Ch-Ch-Changes

Just gonna have to be a different man.

Time may change me; but I can't trace time.

David Bowie’s hit from the ‘70s could be an anthem for the current times. Companies have been forced to adjust, adapt and ally in ways never envisioned before. Take a look at how some companies are making the change...

• Pulte (for sale housing) appoints Avalon Bay CEO (for rent housing) to its Board of Directors. Could this portend a move into rental housing for volume builders?

• National homebuilders Lennar and Toll Brothers open real estate investment funds for distressed properties. Evidently, REO = ROI.

• Westinghouse teams with Lennar on solar homes. Too bad “Sun City” is already trademarked.

• Panasonic considers building smart homes in one of their Japanese factories. An app is sure to follow.

• The Bill & Melinda Gates Foundation funds a $42m initiative to reinvent the toilet. No kidding. Talk about being flush with money.

• Google invests $280m in SolarCity to help homeowners put in solar panels. And, they’ll know where and how you spent every kilowatt.

• DR Horton launches new micro-home project (Division 43) on a 1/3 acre, urban infill site. No job too small for this industry giant.

• SunCal trades development services for 180 acre tract of land. Why buy when you can barter?

Market Update- May 2010

Tell the Troops: The Battle's Not Over

Had an interesting discussion with a Division President of a high volume, national builder. One of his employees recently requested a raise and the Division President was trying to determine market rates for her position. In the course of our discussion one thing was clear: his team had been selling, building and closing lots of homes this year, due in part to the (now expired) homebuyer tax credits. Increased sales and a return to profitability– no wonder employees are thinking it's time to ask for a raise. However, no one should be misled into thinking things are "back to normal". Potential challenges remain, lurking like a storm on the horizon. No one knows for sure whether the storm will pass by or head straight down Main Street.

Therefore, this Division President continues to manage his overhead judiciously which doesn't leave much room for pay raises. However, he can't assume his employees are tracking the economic forecasts like he is. The take-away: Now that the home buyer tax credit window has closed, it's a good time to remind your team that our industry is a long way from being out of the woods. As much as raises might be deserved, survival is still the name of the game and that rumbling in the distance might be thunder. Managing overhead and expenses today might well fund shelter from the storm tomorrow.

Upbeat Attitudes at Spring ULI

Wow! Talk about turning a 180– the energy and attitudes at Spring ULI in Boston were a dramatic improvement from six months ago. With a nod to the conservative forecast above, no one dared claim victory over the recession. However, it was clear that deals were being done, people were busy and there was plenty of forward looking discussion. The one which caught my attention more than any others was given by James Chung of the consumer research firm, Reach Advisors. Some highlights:

Asian American, Hispanic and Mixed Race families will experience significant growth in income, home ownership and as a percent of overall U.S. population. In terms of income earners, Asian Americans will pass White families as leaders of the pack.

Gen X buyers place far more value on community attributes than premium home features. However, they were not afforded the same income opportunities early in their careers as their Boomer parents. Therefore, builder must adapt their product and communities if they hope to tap this segment.

Today, women with equal education earn 79% of what their male peers earn. However, within the next ten years women will earn 1.5 times more than their male work peers. Women are already earning 100-120% of what their male counterparts earn in certain cities. The residual effect is that many of these women will continue down career paths for longer periods of time meaning longer time before marriage and starting families.

White (non Hispanic) families will decline as percentage of population growth and income leadership. In terms of income alone, Asian American families will become top earners yet their percent of homeownership is (today) far lower than their White counterparts. Hispanic families will also see a notable increase in home ownership potential.

To see the complete presentation, drop me an email or visit the website of Reach Advisors.

Market Update- Sept. 2009

My partners and I continue to field some form of the question “Do you see things picking up?” If only the answer were as simple as “yes” and “no”. Here’s some random observations of what we’re seeing and hearing:

Yes... there has been an uptick in activity and to some degree hiring. Is it an indicator that our industry is heading into recovery? Honestly, it is too soon to tell. Let’s face it: the market went into panic mode a little over a year ago. Since then, there has been little activity of any kind. Call it a market paralysis. Wait long enough and sooner or later someone will have a hiring need or want to invest in something. That is what I think we’re experiencing now... an uptick spurred by pent-up demand and special programs rather than signs of recovery, especially on the hiring side.

Meanwhile, banks are still sitting on real estate debt like chickens waiting for eggs to hatch, hoping something better looking will evolve. Add to that the commercial real estate loans that will soon need to be renegotiated amid an environment of stricter loan-to-values and declining appraisals. Can a recovery really get a fresh start with baggage like that? We’ll see.

On a more positive note, the builders and developers who have survived the write-downs and still have money (or lines to money) are on the hunt for land. In the past week we’ve heard reports of one builder staffing eight land acquisition positions and another looking to staff three or four in the coming months. Once again, we see this as the payoff for a few fiscally conservative players rather than an indicator of long term recovery.

