Digg This
Talk Back
Post a CommentMost Recent Post
(Jul 22 2007 1:47PM)
Read all comments (1)
|
||||||||||
HousingZone Most Popular Stories
- Decked Out
- 5 Markets to Watch
- Sound Retreat for this Year’s Giant 400
- 2008 Professional Builder Giant 400 Survey Results
- Housing demographics and homebuilders: An overview
- Great Kitchens and Baths Score Points with Custom Home Buyers
- Homebuilders can build an affordable green home
- Beyond the Deck
- Master Suite Design Celebrates Outdoors
- Weighing the Pros and Cons of Decking Material
Capital Structures Determine Builder Strategies
John Burns
June 7, 2004
HousingZone
 |
 |
To help you distinguish your firm, here are what I have found to be the three primary categories of medium- and large-sized builders:
1. IRR-Driven: Many of the larger privately owned builders work with investment advisors, especially if they do land development. Investment advisors are companies that raise money from institutional investors such as pension funds. These institutional investors expect a return on their money that is commensurate with their risk. They look at home building and land development as a means of diversifying their investments.
For builders driven by IRR (internal rate of return), each deal needs to stand on its own. Timing is also critical. Builders with IRR-driven investors frequently need to prove to their investors that the market is likely to appreciate over the next few years, and that the revenues can be achieved in a short time period. When recent appreciation has been strong, the capital is easy to raise. When recent appreciation has been weak, the funds are more difficult to raise. I like working with IRR-driven clients because their investors usually ask the tough questions and need someone who understands economics, finance and marketing.
2. Wealth-builders: Most of the smaller privately owned builders -- and some of the very large land development companies -- have a long-term perspective. While these builders and developers manage cash flow very carefully, they are more concerned with building wealth over time than meeting monthly goals. If they have already accumulated wealth, these builders can buy land and hold it for a long time if the market dictates. If they are lucky, they have found investors with the same goals. Wealth-builders are some of my favorite clients because they have long-term strategies and do not have to respond to the whims of outside investors, newspaper reporters or stock market analysts.
3. Predictable, Growth Companies: Publicly traded home builders are the only home building companies that need to behave like other industries. Shareholders of publicly traded home builders want predictable, growing earnings, just as they expect from their investments in companies such as Microsoft and General Electric. Their goals are as follows:
- Grow:
- These builders need to increase the number of homes sold, which they accomplish by entering new markets and increasing their market share in existing markets. If it makes economic sense to reduce the number of homes sold in a particular market, investors typically won't understand and their stock values will decline. The best builders find ways to grow without taking significant risks. This might include building in submarkets all over the region and targeting a wide variety of consumers, from entry-level buyers to urban mid-rise buyers to active adult buyers.
- Increase profits: In addition to growing revenues, public builders need to focus on increasing profit margins on each home sold. They reduce costs by perfecting and then reusing floor plans and taking advantage of purchasing economies of scale. If market area home prices appreciate between the date of land acquisition and home sales, these additional profits are just "icing on the cake." The best builders reinvest the "icing on the cake" back into the company to streamline operations, improve future profit margins and position the company for success in the event of a housing market slowdown.
- Be Predictable: Public builders also need geographic diversification so their earnings are not significantly impacted by changing market conditions in a few regions. Diversification poses many challenges, however, including managing a large, diverse business and consolidating financial statements. For medium-sized companies, the additional overhead needed to manage the company can sometimes offset the economies of scale, which is why these builders don't always like to compete with small builders in areas such as Atlanta. Predictable, public builders are growing into new markets, allocating land acquisition capital to the markets most likely to appreciate, and increasing their diversity within markets. They are generally less willing to take significant risks. For example, unentitled land is usually not a large percentage of their balance sheet and debt is usually less than 60% of the balance sheet.
The publicly traded home builders are also very creative, so their individual deals may have IRR-driven or wealth-building structures.
I enjoy working with these clients because their management teams usually include some of the brightest individuals in the business. ConclusionsIn summary, it is important to articulate your capital structure. If you are IRR-driven, emphasize the importance of generating profits as quickly as possible. If you are wealth-driven, emphasize your willingness to take risk as long as it is a good long-term strategy. If you are publicly traded, emphasize your need for growth and predictability. By articulating your capital structure, investors, employees, suppliers, subcontractors, land brokers and others can help you achieve success. John Burns publishes three free Building Market Intelligence e-mails each month: U.S., Local and Strategic. He helps real estate executives develop and execute strategic plans, conduct market research and maximize profitability.
© 2008, Reed Business Information, a division of Reed Elsevier Inc. All Rights Reserved.