Out of the furnace of the six-year housing meltdown has emerged a new breed of home builder—a hybrid infused with private equity funding, private builder agility, and access to low-cost capital thanks to the power of Wall Street ticker symbols.
These newly minted hybrid builders have advantages that many builders with older business models don’t have. First and foremost, they have money. Many were rescued by private equity funds that imparted them with capital to survive and to start reinvesting in land. Public stock sales will further fortify these builders’ cash balances, giving them the ability to borrow low-interest, long-term capital.
Second, most are free of legacy burdens leftover from the crash because they are either brand new or essentially new companies, their debts cleared by bankruptcy and/or paid off by private equity investors.
Tri Pointe Homes is a new company formed by three former William Lyon investors. So is the New Home Co., established by Larry Webb, former CEO of John Laing Homes. A group of investors severed Taylor Morrison from its British parent company, essentially creating a new company as well.
Meanwhile, William Lyon Homes, WCI Communities, and Orleans Home Builders received private equity help—plus trips through bankruptcy court—to render clean financial slates.
When the home building market crashed, the public builders seemed to hold all the cards. Most had coffers of cash and the ability to borrow more by selling stock or issuing bond debt to help them weather the storm. And then, as the storm abated, they were able to buy desirable land at cheap prices.
Many privately held builders, on the other hand, were cash-poor because their sources of capital—mostly banks—fled the sector at the first signs of distress. Many were left with nothing but the executives’ personal savings. Many of these privately held companies died—or were on the verge of death.
That’s when private equity, smelling the opportunity to buy low and sell high, moved in. But undeveloped land is an illiquid investment, so private equity needed the experience-rich, cash-poor builders to build and sell homes on the lots as the market improved.
Many home builders were skeptical. Private equity money comes with strings attached, higher costs than bank financing, and often a shorter shelf life. To some, private equity firms were viewed as vultures, ready to feed on their carcasses. For a fair number of these builders, there was no choice but to sign up for private equity help or fold. Over time, these builders became inured to the private equity participation in their businesses.
“I think we were the necessary evil,” says Jim Bagley, who works for private equity investor Encore Funds to help identify land assets for investment. “I think over time they realized we weren’t the villains we were made out to be.”
As the market turned upward, banks continued to not lend to builders. So, private equity investment has became necessary for private builders to compete with large public builders, some with $1 billion–plus war chests.
“Because the land game is being dominated by the publics, [private equity help] is the only way you are going to be able to afford ‘A’ lot locations,” Bagley explains. “Otherwise, you will be relegated to the [less costly] ‘C’ locations.”
For William Lyon Homes, a Newport Beach, Calif.–based firm with decades of experience, private equity provided a life preserver. The company—cash-starved but with excellent land assets in California—in 2009 received an infusion of operating cash from Los Angeles–based Colony Capital. But as the bear real estate market dragged on, Lyon continued to struggle, even as it bought good lots.
By late 2011, as its cash fund fell into the red zone, more private equity came to its rescue. Luxor Capital Group LP and Paulson & Co., both New York–based firms, as well as Colony Capital took stakes in the company, putting the builder through a quick bankruptcy reorganization that cut its debt and refinanced what was left. The Lyon family invested $25 million into the company to keep a 20 percent stake. As part of the bankruptcy deal, the private equity investors built in an a clause requiring the company eventually go public.
In April, William Lyon Homes announced it would offer stock and become a publicly traded builder again under the WHL ticker symbol. The move came in the wake of Tri Pointe Homes’ well-received initial public stock offering in January, followed by Taylor Morrison, making it clear that Wall Street again has an appetite for home builders.
Ultimately, transforming a private builder into a publicly traded company offers an exit vehicle for private equity investors to harvest the value of their investments. “They don’t wait around for the low returns,” quips Bagley.