What separates public home builders from privates is the ability to get money, as well as the operational uses of money. Private company execs spend money from their own checkbooks and must make money or they eventually go broke. Publics use OPM (other people's money) and do not operate under a make-a-profit-or-lose-the-company mindset. How should privates manage in this climate?
If you look at home building operations cash flow, most publics are losing money. Still, they start specs to keep up with their unsold budget numbers; their associates' salary increases don't have to match cost of living increases; plus they only own about 50 percent of their land—and can take a hit of millions of dollars as they drop contracts with landowners. They can continue to operate at a loss because they have hundreds of millions in the bank. Their stock dives, but they still have billion-dollar lines of credit, bonds at low rates, and cash coming in from the sales of their backlog.
So, don't frustrate yourself or your team by trying to act like a public. We hope this housing slump lasts for only 18 months, but builders may have to wait twice as long for the market to return. Giveaways of $20,000–$40,000 can't cure the low affordability factor in most markets. History is repeating itself. You must do business the way you did in the late '70s or early '90s:
Remember, a 10 percent net on much lower volumes might put you under water for a while. You should keep a rainy-day fund of three years of overhead payments in equity to weather this and any slowdown. You still need people to sell, construct, and close homes even if profits are cut in half.
Don't build specs. It is a poor use of your bank line of credit and costs you hundreds per day to carry. Those dollars can help pay a salary or be added to profit.
Don't carry models on your books. Investors will take prime rate or a little higher to carry models and sell them later.
Build fewer models. You only need one model to show your design ability, quality construction, sales center, and design showroom. This is rarely done effectively from a trailer, so be careful not to get too basic on your presentation.
Most important, you must take care of your team. You will probably let people go or eliminate bonuses to stay profitable. You must keep overhead around 3 percent of closing volume. No matter what players you have, keep only those who will work hard with you to keep the company profitable regardless of what is in it for them. Chemistry is everything in a tough market. Celebrate the team and learn from wins and losses with scheduled meetings that include everyone in the company.
Keep it simple and spend each dollar as if it is your own, because in private home building, it is.
Tom Ryan is a former CEO and owner of Town & Country Homes. E-mail: email@example.com