In 2017, the executive team at Dream Finders Homes in Jacksonville, Florida, began to put the infrastructure and processes in place to eventually launch an initial public offering (IPO). Over the next three years, the company worked toward that goal, but it wasn’t urgently striving to hit the public markets by a certain target date.
But in June 2020, Dream Finders executives decided it was time.
While it may seem odd to kick off the IPO process in the middle of a global pandemic, Dream Finders’ management team determined that the market was open for the company because of its asset-light model focused on entry-level homes in the Southeast. As the firm went through the process, home building multiples were improving through the pandemic.
“We always had it as a three- to four-year goal, but coming out of COVID, we realized the acceleration in the housing sector probably presented a good time to move forward with it,” says Rick Moyer, senior vice president and chief financial officer at Dream Finders, about going public.
After completing the Securities and Exchange Commission (SEC) process to become a public company, Dream Finders stock began trading Jan. 21, under the ticker symbol “DFH,” becoming the first home builder IPO since Century Communities in 2014.
When the shares were released, investors snapped up stock like it was a hot tech innovation from Silicon Valley. On its first day of trading, Dream Finders’ shares closed 61% higher.
The reception surprised many longtime public home builder watchers. The market is usually more cautious when small-cap builders, like Dream Finders, go public, according to Tony McGill, head of investment banking at Zelman Associates.
There’s little doubt that other private builders have taken note of that strong debut. “There are a handful of groups that are giving it a hard look,” McGill says. “Nothing is imminent, but that can change quickly. Dream Finders has a lot of people thinking more seriously about it.”
As other private builders look to accumulate land, scale up, and cash in on robust demand for new homes, an IPO could be one way to generate cash for growth. But there are questions about how long the IPO window will remain open and how many builders might try to push their way through.
Strong Investor Appetite
Dream Finders, No. 24 on the latest Builder 100 list, isn’t the only company to benefit from the white-hot home sales market of the past year. Since the stay-at-home orders were issued across the country in March 2020, home builder valuations have jumped. Two indexes that show the health of publicly traded home builders, the iShares U.S. Home Construction Exchange Traded Fund (known as the ITB) and SPDR S&P Homebuilders Exchange Traded Fund (known as the XHB) have jumped 184% and 187%, respectively, from March 23, 2020, to March 26, 2021.
While the strong home sales market is pushing valuations, it’s not the only reason. “Valuations in the space are also a product of all of the Federal Reserve stimulus,” McGill says. “Liquidity and yields are so low that the investment community is willing to pay today what they ordinarily would have waited until year two or three or more in the future [to pay].”
Jamie Pirrello, president of the Southeast and Texas regions at Century Communities—ranked No. 9 on the Builder 100—sees many of the same trends driving home building valuations. “Clearly, investors have felt good about the home building sector over the last year,” he says. “If you look at home builder prices, all of them have traded very positively. In that regard, for Dream Finders, it was a good time to go and it was smart of them to go.”
There were other factors specific to Dream Finders that set the builder up well for its public debut. For one thing, it has a land-light model that boosts valuations. Just look at No. 4 builder NVR, which has been trading at a premium to the overall home building sector for years.
“Dream Finders did well because it has a unique asset-light strategy that allows for a great return on capital metrics, which is what investors like,” says Drew Mackintosh, principal and founder of Mackintosh Investor Relations. “They had that niche of having a unique business model that appealed to investors.”
NVR’s success helped potential investors understand Dream Finders’ strategy. “There were a lot of discussions about the comparisons to NVR 25 or 30 years ago and the way we’re operating,” Moyer says.
The Florida builder’s focus on entry-level and move-up homes in Sun Belt markets that have been attracting new residents throughout the pandemic—such as Jacksonville and Orlando in Florida and Austin, Texas—also helped feed interest. “Our markets aligned very well with where the migration trends were headed,” Moyer says.
Still, despite the positive initial reaction, some analysts have concerns about Dream Finders’ valuation. In February, Bank of America slapped an “underperform” on the company because it anticipated that the builder’s valuation would “normalize.”
“We also believe that the valuation premium earned by the premier asset-light home builder, NVR, over the course of 20 years was driven by much more than its land acquisition strategy,” Bank of America said in the report.
The Time Is Now
Dream Finders’ IPO success certainly opens the door for more builders to go public. “I think the IPO window is wide open right now,” says Tony Avila, founder and CEO of Builder Advisor Group. “There is a big demand for public stocks right now, including builders.”
Margaret Whelan, founder and CEO of Whelan Advisory, agrees. “If there is any home builder that is interested in raising permanent equity and going public, this is absolutely the time to do it,” she says. “The window is wide open from a capital markets perspective, and valuations are high. They also have great business fundamentals in terms of pricing power, gross margins, and backlog growth, which is driving their cash flow and their returns. So it’s a very good time to think about going public.”
In 2013, the window for home builders opened when Tri Pointe Homes went public, and firms such as William Lyon Homes, Taylor Morrison Homes, WCI Communities, UCP, and The New Home Co. followed suit. The window then closed after the Century Communities IPO in 2014, and it remained shut until the Dream Finders IPO in January.
