JOHN LANDON, CO-CHAIRMAN and co-CEO of Meritage Corp. in Plano, Texas, has studied markets. He knows the employment forecasts, the housing permit situation, and the population figures of the target locales Meritage is considering. There's just one problem: “Numbers can be misleading,” he notes.

Sometimes “ugly” numbers conceal an undervalued market waiting to blossom. And attractive figures might mean the community is overpriced. Other intangibles must be taken into account before buying land, let alone breaking ground. The art of picking the right target markets to house a successful community years from now is a skill the best builders are honing today.

Investing in land or betting on a new community is a bit like picking stocks. There are some bedrock principles, but there is also a lot of subjectivity, emotional preferences, and a bit of guesswork involved. As big builders' teams survey potential markets, what factors are most important to them? Is a formula emerging for success? Is the art of picking winning markets becoming more of a science? Examining how builders choose their markets, and talking with economists who generate the statistical portraits of the markets, reveals a great deal about the values of a company and the way economists are betting this country will develop.

Dan Flynn, director of land acquisitions of the South Coast division of John Laing Homes, also looks beyond the common wisdom when selecting sites for the Newport Beach builder. “Most people will tell you that [in Southern California] there's Irvine Ranch and Ladera Ranch, and that everywhere else is built out,” he says. But California's huge population growth, spurred by both internal and external immigration and projected housing needs, says Flynn, means that there will be an enormous imbalance between home supply and demand for years to come.

This encourages him to look beyond the obvious neighborhoods to underperforming land sites. “You'll see older, blighted warehouses or industrial buildings and strip malls that could be converted to residential or mixed-use purposes,” he says.

Deciding Factors Missing from many “hot market” lists are the subjective factors that drive an individual company: its strengths and personality. “A lot of [successful strategy] has to do with what you're good at,” says James Burns, a real estate consultant in Los Angeles. “For some, it's land development. Others are more comfortable with infill.” For this internal assessment—akin to a personality test—Burns maintains a list of 52 criteria that he suggests builders evaluate. “I probably add two to four criteria every time I look seriously at a new market because new issues arise,” he says (see “Gauging a Market's Strength,” page 56). His and other firms, including The Meyers Group, have built a cottage industry collecting and making sense of local economic and housing-related data.

With so many subjective variables, how can builders know which key criteria to focus on when choosing target markets? The factors influencing where Americans will live in the next few years, say most builders, remain a weighted blend of job and population growth, transportation issues, income levels, education, demographic factors, and housing affordability. However, as the scale of investment for land inventories continues to rise for big builders, so does the demand for trustworthy market forecasts for increasingly smaller geographic areas.

Enter the economists. Mark Zandi, chief economist at in Philadelphia, is one of a growing number of economists specializing in metropolitan area market forecasts. Zandi has gained a reputation for discerning the underlying forces driving local economies—and housing in particular, even though his conclusions are noted for being less optimistic than the majority of housing economists.

What Kind Of Jobs? Zandi says he focuses on population growth, migration, income, and wealth. “That's what drives an economy,” he concludes. “Ultimately, you're asking, ‘what drives housing permits?' ” he says. “The bottom line for builders is where the greatest number of housing permits is located in their price range.” And to arrive at the wealth creation, economists return to employment growth. “Fundamentally, we have to ask what jobs will be created and why,” Zandi concludes.

More fundamentally for the future, says Zandi, is determining the source of jobs in that community. Are they high-paying jobs from defense, health care, and universities? Or are they manufacturing jobs, which might be lost or shipped overseas? Permits reflect what is happening today, he emphasizes, but they give little indication as to why and whether that trend will continue. To build on a solid foundation for the future, says Zandi, builders must understand whether a job or housing permit trend will continue. That rests on what is driving the local economy.

Philip Hopkins is the managing director of U.S. regional services for Global Insight, an economic forecasting company born from the merger of DRI and Wharton Econometrics Forecasting Associates. He takes a similar view but slices job and population data into a number of weighted slivers in determining which markets will grow faster than others. For instance, he tracks the growth and percent of employment represented by the private and service-producing sectors as well as an index of a market's economic structural diversity. Las Vegas, for instance, is booming, he says, but cautions that “If the gaming industry slows down, Las Vegas obviously suffers.”

