Mounting losses and mind-numbing land charges have been the common thread among public builders in their latest batch of earnings calls. As housing prices went from appreciating to declining, builders have worked round-the-clock with land sellers to renegotiate terms and pricing on building lots. Since land prices themselves have remained "sticky," some builders are admitting defeat and walking away, not just from communities that don't "pencil" profitably, but from entire markets. They just can't get land costs to align better with more modest operations and slower future growth.
Centex announced that it will depart the Columbus, Ohio, market, and also confirmed that it is retrenching from operations in the North Carolina Piedmont Triad. Each market accounted for roughly 500 units in 2005. In June, Centex announced that it would build out current holdings in the Central Coast division, based in San Luis Obispo, Calif., without making further investments. In July, the company announced that the Reno, Nev., division will operate as a satellite of the Sacramento division as Centex continues to build out current holdings in the market.
California is also taking its toll on D.R. Horton. After years developing an expansion strategy that includes core and satellite operations aimed at widening its national presence, CEO Don Tomnitz confirms, "We are shrinking back in some areas of California. To date, we have not collapsed more than two or three of those [satellite operations]."
Certainly the largest builders have claimed–amid much debate–that their strength lies in their size and diversified footprint. So now that the retrenching has begun, what are the implications?
One possible realization: Unless critical mass extends across many geographies so that respectable performance can offset the terrible markets, it's not going to make enough difference. Perhaps what builders are beginning to recognize is that activity in the major markets is what will drive business going forward. Assuming this is true, the mid-cap and larger public builders likely have more geographic diversification than they need. Adding an incremental 500 units in Columbus, or even 900 units in a market such as St. Louis, is unlikely to make or break their business.
That being said, it's not such a big deal that builders are starting to pull out of markets on a tactical, one-off basis. Rather, the reasons they are pulling out may be of greater consequence. In some cases, being long and wrong on land isn't proving to be the only problem.
"I think one thing this downturn is showing some of the larger builders is that they really don't have control over their operations like they thought they did," says Stephen East, an analyst with Pali Research. "[The ramifications of a] bigger-is-better [theory] is that they are having a tough time controlling 600 or 800 communities. I think they are realizing it is overwhelming for them and don't have a good feel for what is going on in each one. If many are modest contributors, would [the company] be better off not doing it? I think the answer is yes."
East cautions that the uber-builders such as Lennar Corp., Horton, and Pulte Homes should exercise extra care as they determine the number of markets they'll exit. "Those are probably the only ones that could create enough breadth away from the core markets to really help stabilize their business during the downturn. But the more mid-tier guys? Why not save some of their brain cells and run leaner organizations."
As builders weigh options, a likely outcome is an increased level of competition among the country's fast-growing MSAs, as the biggest continue to gobble market share in an effort to achieve economies of scale in each geographical arena. In time, the super-regional model may gain greater currency versus the wide-net national model. After all, despite its more regional concentration, the financial performance of a company such as Meritage Homes Corp. is not significantly different than that of the four leading builders. Meritage, too, is pulling back.
Meritage executives stopped short of disclosing plans to exit the Ft. Myers/Naples area during an earnings call in July. They did confirm terminating option deals to purchase as many as 2,500 more lots in the market. This, all since Meritage entered southwest Florida in February 2005, when it purchased Ft. Myers?based Colonial Homes for an estimated $66 million. "We are suspending operations," says Hilton. "Whether we pull out completely is a decision we'll make down the road."
–Lisa Marquis Jackson
Although hard, cold prices for land sales may not be as elastic as today's home sales prices, land bankers are reportedly becoming more reasonable in negotiations on takedown terms and costs as builders take the high road. Meritage CEO Steven Hilton says three shifts in the land negotiation environment have taken place in the past year. At first, land bankers expected builders to pay for an extension in terms with an increase in price. Then, several months ago, those terms were being renegotiated without additional cost. Along the way, land bankers have been reluctant to drop current pricing without an opportunity to participate on the upside, should the environment turn around. But during the second quarter, Hilton says his team started seeing more flexibility from land bankers on both terms and pricing. "Things have come far enough today that we don't have to give much upside away," says CFO Larry Seay.
Learn more about markets featured in this article: Los Angeles, CA.