Large home builders have demonstrated the ability to navigate successfully through tumultuous times during the past few years. "When you think of the terrorist attacks, the stock market collapse, the recession, the job losses, the continuing weakness in the economy, and two wars, that's a lot to deal with," says Frederick Cooper, vice president of finance at Toll Brothers, in Huntingdon Valley, Pa. Relentless demand for new homes and the lowest capital costs for a generation of builders and their customers certainly has made it a little easier. But considering how well most builders managed to expand in spite of that turbulence, adds Cooper, "that's impressive."
The rapid run-up in business in the face of those economic challenges has, in fact, been more than just impressive. It has forced home building firms to become better-managed, more financially disciplined companies with stronger balance sheets. That, in turn, has put builders in a healthy position to attract reasonably priced financing to continue expanding.
Ten years ago, says Lennar CFO Bruce Gross, Lennar had six years of land owned and three years of debt maturity on its balance sheet. Today, Lennar's books have two years of land owned and an average of eight years of maturing debt.
With less relatively illiquid land on the books and longer-term debt in their borrowing mix, builders such as Lennar are in far better shape to manage their capital requirements and adjust their financial throttles if business does indeed begin to soften.
Better balance sheets, long-term housing demand plus an industry still ripe for mergers and acquisitions are among the reasons home building firms remain prime targets for investment bankers, lenders, equity, and other capital providers. And though 30-year mortgage and 10-year Treasury bond rates have both jumped from rock-bottom summertime lows to 12-month Labor Day highs, there appears to be no shortage of companies ready to provide funding to fuel builders' growth machines.
Identifying which financial players are serious about serving home builders, however, isn't simple. To make the job easier, Big Builder magazine has assembled a new and up-to-date financial services directory that serves as both scorecard and contact list.
Big Builder Financial Services 2003 Directory
|Companies A through H|
|Companies H through W|
|Top 25 Institutional Investors in Home Builders|
This year, we narrowed the focus of the directory to companies which provide investment banking services, senior and mezzanine level debt, or equity capital packages. In our research, we identified hundreds of companies which claim legitimate capability in being able to put together equity financing deals. But we confined our list to companies that, in general, have a dedicated team of financial specialists who focus specifically on the residential construction and real estate market.
Most big builders report they have a ready supply of capital available on favorable terms. Pulte Homes, of Bloomfield Hill, Mich., is typical. "With our lines [of capital] already in place, the company is in great shape heading into 2004," says James Zeumer, vice president of investor and corporate communications at Pulte. But if U.S. banks grow wary of lending, diverse sources of capital are emerging. "One interesting note is that there appears to be strong interest from non-U.S. banks that are looking to increase their exposure to the U.S. housing industry," says Zeumer.
Capital providers and deal makers remain relatively bullish on builders, but see a variety of issues on the near horizon. Few foresee the kind of "enterprise transformation deals" of large public builders buying other large builders such as when Lennar Corp. doubled its size by acquiring U.S. Home Corp. in 2000.
The stock market no longer rewards such transactions, notes Tony Avila, managing director at JMP Securities, in San Francisco. "If I'm the CEO of a big builder, there might be a lot of reasons for me to acquire another big builder, but the stock prices, which move somewhat in concert," might not react favorably, he says. "The market has had a chilling effect in this era of corporate scrutiny" of anything beyond conservative, justifiable growth, says Avila.
But the home building industry continues to be primed for smaller and mid-size acquisitions, Avila notes. By his calculations, builders, to continue their current pace of growth, need to build an additional 60,000 homes a year. "The only way they can do that is ... to acquire other builders," he claims, and so the current flurry of acquisitions, where big fish swallow the smaller fish, should continue apace.
Bumps in the Road
From the perspective of builders eyeing their cash flow and capital requirements, guarded optimism seems to be the order of the day, with some major caveats: land availability, job creation, mortgage rates, and, to a certain extent, consolidation among banks that lend to builders.
The increasing challenges of securing land entitlements have left most builders little choice but to take increasingly long-term land positions.
"A number of players have been able to build up their war chests of capital," buying up land as well as other, smaller builders, observes Nicholas Beare, managing director of Matrix Capital Markets Group, in Charlotte, N.C. For example, Centex Corp., of Dallas, has already purchased almost 90 percent of its needed land supply for the current and next fiscal year, according to senior vice president and CFO, Andy Kerner. "We're talking about '07 and '08 land acquisition," he says. Still, "I think land and entitlements are becoming more difficult to come by," Kerner acknowledges, and that has affected land acquisition patterns: Builders will take land earlier in the process and hold it longer, he notes.
The next year might be critical for builders who have not squirreled away land and don't have the staying power to navigate development-wary bureaucracies. James Pugash, CEO of San Francisco's Hearthstone, which provides capital for land acquisition and development, says as competition for land grows, and the demand for cash purchases increases for land before it is entitled, financing might become more constrained. "It's hard capital to get since the risk is so much greater when the land isn't zoned for development," he says. "If builders called looking for $100 million for land that isn't zoned," they will both be disappointed, he said. "We might provide $5 million on land that isn't zoned," says Pugash.
He also notes that with the recent run-up in real estate values, and the value of home building stocks, some institutional investors may believe they are over-invested in real estate and might look to re-balance their portfolios.
Availability of Capital
Another factor is the continuing consolidation of banks, notes Ronny Hudspeth, senior vice president of AmSouth Bank, in Birmingham, Ala. "There's a core group of large banks that will lend to the home builders," Hudspeth says. If there is a flurry of mergers among that core, the supply of capital could become constrained, as when Bank One merged with Bank of America, he warns.
Accordingly, companies like Pulte are looking beyond bank lines for capital. "The bond market [has been] very responsive to recent debt offerings issued by Pulte, as well as the other large public home builders," says Zeumer. "In fact, earlier this year, Pulte Homes placed 30-year debt at very favorable rates."
The lowest interest rates in modern history have been a boon to every aspect of home building. Notes Matrix Capital Markets' Nick Beare: "People have issued paper in the capital markets to take advantage of the low interest rates. That's funding for those players for those who are near, or even not near, investment grade. There has been a tremendous appetite by investors for any kind of paper." And he says he doesn't think it's going to end any time soon. "This is a very, very good market," he says, in spite of the recent jump in rates.
As the economy, consumer confidence, and purchasing power begin to gain traction going into 2004, most builders are expected to benefit.
"There may be a five [percent] to 10 percent drop in a few years. But the smarter operators will be able to grow their business through a downturn," contends JMP Securities' Avila. The difference between those who grow and those who stagnate will be how wisely they grow internally and how effectively they manage their acquisitions. In five years, predicts Avila, we will see a more mature industry, growing slowly and steadily and squeezing the profitability from a greater number of subsidiaries and ancillary businesses serving existing homeowners, rising from infill projects or high-rise development. "Clearly, when the growth shakes out," says Avila, "perhaps they will migrate to other businesses that are complimentary but counter-cyclical to the home building industry."