At the market level, former Division Presidents are starting their own companies with subordinated lot deals through developers they know. The big question is whether the banks will play along when real debt is needed once again.

Yes... some positive things are happening. Let’s celebrate the small wins when and where they surface. However, I wouldn’t be too quick to order a cake.

ULI Fall 2009 Meeting Highlights

Just returned from the ULI Fall meeting in San Francisco. The event was well attended by approximately 6000 real estate professionals. Speakers included a wide range of experts such as Ivy Zelman (a leading research consultant on homebuilding), Ron Terwilliger (retiring Chairman of Trammell Crow Residential) and Bill Emmott (Editor in Chief at The Economist). If I had to summarize what I heard in two words it would be “jobs creation” as the key to a sustainable recovery. Here are the quick takeaways:

The Economy

• Non-performing loans continue to rise, trailed by a similar amount of loans “at risk” due to slow/no payment.
• Inflation will rise from 1% to as high as 3-5% in the next five years.
• Of the thousands of ULI professionals surveyed during the Fall meeting, 65% feel the recovery will be a “broken W”... meaning a long trend line of improvement on the back side.
• Some of the positive rebound we’re seeing could be due to recovery from an over-correction of the markets, stemming from last year’s panic. Companies rushed into cutbacks in starts, staffing and budgets to counter the situation and quite possibly– cut too deep.

Unemployment

• We’ve lost 8mm jobs over the last two years. It is critical to the recovery that we have a public policy that fosters jobs creation. Buy-side programs like Cash for Clunkers and the current tax credits for home purchases, while helpful, will not sustain a recovery over the haul; reducing unemployment will.
• A significant portion of the unemployed will not be re-hired into the same roles. Instead, new roles are likely to emerge over the next three years that may not exist today.
• It will be late 2013 to early 2014 before full employment recovery occurs.
• The good news: we still have over 100 million people who are employed and need places to live. While they may be more cautious now with their buying decisions, it doesn’t replace the fact they still have needs. For several years now the American consumer has lived beyond his means and now must pay the bill. The days of consumers buying on a lark or without making comparisons are long gone– which most experts agree is not necessarily a bad thing.
• Recommendation: train your salespeople to diligently counsel buyers, arming them with convincing data on why it is in their interests to buy now vs. later. Salespeople should be experts on every facet of homeownership, tax credits available and mortgage programs.

Residential leads the Recovery

• Housing was the first sector to take the hit and will be the first out to lead a recovery. Extension and expansion of tax credits certainly helps, but once again “jobs” are the key to sustaining a long term housing recovery.
• Equally important is the ability for builders to obtain AD&C financing, especially for the local and regional builders. The public builders left standing have far greater resources and can afford to sell at near break-even margins in order to ride out the downturn. This places significant pressure on the smaller private builders, who absorb higher costs across the board but are unable to recover those costs through higher pricing.
• Expect the public builders to aggressively buy-up the majority of finished lot inventory in major markets– even if they already have ample land on their balance sheet. Strategy will be to sit on any raw land on the books and hold for long term recovery while building out newly purchase finished lot inventory. This too will put additional pressure on local and regional builders who lack similar resources.
• In spite of the bleak economic news, demand for housing will remain. Expect a 13% increase in housing starts in 2010 and higher numbers in 2011 and 2012.
• Recommendation: Smaller builders need to demonstrate a unique selling proposition to the customer in order to counter price differentiation with the big builders. Higher grade amenities alone may not accomplish this due to appraisal difficulties (more on that later).

The Lender Side

• Government sponsored financing at both the consumer and banking level, has “bought” us some of the recovery.
• Moving forward, two options appear to exist: Option 1. The more government aid is utilized to bolster banks, the longer the recovery process will be– albeit with less pain. Option 2. The sooner foreclosures are dumped on the market the faster recovery will occur– accompanied by more immediate pain and bank closures.
• 5.6 million mortgages are in imminent foreclosure or "at risk", meaning 60 days past due. If all of them reach foreclosure, home ownership will drop to 63%. This is no longer a sub-prime issue, as 41% of these mortgages are prime, non-jumbo loans.
• In spite of the government sponsored modification program, only 9% of delinquent loans reach that process.
• Bank failures will increase as the Fed becomes more confident in the economy and therefore, less willing to extend support.
• As more banks fail, the FDIC will struggle to absorb the losses and will require additional governmental support.
• Problems with commercial real estate loans are just now beginning. (The graph one economist used to show the potential debt “at risk” was downright shocking; imagine a trend line that shoots straight up in one year– in this case, 2010.) This becomes a potential cancer on the balance sheets of banks; whether or not the cancer is curable will vary with each patient.
• Pension Funds and Insurance Companies are in better shape and should recover slowly over the coming year.
• Whatever the timeline is for recovery, some banks will opt-out of real estate lending altogether or, limit their loan portfolio to projects with shorter time lines for completion. Speculative projects or those early in the entitlement and planning process will have a much more difficult time getting funded– banks will foresee too much potential for problems before build-out.
• Recommendation: builders with should approach their lenders with multiple solutions in hand. Don’t wait on them to help you figure it out.
• Recommendation: offer to help lenders workout their other problem projects, either on a fee basis or as help-in-kind. This might also give you the inside track on short sell opportunities.
• Recommendation: of the deals considered for acquisition, avoid the ones requiring preliminary approvals or which required significant debt commitments. Look for the “A” projects further along in their life cycle so you can hit the ground running.