“The window opens, but it can just as quickly close,” Pirrello acknowledges. “If you’re a builder and you’re thinking about going public, you want to go fast while the window’s open.”
Many events might close the window. Avila sees too much stimulus money being pumped into the economy as a potential issue. If interest rates start climbing dramatically, monthly mortgage payments will inflate as a result. “If we see a significant amount of inflation and high-interest rates, that will dampen the demand for housing,” he says.
Affordability is another wild card, according to Avila. “Housing prices running up too fast can create a lack of affordability and the potential for a bubble,” he says.
Pluses and Minuses
Despite the path being paved for more IPOs this year, there still may not be a mad rush to the public markets. Sitting at the helm of a public company brings board and analyst oversight and shareholder interaction. That can be a tough adjustment for entrepreneurial builders who are accustomed to not answering to anyone.
“There are significant costs and governance required to be a public company, and principals ultimately have to decide whether or not they want to run a public company,” Whelan says.
Then there are the performance expectations. If you tell Wall Street you’re going to deliver a certain number of homes, you better follow through.
“You have to have the right operational processes up and running because once you’re putting out guidance on closing numbers, your ops teams need to make sure you’re getting the homes built and closed in the right cadence,” Moyer says. “Then, on the back end, you need the finance, accounting, human resources, and legal compliance set up to be a public company.”
Despite these extra hurdles, the benefits of being a public company outweighed the additional compliance for Dream Finders. There are reasons to believe other private builders will feel the same.
Tim Sullivan, senior managing principal for Zonda, thinks a few more builders will go public. “Going public offers a direct route to raising capital more efficiently,” he says. “It also raises the prestige of the company.”
Cheaper capital is an often-cited reason for doing an IPO. And there are tangible financial benefits. Whelan says the cost of equity for public builders is 9% or 10%, which is where the stocks are trading today. Joint-venture equity, on the other hand, costs about 20%.
“One of the reasons going public is so popular is because you get access to permanent equity, plus it’s substantially less expensive than private equity,” Whelan says.
While Dream Finders could raise a significant amount of capital as a private company, it was difficult to fund ongoing vertical construction and lot acquisition costs once it hit a certain scale. Not only was the company able to get access to public equity, but it also received an unsecured credit facility led by Bank of America with the IPO.
“It probably would have taken us a couple of more years to get to an unsecured credit facility, which just allows the company to build and start homes much more rapidly,” Moyer says.
If a builder wants to gain scale through mergers and acquisitions or land acquisition, it will need this efficient capital to compete. “We have a tremendous amount of capital looking to invest into the sector,” Avila says. “That creates a tremendous demand to buy companies.”
The Right Candidates?
With more IPOs possibly coming, the question becomes what builder profiles would make suitable candidates? A central theme in Dream Finders’ public reception was its land-light model. Mackintosh says he could see other builders with specific niches or “interesting operating models” hitting the public markets. For instance, investors may welcome a company, like Dream Finders, that can consistently produce homes for entry-level buyers.
Sullivan agrees, noting builders that have a “unique business proposition” in addition to significant land holdings and operational capabilities will make good public candidates. “If they only have land and have owners that want to cash out, then they are more of an acquisition candidate,” he says.
For builders of a certain size, an IPO could be a viable alternative to selling out to a larger company. In a market where it is already hard to find viable merger-and-acquisition targets, this could make it even harder for builders looking to acquire other companies.
“Could Dream Finders potentially make an IPO something that is a higher probability for a very small number of groups?” McGill asks. “It could, possibly, on the margin.”
Pirrello sees scale as the driving factor behind a possible IPO. “I don’t think a builder can go public right now if it’s a single-market builder,” he says. “You need more size. And you need to diversify the risk by having multiple markets. I don’t think you’re going to see small builders go public.”
To be a viable candidate for an IPO, a builder needs to be in the top 50 of the Builder 100 list, according to both Sullivan and Pirrello. “Given that a company needs significant size to grab attention in the public markets, it is unlikely that builders outside of the top 50 will make the move,” Sullivan says.
But that doesn’t mean smaller, fast-growing builders don’t have hope of being public one day. “To get a sense of companies that are not ready but may consider going public in the future, look at the builders that have gone from the bottom of the top 200 list and are rising fast,” Sullivan says. “They are also acquisition candidates.”
Whelan also sees a pretty limited pool of potential public companies. “The industry has been getting increasingly consolidated over the last decade,” she says. “There are not a lot of companies that would have the right scale or critical mass to go public.”
But for those builders with the right scale and critical mass, the time appears right to make a move. Investors are waiting.
“A lot of people are becoming more invested in the home building sector because of the macroeconomic forces—the millennials are coming of age and the baby boomers are moving into their active adult communities,” Moyer says. “There is a big multiyear demand cycle that needs to play out. I don’t believe that’s going away anytime soon.”
