Doug Smith of Miller & Smith in McLean, Virginiacredit: Chris Usher/Sublime Management212.777.3515

The Rebound

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    Builder Doug Smith says the Washington, D.C., market is up 25 percent.

    Chris Usher/Sublime Management

    Builder Doug Smith says the Washington, D.C., market is up 25 percent.

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    Houston markets face a serious labor shortage, says builder Ken Williams.

    Pam Francis/Sublime Management

    Houston markets face a serious labor shortage, says builder Ken Williams.

It’s official: Home building is on the mend.

As 2013 begins, the signs are mostly positive. Sales and starts are up. Inventories are low—and even the backlog of foreclosed properties is dwindling.

Builder’s annual State of the Industry survey confirms that there’s a striking improvement in our readers’ views on the economy. Last year, we asked builders when they thought the industry would start to recover; only 7 percent answered, “It already has.” This year, 53 percent say the recovery is under way. Readers are upbeat about their prospects, and their reports on objective measures—hiring, starts, and sales—show dramatic gains.

In follow-up interviews, we added detail to that statistical picture. In past years, conversations focused on survival—how to keep a skeleton staff employed, how to get by with smaller jobs, how to make even a tiny profit margin when buyers have no cash and no credit. But this year, builders are talking about the problems of a market that is heating up: containing costs, managing subs who are too busy to show up on time, and finding enough buildable lots to meet demand.

But there’s a fly in the soup. When we break the data down and compare large and mid-size builders with small local builders, the views diverge. Big public builders with national operations, and even the mid-sized builders who work in just a single metropolitan area, are far more optimistic than small builders confined to local markets.

Clearly, the recovery’s effects are hit-and-miss. Many small builders, stuck in towns or counties where the recession is far from over, are held back by unemployment and tight lending. Where the tide is turning, small builders have to face cost spirals, labor scarcities, and land shortages—the emerging problems of the upswing. Where the market’s hot, small builders are competing for resources against bigger companies with deeper pockets. And where the market is still cold ... well, brother, it’s cold out there.

Let’s take a closer look.

Environment and Outlook

Our survey asks two general questions about the economy. One is broad: How do you think the economy is doing? The second is more narrow: How do you assess your own company’s prospects? On each measure, this year’s results show a sharp improvement.

Asked to rate market conditions in 2011, 15 percent of builders reported that they saw improvement. This year, that proportion has tripled to 46 percent. The slice who saw conditions deteriorating was cut in half, from 36 percent to 18 percent.

Interestingly, our readers have a rosier view of their own companies’ prospects than of the broader economy. In 2011, 36 percent saw an improvement for themselves, though only half that number believed that the economy was looking up. This year, a solid majority of respondents—55 percent—say their businesses see better times ahead. And again, the ranks of pessimists are cut in half: This year, only 12 percent say their business prospects look worse, versus 23 percent last year.

Starts and Sales

Government figures show sales are up, and our readers apparently agree: 40 percent saw increased closings in 2012 (compared with 28 percent the year before); only 10 percent closed fewer homes on the year (down from 23 percent in 2011).

Nationally, housing starts were up sharply in fall 2012. Our survey asks a more limited question about spec home starts, and the results are ambiguous. Around one-third of builders (39 percent in 2011, 32 percent in 2012) say they’re building fewer specs on the year. In 2012, just 17 percent said they were building more specs. Still, that’s up from a scant 10 percent in 2011.

Hiring Up, Layoffs Down

In good times, home building is an engine of job creation. This year, that effect is finally showing. In 2011, builders were twice as likely to lay off workers than to hire more help (by 34 percent to 15 percent). In 2012, the numbers flipped: By 28 percent to 18 percent, builders reported that they were hiring people, not letting people go. (Roughly half in each year said they were keeping staffing constant.)

Size Matters

Every year, Builder asks a handful of open-ended questions, hoping for insight into challenges and strategies. This year, we stacked the responses up by size of company (as reflected by sales volume), and a pattern jumped out at us. At the top of the heap—among companies who build hundreds or even thousands of houses a year—answers were focused on the problems that come with a rebounding economy. Builders had questions of their own: Where’s the good land at a decent price? Why is there a shortage of skilled trades? And why won’t the banks lend to qualified buyers?

But at the bottom of the stack—among companies who built five houses or fewer on the year—the comments had a different tone. Builders painted the picture in short brush strokes: “Cash flow.” “Getting customers.” “Economy.” “Turning a profit.” One builder summed up his big challenge in one word: “Surviving.”

