Toronto-based Empire Communities adds Atlanta's Edward Andrews Homes to its U.S. group.
Toronto-based Empire Communities adds Atlanta's Edward Andrews Homes to its U.S. group.

2019 may not set up to be as robust a year for home builder mergers and acquisitions transaction as have the prior two or three years, but that doesn't mean buyers and sellers have called off the hunt for a perfect match here and there.

"More cautious," says Michael Kahn, the dean of all-things M&A in the home builder space for the past three-plus decades, and founding principal at Michael P. Kahn & Associates, when he describes the current big-deal-flow environment through the first quarter of 2019.

The cadence, number of bidders, and intensity of buyer motivation have slowed, as would-be acquirers try to curb their enthusiasm and become ever-more-measured in their interest and more precise in their calculations. Meanwhile, would-be-sellers look to mask the urgency of their need to find a willing buyer.

"It has to be practically a perfect deal to work," says Kahn, who nonetheless, has a few in the hopper for the coming months.

"Perfect" means two things these days, as headwinds and tailwinds fling forward momentum and near- and medium-term projections into a vacuum of uncertainty.

  1. Access to vacant developed lots, preferably positioned for entry-level, low-ish price-points, in a demonstrable economic path of growth, that will pencil with an acquirer's internal rate of return hurdle rates, operational footprint, and local scale.
  2. Access to superb operational talent that--if given an opportunity to "win" a market without needing to spend time and energy raising capital--can out-maneuver, out-grow, and out-perform local competitors in economically constructive markets and submarkets.

Those two criteria appear to be non-negotiables for a potential acquirer these days, especially since prospective buyers recognize that building clouds of uncertainty and doubt in the macro economy tilt the playing field in their favor in at least four ways:

  • One, is that upward pressure on borrowing rates makes both acquisition and development capital and project-level construction and operations financing more expensive for privately-capitalized builders.
  • Two, and related to the first, is that almost all of that bank financing comes accompanied by personal guaranties that expose borrowers to greater risk to their own money and assets should the market turn, pace slow, and the cash-flow spigot tightens from a stream to a trickle.
  • Three, concerns strict age demographics and the need for many multi-cycle entrepreneurial firm principals to execute on a succession or exit plan or both.
  • And fourth, for firms who're energized, growing, and have local mojo, the cost to compete in more and more markets with heavyweight big builders whose financial pockets run deep becomes more intense by the day, and they're paying for lots at retail at a greater and greater premium, so their motivation to align with a capital sugar-daddy may be rising to a crescendo.

Although, as Kahn observes, the pace of transactions, the number of bidders, the speed to letters of agreement, and the closing table final details have taken a decided step down from what it's been in 2016, 2017, and 2018, prospective buyers, strategic and financial, domestic and overseas-based, are still rumbling around, looking for both incremental growth opportunity and portfolio improvement in the near-term, and for structural, strategic strength over the longer-haul of a 2020s market expected to be buoyed as both Millennials and 55+ buyers play out their demographic hand in the 10 years ahead.

If you had to rank M&A buyers by the keen-ness of their interest in this market, strategic publics looking for lot price, customer segment positioning toward entry-level price points, pace and volume, and local-market scale probably would come in No. 1 among acquiring types. A close second would have to be foreign buyers--from Japan, Canada, and China--who are motivated by both by domestic demand constraints in their home markets and by favorable capital cost exchange rates that allow them to unleash money that may produce lower return rates thanks to the lower costs of debt in those markets.

Third, and always a wild card, is Clayton Homes, the Berkshire Hathaway operating unit, which completed three private-builder transactions in 2018, and--while it may take a breather to ingest, integrate, and optimize its 8-company portfolio--may have an appetite to add one or two companies to the mix this year as well.

Among the foreign powers flexing muscle at the moment, we're getting word that Sumitomo Forestry is actively on the hunt to get to its stated goal of building a $1 billion portfolio among its increasingly national looking North American operator group. As well, Toronto-based Empire Communities, with $225 million in backing from Washington, DC-based investment firm Carlyle Group LP, just closed on its expansion into the Atlanta market with the acquisition No. 14-ranked Local Leader Edward Andrews Homes (EA Homes), and word is another purchase may finalize within the next few weeks.

"We've been involved in what will work out to be six deals since the start of 2019," says Tony Avila, ceo of San Francisco-based Builder Advisor Group, which advised EA Homes and its lead investor Carlyle on the combination. "You're seeing drivers in the form of the ongoing scarcity in vacant developed lot supply in many of these markets, and the growing interest in top-grade operational talent, which is what we saw with the Empire investment in EA."

Avila would not likely contest Kahn's assessment that the M&A market is proceeding more carefully than it has in the few years past. What he'd contend is that factors that can make a deal fit--from a land asset, customer segmentation positioning, business culture, and management talent standpoint--have as many strengthening motivators as ever. "M&A is taking a prominent role in builder strategy in 2019, after a very robust 2018," says Avila.

Empire, which has been a Toronto-area local power since 1993, started as a de nova developer and builder in the Houston market in 2012, and launched the Empire U.S. brand in 2017, with the acquisition of lots in northwest Houston's Dellrose masterplanned community. It made its first acquisition in mid-2018, with the purchase of Austin-based Centerra Homes, which builds in Austin and San Antonio.

"The EA partnership allowed us a way into Atlanta with alignment with a company that shared Empire's focus on doing the right thing by our homeowners, associates, trade partners, land brokers, and, important local relationships at the munipal level," says Andrew Guizzetti, Executive Vice President and CFO of Empire Communities. "Atlanta, like Austin to some degree, is a maturing market, and you're seeing a similar kind of development and residential opportunity there that we've had a great deal of experience with in the Toronto market. The economies are strong, and the development patterns are following that suburban-urban hybrid people call 'surban,' community planning, with walkable, transportation-oriented, liveable neighborhoods. This type of growth is our forte at Empire."

Guizetti made clear that it's not just access to EA Homes' lot pipeline, which has them at about just over 400 closings in the market, or a 1.6% share of Atlanta's growing new home marketplace.

"The secret sauce is the relationships our partners have with local land sellers, real estate brokers, trades, and those area officials that make such a difference in what you do and when," says Guizetti. "[EA principal/founders] Paul [Corley] and Todd [Hager] have built a company that, as much as it's focused on customer care and operational excellence, it's also really got the feeling of a family company, which is what really attracted us, because that's what we've tried to build here at Empire."

In that sense--where human talent and local relationships matter to the acquirer at the same level of priority as the lot pipeline--"we see ourselves as not dissimilar to the Japanese firms that are finding partners to acquire in the markets, because they're looking for long-term, long-haul relationships rather than a quick incremental bump in volume," says Guizetti. "This is definitely not our last acquisition," says Guizetti. "We're working now on another one."

We expect M&A action through at least the mid-band of 2019, with a typical seasonal pick-up again just before the end of the year.