Appraisal Challenges

• New appraisal processes are stripping new home values of value-added features such as lot premiums. Instead, appraisals are being made on a strict price per square foot basis without much consideration for upgrades or lot premiums.
• Recommendation: Builders must rethink their pricing structure if their product or community relies on upgrades or lot premiums as a profit tool. Simply put, the new appraisal environment focuses heavily on straight price per square foot formulas.

Your Last 25 Years in Home Building

Several weeks ago we shared our observations of how the home building industry has changed over the last 25 years. Several of you replied back with you own thoughts. Here's what you had to say:

What I've noticed is more volume builders coming into smaller markets displacing what had traditionally been local builders. I can see a scenario where large portions of a number of markets (even small ones) will belong to volume builders because they don’t face the financing hurdle independent builders do. As I sat at the Presidents round table at a recent State HBA Meeting the remarks from the group had more to do with the inability of their members to get financing (even for presales) than anything to do with their local associations.My sense is that the volume builders will (fill) this void and for the next few years, back away from performing their own development as they capitalize the hoards of developed lots that the developers (or the banks) could never sell to independent builders and will likely partner with developers in the future with some sort of profit sharing agreement – more like merchant banks. — Eric Coffey

I hope that effective construction management will not come solely from the colleges and universities in the future; it just cannot take the place of progressively developed sensibilities in the builder/developer environment. This is a profession requiring the broadest skill set of any I know. — Bill Mayben

I’ve been disappointed at how conventional most builder/developer firms became. Many companies just followed other builders, or a formula– resulting in a series of paint-by-number projects and homes that the consumers ultimately put in one category, and compared solely based on price. In an effort to appeal to the broadest customer base it appears that real innovation and evolution took a back seat. Now, with nobody to copy, they are really stuck. Many actually believe the market will return to what it was, and that they can continue as they were. It appears that the company that is able to innovate may capture the market again. This speaks well for creative architecture, evolutionary home and community design and specification, and offerings that can make a long-term positive difference in the lives of residents. — Bill Mayben

The most important changes I have seen involve the “standardization” of housing plans, specifications, processes, budgeting, workflow, measurement, organizational structure, training, customer relations, and an attempt to commoditize land. As Standardization starts to merge with Centralization of processes and decision making, the opportunity for smaller homebuilding firms to tailor their product offerings and business processes for targeted consumer groups will allow them to compete effectively against larger public competitors. — Peter Tremulis

You were spot on with some of the critical path and relational selling methods that evolved over the years. As you know, some of the "tried and true" formulas are no longer in play. What happens next? Who is seeing around that curve into the future? One small example, how does social networking play into the sales process? — Nelson McDonald

The profile of a Sales Consultant has changed. The top sales professionals today are people who ask the right questions and listen to the answers. Trust is the essential component to build the relationship between customer and Sales Consultant. If a salesperson does not have great listening and problem solving skills, today’s customer will not bond with them. This isn’t much different than what salespeople seek from their own managers. I have interviewed hundreds of Sales Consultants over the years and NEVER has one of them said they want to leave for more money. They want to leave because of how they are treated. It saddens me when I hear about managers who don't value their people or take time to coach their team. It is a talent that is needed to keep a happy, productive and energized team in today’s market. — Millie Regal

In my early years, I kept knowledge of my college degree between my production manager and myself (he also had one). Very few others were college graduates. That changed in the 1990s to being a “must have” requirement for being hired. The same happened on the sales side, too. In prior years, a real estate license would suffice. Design Centers came on the scene as revenue and margin generators. Lastly, the life of a good floor plan grew shorter each year, as new designs & features were demanded. Who would have imagined granite as standard in a Fox & Jacobs home? — Jerry Whelan

Volcker hit the nail on the head. Business school majors are now either all Finance/Accounting or Marketing - very few in Purchasing, Supply Chain, Operations or Management. Everyone wants to “make it” by “manipulating minds or money.” No one wants to produce anything any longer. That is a huge problem. — Scott Sedam

