If strategic home builder mergers, acquisition, and overall consolidation had taken a relative back seat over the past couple of years to acquisitive non-endemic players from Japan or Berkshire Hathaway's Clayton Homes, U.S. strategics are fully back at the driving wheel now.
A flurry of 11th Hour--calendar year-ending--deals transferring capital and strategic support from heavyweight enterprises to nimble, reputationally strong private firms, reflect plans among strategists who may hope for the best in 2019 and 2020 and beyond, but are planning for something else. Something worse.
Yesterday, TRI Pointe Group announced the expansion of its workhorse Trendmaker Homes Texas brand to the Dallas-Fort Worth market via the $60 million purchase of Dunhill Homes [Builder 100 ranked No. 124] and its 55+ brand Nathan Carlisle Homes. Any day now, announcement that Toll Brothers will enter a big strategic capital structure with single-family rental up-and-comer BB Living is due, and we're hearing a number of large and small M&A deals may reach settlement in the wind-down days of December.
Big, well-capitalized players are shoring up their footprint, customer segment, operational, and investment models for a period of uncertainty whose lone, shiny bright-spot is a customer segment and pricing spectrum it takes a lot of discipline, relationships, and flawless execution to serve--the entry-level and lower-end 55+ community barbell segments.
As well, geography and its relationship to new regulatory barriers, soaring costs, and rising entitlement risk in new-home meccas up and down the West Coast has peeled back a new level of attractiveness to less cost-laden, fundamentally sound economies in Texas, the Carolinas, [where TRI Pointe recently launched de nova operations under the leadership of a regional over-achiever Gray Shell] and the Midwest. Whereas, overexposure and over-concentration in higher-risk, higher-end, higher-cost California and mid-Atlantic markets may subject builders' Wall Street share valuations to intensified scrutiny and second-guessing.
For acquirers and sellers alike, it's a moment, and whether they like it or not, the moment reflects primal, gut instincts and wagers around "downturn proofing" business, organizations, and capital investment. Buyers get to move chips into place to try to secure incremental unit volume capable of absorbing overheads and generating steady cycle-resistant cash, and do that at a cost that may have moved off peak land acquisition levels, and sellers get to take chips off the table for a possible period of financial hibernation, not wanting to subject their recently-found cash troves and their personal family assets to a housing recession's jeopardy.
Motivating factors--including a pall of uncertainty clouding capital lending and investment flow into acquisition and development finance for smaller, more personally-risky private company borrowers, a host of cost headwinds, a potential government shutdown, and continued opportunity at the low-asking price end of the spectrum--are aligning for a robust deal environment well into 2019.
Strategic buyer motivations--clearly brought well into focus with latest TRI Pointe deal--include:
- Exposure to entry-level, both household demographics and recent job formation data support continued demand, which will either be met with supply or revert to "pent-up" status if supplies of inventory in the lowest price tiers don't loosen up.
- Exposure to lower price points overall in economies of Texas and Carolinas. Again, both jobs and people have indicated a disposition to migrate toward attainability and a lifestyle that balances household means with housing value. This force will impact operational, land strategy, and profit-model focus for multiregional players over the next couple of years.
- Exposure away from California, the epicenter of stretched input expenses, increasing regulatory hurdles vis a vis 2020 solar mandate, scarce labor, and painful entitlement process. To date, builder returns on their investment against all of these costs have been healthy margins, but demand versus ever-rising asking prices has suddenly caved.
- Exposure to strong talent to reinforce existing leadership and operator ranks, reflecting one of home building's biggest vulnerability, a talent shortage. New acquisition models--especially well practiced by the Japanese and Clayton Homes--have begun to shift seller company valuations beyond their land assets to more intangible Intellectual Property characteristics of private company principals with track records of strong reputational relationships with trades, land sellers, and customers, and the way that can iterate as a pan-cyclical ability to create value. [Dunhill Homes ceo Rich Rodriguez, expected to remain as a TRI Pointe division leader for the Dallas-Fort Worth market, fits this bill to a tee.]
- One more consideration on the buyer motivation side is the inevitable "rising knife" of borrowing and capital costs. So, enterprises may be triggering a flurry of capital investments now using their lower-cost funds, knowing that their going to pay a higher price for capital as interest rates continue to climb.
As mentioned, seller motivations--which typically run the gamut from an aging principal's interested in a succession plan, to an outright exit, to an infusion of capital to extend a specific operator's runway for growth--have pivoted in tenor, from interest to urgency. At the same time, thanks to some of the combinations initiated over the past three or four years by Japan-based Sumitomo, Sekisui House, and Daiwa House, and by Clayton Homes, and owing to a host of challenges that make local relationships a lever to the kind of deep local scale big aquirers are trying to achieve, private builder operators have more say in what happens after they get bought.
Sellers, or those firms thinking about selling, are vibrating now over:
- Capital lending risk--particularly personally guaranteed loans--intensifies as market complexion changes.
- Land acquisition risk--as heavyweight builders concentrate in fewer more critical markets, smaller players get forced to bid higher for lots, taking them out of their IRR hurdle rate comfort zone, and jeopardizing their community offering business models.
- Subcontractor labor access risk--Deep local scale among mammoth players in a market drive complexity and cost into small companies' relationships with their trade base, marginalizing them because of less long-haul visibility into demand for services, and business stability for the trades.
- Opportunity to grow with deeper pockets, the upside for strong operators with great local intel into customers, land sellers, and trades, and the ability to model that capacity to growth in the next two to three years gives some private companies a critical moment to differentiate themselves from the pack in terms of valuation. There are probably two to three private operators--depending on market size and big builder concentration--remaining in the top 25 most active--non-California and other high-cost regions--home building markets, who could stand out from peers as particularly attractive to strategics right now.
- Further, while Clayton's own private builder shopping spree may have concluded in general, additional purchases are not out of the question, and we know that Japan-based companies, which continue to enjoy a disproportionate advantage of cheaper capital costs than U.S. firms, have yet to complete their portfolio puzzles.
Add, now, one less obvious but ever more important risk for private companies with hand-to-mouth capital structures: the lack of capital to access new productivity-improving access to off-site construction capability as integral dimensions of their operational model. This is an existential differentiator over the next two to three years.
So, we figure the year-end flurry of deal activity may only be the start of a more material accumulation of American home building power in fewer and fewer companies over the next 24 months.