“The presence of a university,” he notes, “provides a steady labor force and a diverse source of jobs.” To the extent that universities can keep their graduates in town, the spin-off of small businesses is seen as a buffer against an uncertain future for sectors like manufacturing, where the future may be cloudy. “Think of Detroit and the automobile industry,” says Hopkins. He also tracks the presence of “the creative class” in a given market—a term coined by Carnegie Mellon researcher Richard Florida three years ago to capture the upwardly mobile, highly educated residents who create vibrant cities and influence median incomes and housing prices in and around those markets.

Stanley Duobinis, who was the NAHB's director of forecasting for almost 10 years before leaving recently to start his own company, Crystal Ball Economics in Millersville, Md., also focuses on where the jobs are and will be, looking at the types of industries that will grow over the next 10 years by major market. Those factors include anything that relates to health care; serves the retiring baby boomers and educational services; and serves not only the children of the boomers but also the boomers who are brushing up on new skills and interests. In fact, a growing number of university towns have become magnets for active-adult communities as well as hot spots for housing expansion (see “Booming University Towns,” below).

Driving Forces Duobinis focuses on another driver: the one behind the wheel of a car, trying to get to work. One critical issue sometimes overlooked is commuting distances and times, he says. There might be tremendous job growth in a city, such as Washington, D.C., but people grow weary of difficult commutes.

His own recent move illustrates how commuting dynamics are driving opportunities for many builders. It took him an hour and a half to commute into the capital, no matter whether he commuted by car, train, or Metro, he recalls. Eventually, he decided to stay home in rural Maryland and build a bigger house that could accommodate his home office and new company. Faced with long commutes, people with wealth and the luxury of choice will either change their location or change their job, says Duobinis.

Thus, he says, job growth statistics are best examined in conjunction with commuting distances. Only then can home builders understand not just where people will work, but where people will want to live. While he deplores builders who “force people to live in remote suburbs, because that's where the builder can get a permit for big expensive houses,” he acknowledges—from his big expensive house—that people are drawn to open spaces, good suburban schools, and cheaper houses on the region's edge.

The average American's commute is 26 minutes. So if a builder wants to know where to build, one good strategy is to look at where the jobs are and build within a 26-minute commute of them. That's what Tim Kane, president of MBK Homes, does.

“Jobs and housing are so much of a cliché that people forget about real-life applications,” says Kane. “We have built on sites in inner-city locations that other builders have passed up on because the neighborhoods look rough. But we saw the number of jobs offered within a 20 minute commute of that location and we sold out. It's the jobs, stupid. If there are jobs, there will be home buyers.”

Kane, whose company builds exclusively in Southern California, is so convinced that jobs and commuting time are the cornerstones of a successful community that he overlooks many other indicators, such as crime or poverty, that frequently deter builders. “Five or six years ago, we bought a community whose front had a junk yard; the other side had a liquor store whose cashier stood behind two-inch thick Plexiglas,” he recalls.

“We hired someone to do the demographics, jobs, and commute. Twenty minutes away, were there jobs?” Yes. “We gate-guarded the community and built there.” The community sold well, he says.

Kane says he thinks traffic congestion, not land shortages, is one of the biggest problems for California's future growth. “Unless we solve the freeway and commute issue, it will affect the value of our housing,” he states. “It's purely and simply a time issue.” Builders must get involved in improving traffic flow, just as in the pioneer days when investors looked at building bridges over rivers. Today, they look at toll roads or additional freeway lanes. “Either way, you have to cross to the other side,” he said.

In some cases, builders such as MBK are working with employers to create housing closer to the jobs. “We're in the infant stages of working with several state universities to build faculty housing on university land,” he says. “Land is so scarce here in Southern California and housing is so expensive that a professor thinks, “ ‘I might be paid more in Los Angeles, but the higher salary might not cover the difference in cost of living over, say, Madison, Wisc.,'” he says. A university will tell MBK what their professors will be earning, and MBK will come up with a house that will fit that budget, says Kane, noting that the university donates the land.

Different Strokes But the focus on employment growth should not be myopic. John Laing's Flynn says that “Quality of the land and site is the biggest factor” in selecting what land to buy.

The focus on employment may underestimate the buying power of retirees, who make up an increasingly important slice of home buyers. They want easy-to-maintain and typically less expensive housing without sacrificing elbow room for visiting grandchildren. That has made places like Colorado, Idaho, Utah, and New Mexico more attractive to people 65 and older. Each of those states saw its senior population grow by at least 6 percent between 2000 and 2003, placing it among the 10 fastest-growing states for that age group, according to Census Bureau figures.

