Builder of the Year report: Toll Brothers - new guard, new era, more success

Financial Conservatism with Access to Public Markets

Being a publicly traded company has numerous benefits, chiefly low-cost access to capital. About the time Hurricane Katrina hit New Orleans in the late summer of 2005, Toll Brothers executives, says Bob Toll, began “seeing the movie” they had seen preceding other downturns. Beginning in 2007, they scaled back their land purchases and they continued to do so for two or three years, at the same time selling homes on existing lots. Through that process, the company built up its cash position from approximately $600 million to nearly $2 billion, says Connor.

Toll Brothers City Living: A Commercial Construction Powerhouse

In 2004, Toll Brothers ventured into a segment of the residential construction business that few traditional production builders dare to enter — inner-city mid- and high-rise living. The company’s first foray into urban multi-family development was the 325-unit, 17-story Sky Club luxury complex in Hoboken, N.J., which sold out in two years.

Today, Toll Brothers City Living has projects in half a dozen metro markets throughout the Northeast, including Manhattan and Brooklyn in New York; Hoboken and Jersey City in New Jersey; and Philadelphia. Recent projects include The Touraine, a 22-unit building in Manhattan that sold out in just four months; 205 Water Street in Brooklyn (see pictures), which sold all 65 units in a year; and 1450 Washington Street, a 157-unit development in Hoboken that is nearly 80 percent sold out.

The company’s move into urban living was spurred by the up tick in the number of past Toll buyers that, upon becoming empty nesters, were downsizing and moving to more urban areas.

The division has grown to represent about 15 percent of the company’s home-building business, and CEO Doug Yearley is looking for that piece of the pie to stay strong.

“It’s largely an untapped market for us across much of the country,” says Yearley, adding that a major source of revenue growth for the company moving forward will be expanding its diverse set of products, including urban living, to more divisions.

“We’re not looking to acquire builders or open new divisions,” says Yearley. “We plan to grow organically by expanding our product offering to more divisions — where it makes sense, of course.”

As a public company, they had for many years created a massive pool of liquidity by selling bonds and staggering the maturity dates in a process called laddering. Their cost of borrowing hundreds of millions averaged near 6 percent throughout most of the toughest years for home building. Furthermore, with all of the company’s cash on hand, Toll was one of very few builders that was able to consistently maintain a significant line of credit during the downturn. Currently, a consortium of 12 lenders around the world maintains a $900 million facility with the company. Toll’s head of investor relations and SVP of finance, Fred Cooper, says the firm tapped that credit line only sparingly, as a function of facilitating land deals as the market began to hit bottom.

Perhaps the crowning achievement from a financial management perspective came late this past summer when the firm successfully accessed the convertible bond market in a $287 million deal that was announced just after Labor Day. The terms were 0.5 percent interest (one-half of one percent) over 20 years. Bond holders are betting that the stock price will grow 50 percent in the next five years enabling a potential 10-15 percent overall return. Not only was it a huge vote of confidence in Toll Brothers’ stock, but it also showed investor confidence in home building generally.

Builder of the Year: Through the Years

1966 William J. Levitt
1967 Eli Broad
1968 Ray Watt
1969 Donald Scholz
1970 Trammell Crow
1971 George McKeon
1972 Robert Winnerman/Charles Rutenberg
1973 Raymond L. Watson
1974 David G. Fox
1975 Philip J. Reilly
1976 Bob Schmitt
1977 George S. Writer, Jr.
1978 Richard B. Smith
1979 Guy Odom
1980 Ray Ellison
1981 None
1982 William Lyon
1983 Tawfig Khoury
1984 Nash Phillips/Clyde Copus
1985 John Crosland Jr.
1986 Arthur Rutenberg
1987 Ralph and Goldy Lewis
1988 Bruce and Robert Toll
1989 Peter M. Ochs
1990 David M. Weekley
1991 Ralph Drees
1992 Joseph Duckworth
1993 John Wieland
1994 Robert Strudler and Isaac Heimbinder
1995 Millard Fuller
1996 Philip Dion
1997 Sarah Peck
1998 Tim Eller
1999 D.R. Horton Inc. (first corporate award)
2000 The Olson Co.
2001 Pulte Homes
2002 None
2003 Hedgewood Properties
2004 WL Homes (aka John Laing Homes)
2005 Bigelow Homes
2006 Simonini Builders
2007 Shea Homes
2008 Veridian Homes
2009 Legacy Communities
2010 Jagoe Homes
2011 DSLD Homes
2012 Toll Brothers

These are the advantages of being a publicly traded home-building company, particularly those companies that are well regarded by the investor community. John Burns, the respected head of the real estate consultancy that bears his name, recently blogged about the huge advantage public builders have when it comes to accessing low-cost capital.

Of Toll’s convertible bond deal, Burns said, “To our knowledge, there are no restrictions on the use of this cash. In the meantime, private equity requires a minimum 20 percent annual return for their equity investment, and debt costs most private builders 6 percent to 16 percent. How in the world is a private builder supposed to compete with a builder whose cost of capital is that low? The answer — they can’t compete head-to-head.”

But the benefits of being a public home builder did not always seem so clear in 2000, when public builders were trading at sickeningly low levels versus earnings. At the time, dot-com stocks were taking all of the air out of the room. Home-building stocks were respected only as trading vehicles to be held during an upturn in housing and sold soon after.

IR chief Cooper took the time to explain, to this magazine, the error being made by investors in thinking of home-building stocks this way. Way back in 2000, he pointed out that leading home builders like Toll had become more professionally managed, that they could weather the downturns and emerge on the other side making profits. Neither he nor anyone else knew the extent to which this theory would be tested. But, by and large, Toll Brothers did exactly what they said they would do.

Operating on an October 31 fiscal year, Toll this year is likely to show an increase in revenue of 40 percent or more, with commensurate growth in profitability. And with all of that capital behind them, they are uniquely positioned to buy more land. On top of owning or controlling perhaps the best land positions of any builder, they get to see all of the deals and to be selective, notes Yearley.

A recent analysis of land holdings by John Burns Real Estate Consulting ranked top builders according to the quality of their land holdings. They call their analysis the Submarket Desirability Index. The higher the index, the better the land positions. Toll Brothers came out No. 1 in this analysis, followed by M/I Homes, Ryland, PulteGroup, K. Hovnanian, Meritage, Beazer, Standard Pacific, Lennar, D.R. Horton, NVR, KB Home, and M.D.C. Holdings to round out the top 13.

According to Yearley, this enviable bank of land is less about a grand plan than it is about the aforementioned rigor they apply to buying it. If anything, he says the company may have missed some opportunities in California in the early 2000s when they shied away from deals in markets where prices kept escalating. For him, it goes back to the company’s innate financial conservatism.

“We have always had cash,” says Yearley. “Marty’s predecessor, Joel Rassman, as the CFO of this company, was so conservative. We were always looking to do the next bond deal, even though we did not need it. We were always looking to expand our line of credit, even though we did not need the money. That has allowed us to look at deals when others were tightening up. As a result, we’ve grown after every recession.”