On the heels of 2021, one of the busiest years for home builder merger and acquisition (M&A) activity, the first half of 2022 remained busy despite signs of slowing market demand. Six transactions occurred in the first half of the year, including the acquisition of Chesmar Homes, the No. 40 company on the 2022 BUILDER 100 list, by Japanese company Sekisui House.
“Valuations are quite good for [companies] looking to get liquidity right now,” says Tony Avila, founder and CEO of Builder Advisor Group. “There’s quite a bit of capital looking to invest, which translates to attractive valuations for builders looking to sell equity interests in their companies.”
Avila and Margaret Whelan, founder and CEO of Whelan Advisory, say the strong demographics, rules of law, and the liquidity of the public housing sector in the U.S. are contributing to favorable conditions for M&A activity. Many public builders have large amounts of cash on hand and availability of credit facilities to provide the liquidity required to be acquisitive, which will support M&A transactions as rising mortgage rates contribute to the normalization of unit absorption for builders.
“[As] we see a more normal absorption pace, it gets a little bit more challenging for public builders to make what they were hoping to from a revenue and earnings per share (EPS) perspective,” Avila says. “But they do have a lot of capital to put to work. So we’ll look at mergers and acquisitions as a way to supplement public builders’ revised [lower] earnings to meet previously provided EPS targets and research analyst/Wall Street expectations.”
Whelan says the outlook for M&A in 2022 remains positive because of the continued robust performance and strength of the U.S. housing market, which is attracting interest from private equity investors, international investors, and single-family rental REITs.
“There’s still a lot of supply constraints, and it’s very hard to find good land positions,” Whelan says. “If you want to continue to grow and meet demand, to generate a profit margin that’s above average, and a return on capital that’s higher than average and higher than your cost of capital, then you’re going to want to buy companies that have what you want.”
Many buyers, in particular foreign real estate companies that have seen the U.S. housing market as an attractive investment, are not interest rate sensitive and are likely to be undeterred by mortgage rates surpassing 5.5%. Foreign buyers, such as Sekisui House, continue to see the U.S. market as a high-growth prospect and a way to diversify away from local economies.
“We do not see a scenario whereby there’s no demand whatsoever for these companies,” Whelan says. “The buyers who are thinking about [transactions], they’re still fully engaged.”
Despite projections that the sales pace will slow in the coming months amid rising rates and softening demand, the outlook for M&A activity moving forward is relatively unchanged. Some public builders may become “disenchanted” when their stock prices go down and hold off buying land or buying other builders in the short-term while they evaluate the market, according to Avila. However, many buyers remain “very interested” in pursuing M&A, and the number of completed transactions is not expected to deviate significantly from expectations in the second half of the year.
“Typically when rates are starting to go up and housing starts are dropping, the big builders buy their way through the correction period,” Whelan says. “[Big builders] are usually looking to fill a price point, a type of product, or a geographic market that they’re not already in or to fill out a gap they feel they have in their portfolio.”
Whelan says if there is a protracted slowdown in the market, with slowing traffic and sales and spiking cancellations, some private builders—many of whom currently have record-high gross margins, could get over-leveraged and reliant on unsustainable cash flow—may get distressed and look to sell.
“Some [private builders] are thinly capitalized, meaning they do not have a lot of equity on their balance sheets,” says Whelan. “If this downturn is protracted, and gets difficult, you could see some discounting, some distress from sellers. But there's not any indication right now that that is happening.”