But even then, MBK's Kane maintains employment data is a good barometer for this group. Many retired seniors want to live within an hour or so of their families, he notes. “Where do the children live? Near their jobs,” says Kane.

No matter what the forecasts suggest, however, there is always unpredictability—especially in dealing with the permitting process, observes Hopkins, who has a degree in city and regional planning. “I've been to my share of subdivision site-management meetings,” he sighs. “The outcome is always uncertain.” That's why housing starts remain one of the most important barometers of a market's potential. These are places where builders are actually getting permission to build, he says.

“Maybe the [number of housing starts] doesn't mean much in terms of number of units, but it tells you where the upscale houses are going to be built,” Hopkins says. “That's where we believe that construction is most likely to take place.”

While the numbers hide a bit of uncertainty, Hopkins knows one thing: The key to success is not a good betting strategy, but a good management strategy. “A well-managed builder could build in any one of these MSAs—if he found the right niche—and do well,” he says.

The Talent Factor Betting on the right markets is especially important for acquisition-minded builders. Market selection is difficult, notes Los Angeles consultant Burns, but it is much easier integrating acquisitions once the decision has been made. “I have found that the builders who are methodical about their choice of markets, and who devote significant internal resources to due diligence, usually end up with fewer surprises and better returns. There are many companies in our industry who are excellent at entering new markets, and there are a few who are absolutely miserable.”

Meritage's Landon knows what he wants to see when he enters a market, and it's not in the numbers. “Top local-management talent,” he says, is among the biggest magnets for Meritage, citing the company's acquisition of Citation Homes in January as an example. Southern California had all the basics: attractive demographics and solid employment characteristics for the foreseeable future. “We needed to be there, through startup or acquisition,” says Landon. Finally, in Citation, they found the right team and are ready to go. “We like the people, we like what they've done, they liked what we'd done, and we thought there was a good fit,” Landon says. The same holds true for the southern U.S., especially Atlanta and Charlotte, he says. “We'll be there through acquisition or de novo,” he says, as if the market chose itself.

Finally, he adds, it's not as if the indicators always paint a clear picture. Take Denver. “We've been looking at Denver for a long time,” says Landon. First, it got too hot. Then it cooled off. Now it's heating up a bit. “It might be a good time to enter,” he muses. Meritage wouldn't look at the largest builder, he says, as the chances of growing it are much less. But a small acquisition—say, the tenth- or twentieth-largest builder—might be just right. “We could double the size of their business,” he predicts.

He rattles off details about Denver's new airport, recreational activities, the major sports leagues, and the mix of businesses, including energy, tourism, and technology, which shows signs of renewed growth. “It's not something you can touch or feel,” Landon says, nor is it in the numbers. Picking markets for Landon still boils down to this: “You just have to find the right people in the right place at the right time.”

Meritage's market analysis ultimately led the builder to expand its roots into Denver, it announced last month.

Gauging A Market's Strength Real estate consultant James Burns groups his target market criteria into 10 broad categories:

  • Geographic and cultural synergies—including local business practices and ethics and consumer home buying attitudes.
  • Land quality—including land availability in desirable lot widths and soil and entitlement issues.
  • Depth of demand—by price point and household composition, from renters to luxury buyers.
  • Company acquisition possibilities—from established relationships with synergistic companies to whether or not bidding wars are occurring.
  • Management depth—assessing the ability to relocate your current management to hiring local expertise, including consultants.
  • Job base growth potential—gauging the outlook on major industries to pro-business attitude of local governments.
  • Construction quality—determining the availability of qualified labor force to “friendliness” toward construction-defect lawyers.
  • Competitive assessment—from core competencies and ancillary services (mortgage, design centers, etc.) of builders to voids in the resale market.
  • Housing market cycle—tracking construction volumes to affordability levels and home equity.
  • Customer relations—gauging loyalty to local brand names to J.D. Power scores.
  • LAS VEGAS, NEV., leads the list of 317 metropolitan markets projected to have the strongest growth in private and service-producing employment over the next five years. COLUMBIA, S.C., is among the fastest growing college towns in the United States. ATLANTA, which will lead the nation in new home starts over the next five years, according to Global Insights, ranks twentieth among metropolitan markets projected to have the strongest rates of population growth over the same period.

    Learn more about markets featured in this article: Los Angeles, CA.