The housing recession and the year-ago near collapse of the commercial real estate lending system have been game changers. Dichotomies between public and private builders have sharpened. Now, publics and privates need to play aggressively to their respective strengths amid the shifting landscape—each in their own distinct way.
Publics have access to big cash reserves while private builders' stockpile of capital is nearly out. Publics have access to comparatively inexpensive capital through the public capital markets, while private builders struggle to gain access to capital from commercial banks at nearly any price. Privates have had to become nimble, while public builders are less flexible because of their large operations in multiple geographic areas. A passion, a sense of urgency, and a level of determination galvanize private builders—they're the underdog who has a limited number of battles, but can't afford to lose one. Publics have many battles—losing one or two is a cost of doing business.
So, which operational strategies are public builders putting into play? D.R. Horton is using its treasure trove of cash to tie up finished lots on very soft terms and is producing specs in massive numbers in many of its submarkets. For Horton, the strategy makes sense. Knowing it can access capital that private builders can't, here's Horton's game plan: Controlling land and flooding the market with specs in conjunction with an aggressive pursuit of Realtors motivated to sell near or completed homes with a quick close allow Horton to gain market share and increase volume. With higher volume levels, Horton can shrink margins as long as it controls overhead. It's hard to argue with that plan in this market.
The introduction of KB Home's Open Series has won acclaim from Wall Street. Using its buying power and strong name recognition, KB Home saw an opportunity to position itself aggressively in the lower price points in each of its operational markets. This way, it could close the gap between itself and foreclosures and short sales. Did the plan work? KB Home just reported a 62 percent increase in year-over-year sales and gross margin improvement to 14.6 percent during its most recent quarter.
In these examples, you get the picture. Cash reserve access, control of finished lots on attractive terms, attracting Realtors with completed spec inventory, buying power, name recognition, and an ability to improve profits by lowering margins and increasing volume are a few of the tools in the publics' tool boxes.
Should privates compete using the same operational strategies as public builders? Probably not. If publics build significant numbers of specs, lacking the ability for buyers to customize and personalize their homes, then privates should zero in the market looking to avoid mass-produced spec homes. This strategy fits with the commercial bank credit facilities used by most private builders: They'll lend construction financing for pre-sales, but not for specs.
Privates need to generate premium pricing opportunities in order to achieve higher gross margins. They can't generate the volume it takes to be profitable on the lower margin. The viable alternative is to provide locations, designs, features, and services for which buyers will pay a premium price.
Publics have consolidated their competitive strength of access to capital and the benefits associated with utilizing their capital stockpile to increase volume and market share. New operational strategies are necessary for private builders to survive and prosper. The threat to each group—not capitalizing on their respective strengths.