I remember hearing from "old timers" after the crash of the early 80's that business would never be like it was in the mid to late 70's. They were right – it was better. Then came the calls in the early 90's that business would never reach the prosperous levels of the mid to late 80's. Right again they were ­– it was significantly better. Remember just a few years ago when there weren't enough qualified people around to build the record number of new homes people were bidding up to buy? Now here we are again. Let's just hope that by the time history repeats itself (again), that we've regained a degree of balance at the decision making table. Because without expert input from real home building experts, it could get awfully costly to learn that houses don't just build themselves. — Joe Keppler

There seems to be a significant push in our industry recently to have better systems and processes to compensate for a perceived lack of understanding of what really drives our business: people! There are those who think that if we have the right “Manual” we should be able to execute and achieve success. Instead, the focus should be on culture, training, and enabling people to make decisions, learn from their mistakes and take care of the customers. — Name withheld by request.

The Internet has changed everything. Buyers are more educated than ever and probably know as much about the product and community as the sales agent greeting them. Sales agents need to be perceived as more of a resource in the process (and heaven forbid they actually BE a resource!) Going Green is another big change. Builders must be thinking and building this way (and communicating it better to the marketplace) to be competitive ... especially in the higher end product. Home designs are also getting more and more "open" with space emphasis in the master suites, kitchens, and family rooms. Curb appeal is more important now than ever, certainly more so than in the 1980's. Lastly, master-planned communities have become the best opportunity for a builder to sell real quality of life as a value. This also forces builders to get back to the core of our business– building homes for families, instead worrying about dividends and stock price. — Shane Johnson

What is truly amazing to me is how little we have changed in 25 years. My first computer weighed about 50 pounds and cost $3,200. Today, that computing power can be purchased in any simple electronic device weighing a pound or two at a cost of $200-$300. During that same time, we have not made comparable advances in the homebuilding industry. We still build houses primarily with 2 x 4's, and we waste interior space like crazy. Our energy efficiency is laughable. No other industry would have survived this long without changing their product more than this, and (shelter) is the most important commodity there is, besides food and water. — Ken Mitchell

Our industry has transformed into a “Starbucks” environment (one on every corner), with more of a focus on absorptions rather than profitability. — Eddie Servignon


The Talon Group
Bob Piper, Rodney Hall, Tony Cleveland & Jean Mason
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25 Years in Home Building & Real Estate

The New Year is a landmark for Talon as we begin our 25th year in the search business. During that time our industry has taken quite a ride: the meltdown of the '80's, followed by boom times in the '90's and now the current state of affairs. Here are some of the changes we've observed during that time:

The Career Track to Division President. In the 1980's, most Division Presidents for home building companies were promoted through the construction ranks. By the mid-90's, the shift was on to promote finance and accounting professionals to profit center roles. Today, you would be hard pressed to find a DP with an early career in construction. This brings to mind something Paul Volcker said in his speech at the Spring ULI meeting: "Over the last 30 years our colleges have graduated far more financial engineers than civil engineers. Perhaps that is one of our problems." No question that home building has become BIG business, but somewhere along the way, the drive for volume and revenue seems to have replaced the central theme of our industry. Perhaps that is why we often define volume in terms of closings or units, rather than houses.

Builders became Developers. Most builders in the 1980's focused exclusively on bricks & sticks; land development was left to development companies. Builders who bought and developed raw land were rare. A divisional pretax profit in the $3-5mm range was quite respectable. Then, the '90's came along and volume builders discovered they could better control their pipeline by developing land in-house. The additional land profits didn't hurt either. Soon, single market divisions were generating $10-20mm in annual pretax profit, with a few mega-divisions hitting $50mm+. Of course, what takes you up can also take you down. The root cause of financial failure for builders in the late '80's and again in recent years had more to do with land than it did bricks & sticks.

Path to Riches: When we first started recruiting Division Presidents the compensation packages were fairly consistent: $100-125k base + 100% bonus. "Gee whiz," we thought, "can you imagine someone making $250k just to run a home building division?!?!" Of course, once builders began developing land and generating profit, as described above, the compensation plans began to look like third round NFL draft money. Of course, that's now changed - again.

From Critical Path to Relational Selling. The sales blueprint 25 years ago was the Critical Path: Meet & Greet, Qualify, Demonstrate, Site & Close. Salespeople were counseled to NEVER deviate from this time-tested model. That lasted for 10-15 years, until someone discovered buyers were actually real people with opinions and feelings. Soon relational selling was all the rage, with a focus on building trust & relationships with prospects. It will be interesting to see how this evolves with the growing move towards online sales and marketing.

Your turn- what changes have you seen over the last 25 years?

The Talon Group
Bob Piper, Rodney Hall, Tony Cleveland & Jean Mason