What would happen, we wondered, if we tabulated the answers to structured questions about economic conditions and company prospects along that same dimension: company size? The results were striking. If you ask every builder in the country, sure—people sound positive. But if you ask only the mom-and-pop outfits—the ones building fewer than five houses? Not so much.

Almost unanimously, builders representing companies that build more than 100 houses a year say economic conditions are getting better. Builders with volume under five homes say the opposite, by 2 to 1. Asked about their own companies, the smallest builders aren’t quite so pessimistic: 41 percent say things are getting better, while only 19 percent say they’re getting worse. But what about the big boys? In our sample, just 4 percent of top-volume builders thought things were looking worse for their businesses next year. In raw numbers, out of a sub-sample of 11 giant corporate builders, that negative response represents exactly one executive at exactly one company. Clearly, companies big enough to move to where the action is are happier these days than builders who have to make the best of things right where they are.

In Their Own Voices

This year, we reached out for follow-up phone interviews with two builders who had offered interesting responses to some of our open-ended questions. Doug Smith of Miller and Smith in the Washington, D.C., metro area, and Ken Williams of Colina Homes in suburban Houston both run medium-sized firms building in multiple neighborhoods, in metropolitan areas that are solidly on the path to recovery. Far apart geographically, the two companies face similar challenges. They’re both up against tight labor markets and stiff competition for a limited supply of buildable lots. And they’re both planning for a period of growth.

The D.C. and Houston areas are exceptional—in D.C., government spending boosts the local economy, while in Houston, oil industry investment has added energy to the market. In terms of the rebound, they’re ahead of the national curve. So they point the way to where the rest of the country will end up, if the recovery takes root and spreads beyond this year’s hot markets.

Colina Homes entered the downturn with a strong balance sheet, Williams says. “I run a lean ship and I watch my overhead.” The company wasn’t stuck with excess land or extra specs, and it’s grown every year throughout the downturn. During the slow times, land was easy to get, Williams notes. “You could option lots on pretty soft terms with very little earnest money. But now, we’ve pretty much gone through those lots.”

Now Colina is back to purchasing lots outright. “We’re closing on some fairly large positions because we have confidence in the market going forward,” Williams says, adding that supplies are tight. “Replacement lots are costing more, and there aren’t very many lots. My peers here are seeing the same thing: the lots they want are being bought up by big national builders. In the greater Houston area, builders would be doing more starts and more closings if we were not constrained by lots.”

In D.C., Smith tells the same story. “During the downturn, no banks were lending to do land development. So we were all going through existing product that was ready to go. But this year, the market is up by 25 percent. Everybody at the same time is trying to find lots. But it takes about a year to develop a piece of ground, so all of a sudden there is a big void.”

“Two or three years ago, there were lots, but you couldn’t find any buyers,” Smith says, but now first-home purchasers are back. “People delayed getting married, they delayed having kids, they lived in their parent’s basement longer than they or their parents wanted,” he says. “But they were saving money.” Now, with interest rates at all-time lows, those customers aren’t just buying houses—they’re willing to spend on extras like a finished basement or a spare office/bedroom with bath. “They can have a serious upgrade for an extra $20 a month on their mortgage,” Smith explains. “That’s one week of not going to Starbucks. So they’re doing it.”

But labor supply is tight. “Trade contractors have been reluctant to hire because everybody got burned back when the tax credit boosted short-term demand and then it went away,” Smith says. “But this is a true recovery, and now I think subs are starting to hire because they see the backlog that builders have.”

Out in Houston, Williams is not so sure. “A lot of trades that were in the business prior to the downturn are just gone,” he says. “We’re very constrained on framing crews, and it’s starting to trickle into other trades as well. There just aren’t enough crews to go around.”

Smith and Williams are both boosting what they pay to the trades, but Williams also is now helping new subcontractors get into business. “We had a framing crew that was doing a good job, but they just couldn’t keep up,” Williams explains. So when one of that crew’s best framers wanted to start a new crew of his own, Williams’ company gave him a boost. To help the fledgling business take off, Colina offered better payment terms: “Instead of paying every two weeks or every month, we’re paying twice a week so they won’t get into cash flow trouble,” Williams says. “And we pay well enough that he can afford the insurance and things that he needs to have.”

As the new year opens, builders—especially the larger, better financed companies—see brightening prospects. The aftereffects of the housing bubble are fading. The underlying need for housing is now driving a recovery. And as that recovery spreads, the problems of the next few years will be the problems of the rebound: availability of land and labor, cost of materials, and financing. The builders who can best solve those problems will be the builders who succeed in the coming decade.