanley Wood Market Intelligence co-sponsored the two-day event.
The tone of the conference had been set the day before, when experts on bankruptcy and foreclosures presented a dismal assessment about the prospects of builders coming out of Chapter 11 (virtually nil), and the government staving off mounting foreclosures. (Sixteen percent of all mortgages will enter foreclosure in 2009, predicts Rod Dubitsky, a managing director for Credit Suisse, whose solution to this problem is the government buying loans from banks and forgiving a portion of the loans' principal balances).
Every builder speaking at the conference listed foreclosures, along with the mountain of unsold existing homes on the market, among the biggest problems their companies confront in trying to sell new homes. And most sounded like they agreed with Boyce Thompson, Hanley Wood's editorial director, who predicted that 2009 would be the worst year for the housing industry since World War II, with starts falling anywhere from 20 percent to 30 percent.
The builders strained to squeeze out some positives from the plight of their industry and companies. "The good thing is that everyone understands that it's not good out there right now," said Larry Mizel, M.D.C Holdings' chairman and CEO. Larry Nicholson, president and COO of Ryland Group, added that while current market conditions are "horrible," they've forced all builders to take a closer look at their businesses. And all of the builders at the conference are convinced that the downturn and the credit crunch will significantly winnow the ranks of builders (particularly smaller companies), opening the door for better-capitalized builders to capture more business.
However, expansion is not on the minds of public builders, which have been in survival mode for more than a year by focusing on liquidity, debt reduction, and expense control. Some have better stories to tell than others, depending on their cash situation, land positions, and how soon their debt matures.
The conference had its surreal moments, too, as when Beazer Homes' CFO Allan Merrill, in response to questions about his company's 45.6 percent cancellation rate in its latest quarter, stated that the ratings of buyers who took ownership of a Beazer-built house "have never been higher"; or when Stacey Dwyer, executive vice president of D.R. Horton (which lost $2.6 billion in fiscal 2008), emphasized how Horton had significantly increased its cash flow, to $1.88 billion, at the end of that year.
Cash flow, admittedly, is the name of the game for public builders, some of which seem to be amassing war chests in anticipation of picking up land--and, possibly, companies--as the downturn shakes out the housing industry. Right now, though, land deals that make sense financially are scarce, as the asking price of owners is still much higher than what builders are willing to bid. "I can count on one hand the number of deals we approved in the last year," said Pulte Homes President and CEO Richard Dugas.
All of the builders have aligned their companies to lower buyer demand by shrinking their staffs, consolidating their divisions, and, in several cases, exiting unprofitable markets. Virtually all of the builders have made adjustments to their products, and are offering smaller and less-expensive models. (For example, more than half of Beazer's house plans are under 2,000 square feet now.) But it appears that builders' attempts to exact more price concessions from their suppliers and contractors have reached a point of diminishing returns. Consequently, builders concede that generating cash though cost savings will be exponentially harder this year, especially if market conditions don't improve.
Each builder voiced his or her strong support for Fix Housing First, the housing industry's recommendation to the federal government to buoy consumer confidence and boost buyer demand by offering a $10,000 to $25,000 tax credit to all buyers and reducing mortgage borrowing rates to 2.99 percent through June 30, and to 3.99 percent through Dec. 31. Hovnanian Enterprises CEO Ara Hovnanian even skipped the conference so he could be in Washington to lobby Congress to include this measure in the next stimulus package. The builders at the conference argued that stimulating buyer demand is the best way to stop home prices from falling and stemming foreclosures. However, they also expressed uncertainty about whether President Obama would include this plan in his stimulus package.
In their defense of Fix Housing First, several of the builders harkened to a similar plan that President Ford put in place in 1975, which helped kick-start home buying in the late 1970s. Larry Sorsby, Hovnanian's CFO, also drew from history to argue that the eventual recovery from the latest downturn could be steep, as it has been during past recessions. When that recovery will occur, though, is still anyone's guess. Thompson pointed to a recent BUILDER Online survey in which more than half of those polled believe the industry will hit bottom in the first half of 2009. Mizel of M.D.C. playfully predicted that the recovery would occur on a Monday. "We just don't know which Monday."
Meanwhile, builders are doing whatever they can to generate sales. "We're not counting on a housing stimulus or waiting for better times," said Jeff Mezger, KB Home's president and CEO. Within the past six months, KB has developed its "Open Series" of house plans, which Mezger calls "the fullest expression of our made-to-order business model." KB is allowing buyers to customize their homes right down to the size of each room. And through value engineering and help from suppliers and trades, KB can offer their homes at reduced prices: in Tucson, Ariz., a 1,700-square-foot Open Series house costs $23,000 less than a previous KB model in that same market. KB expects to hold Open Series grand openings in half of its communities by the middle of this year.
In such a difficult and unpredictable economy, many builders at the conference were reluctant to project their financial performance for the quarters to come, but that didn't mean they didn't share some interesting tidbits about their current strategies:
M.D.C. is rolling out what Mizel calls its "customer experience" initiative, with the goal of dramatically improving its services to buyers;
Doug Yearly, Toll Brothers' regional president, revealed that his company has assembled an internal workout team to evaluate purchases of distressed land. He noted that land prices have started to come down a bit over the last 30 days to 60 days, although he still thinks they are mostly too high. Yearly also said that Toll has been investigating opportunities for expansion outside of the United States for the past two years;
Dugas said that Pulte is unlikely to expand its Pulte Building Systems (PBS) operations, which provide turnkey construction solutions for its construction activities in certain high-volume markets. He also explained that Pulte decided to close its component plant in Manassas, Va., because it was only supplying 800 homes to 900 homes per year, when it needed at least 2,000 to make sense financially. However, Dugas was quick to note that his company's ventures into vertical integration have "opened our eyes" to achieving cost savings through "process improvements" that include working with contractors and suppliers to value-engineer the builder's homes;
Ryland has been working with its trades, too, to reduce its construction costs. Nicholson said that his company has modifying its competitive bidding process so that it now has multiple trades for each stage of a community, instead of just one. Ryland has also eliminated the use of turnkey providers and buys all of its materials itself. Nicholson added that his company has made "wholesale changes" to its product that include simplifying its house design by standardizing room sizes, adjusting roof pitches, and "squaring the box;"
Hovnanian has reduced the size and price of its product in some markets. But Sorsby noted that his company has also gone larger and more expensive in other markets where there's a void due to builders that have left the area or gone out of business. "The only shield you really have is finding a niche that no one else is in and filling it."
John Caulfield is senior editor at BUILDER magazine.