The party started by the federal home buyer tax credit is over, and the quarter’s end found most publicly held builders suffering from varying degrees of sales slump hangovers and happy to see the tax credit gone.
"Frankly, I don't want the tax credits," D.R. Horton CEO Donald Tomnitz told analysts during the company’s quarterly conference call. "It's a lot easier to run a business and design a business on current demand" rather than to have to guess about the impact of the stimulus.
That comes from the builder who most likely garnered the most benefit from the tax credit, building thousands of speculative homes to capture as much of the refund-spiked demand as possible.
"We wrote every deal we could write by April 30," Tomnitz said. "If they had a pulse and they were warm, we wrote them." As a result, closings were up 60% for the year in its third quarter, which ended June 30. But sales have since slumped.
Tomnitz wasn’t the only one glad to see the tax credit gone.
"At some point the home building industry must recover on the basis of actual demand," said Ryland Homes CEO Larry Nicholson during that company’s earnings call.
"I don't know how much more we could do for this industry to keep subsidizing it," he said later in the same call in response to an analyst's question about federal stimulus. "I just don't think you can keep going along the way we have. I don't think you can keep Band-Aids on things. I think you have to rip the Band-Aid off."
Now that the Band-Aid is off, builders are feeling the stinging realization that no meaningful recovery is expected to happen in the second half of the year. No CEO was expecting the remainder of the year to be anything but “challenging,” which continues to be the most common word used to describe what’s ahead for the rest of 2010.
"For the back half of the year, based on what we know today, I think it would be ill-advised to plan for things to get much better, if at all," M/I Homes CEO Robert H. Schottenstein told analysts. "There is a significant lack of clarity. Things are very choppy now and are likely to remain so for at least some time."
Most economists say that what the economy in general and the home building industry in particular need in order to see better days is an increase in jobs. And that seems also to be the general consensus among CEOs commenting on economic conditions during the earnings calls over the past couple of weeks.
“When someone’s buying a home, they need to know they are going to have a job and know that the value [of the home] is going to be there,” said M.D.C. Holdings CEO Larry Mizel.
"History had it where housing led the economy into a slowdown and usually housing led it into recovery, and here it's a bit different," Mizel continued. "Other segments [of the economy] feel like they have turned around, and housing is a laggard."
"It's impossible not to acknowledge the weak market," said Standard Pacific Homes CEO Ken Campbell. "My view of the home building market, although I'm the new guy, is I think the job market has to improve before the home building market will. Any movement [up in sales] without jobs is a blip in my mind."
Since builders have little or no control over job creation, they are concentrating on keeping the lights on by selling what they can at higher margins. Many are looking to increase margins by improving processes and cutting costs, but the biggest margin booster on the horizon is expected to come from building homes in new communities where the land costs less.
Many builders gave progress reports on their efforts to increase the numbers of new communities they are opening and on the increased margins they are offering.
Companies that keep less legacy land appear to have an advantage in resetting their land holdings with cheaper land to boost profits.
M.D.C. Holdings’ new, smaller, more affordable, and more profitable homes on its lower-priced lots comprised 55% of all its home orders, 90% in some markets. Of course its land-light model makes it more imperative that the company reload its land quickly. It secured control of 157 new communities in the last 12 months, 36 in its second quarter.
Meritage Homes, another builder that didn’t have significant legacy land to work through, is already seeing strong margin improvements related to new community openings. Gross margins were up 18.3% for the second quarter compared with 12.3% last year. Roughly 20% of its second-quarter closings came from the newer communities.
Ryland Homes’ results show how being slower to bring newer, less expensive land online can hammer returns. Ryland lost $21.8 million, or $0.40 per share, in the quarter, and part of that was blamed on a 17% drop in community count.
Only 5% to 10% of its sales came from new communities, which are producing higher margins between 400 and 600 basis points. By next year, roughly 40% of the company’s closings are expected to come from new communities.
Buying land remains a strong priority for many builders, and some with huge war chests intimated that was what they plan to do with some of their cash. Analysts peppered builders with the biggest cash hordes, such as PulteGroup, Toll Brothers, and D. R. Horton, with questions about what they plan to do with all their money.
PulteGroup, which has $2.7 billion in cash, the highest in the industry, said company executives have been discussing that issue.
"We do think that any significant liquidity concerns for a couple of years are gone, and we are looking at funding something," PulteGroup CEO Richard Dugas said, adding his preference would be to put the money in more land inventory, though paying down debt is another option.
M.D.C’s Mizel was a bit cagier in his answer to the question about his plans for the company’s $1.6 billion in cash.
“We expect to use the resources we have in our business. This is a very opportunistic time in this industry, and we will not miss any opportunity,” he said.
Teresa Burney is a senior editor for BUILDER and BIG BUILDER magazines.