The Housing Chronicles Blog: Big builders must get out of land development, economists say

Monday, April 28, 2008

Big builders must get out of land development, economists say

Economists Carl Reichart (Wachovia) and David Goldberg (UBS) contend that the nation's largest homebuilders need to get back to their roots as manufacturing companies and continue to pull back from land development, which ties up capital and reduces potential efficiencies. From a story in the Nation's Building News:

The large, public builders will have to consolidate operations and focus more on construction than land development or risk facing “hyper-competition” with each other that could prolong the downturn, Wall Street analysts said at NAHB’s Spring Construction Forecast Conference in Washington, D.C. last week.

The analysts, Carl Reichardt, Jr., with Wachovia Capital Markets, LLC., and David I. Goldberg, with UBS, also said that widespread acquisitions and bankruptcies among the big builders were unlikely as a result of the downturn ― even though the big builders compete with each other in nearly every major market in the country and their overall market share has shrunk from a peak of 26% in 2006 to about 20% today.

The big builders currently operate in 78 metro markets. Ten or more big builders are competing against each other in 19 of the markets and at least six big builders are competing in nearly half the metro markets.

Reichardt said the top public builders have increased their liquidity during the downturn and are beginning to reduce their “store” count — the number of communities where they operate.

But he added that they still risked remaining in a price-based competition with each other that would “mute the recovery” and “compound the cyclical excesses” largely because most of the big builders based their run-up during the boom times on land and are in too many markets.

Goldberg said the public builders have “cut prices pretty drastically” to reduce their inventories, but that during the boom years most of the builders got more involved in development and buying raw land.

“The industry must change,” Reichardt said. "Right now, the home building industry is a land-based business.” The large builders, he said, must “shift back to their core markets” and core competencies of “building and contracting.”

Reichardt said the builders could have to get out of land development and adopt a “land lite” business model.

“The home building industry is really a manufacturing industry,” Reichardt said, adding that he hoped the big builders would “reinvent themselves by focusing on processes and efficiencies.”

Going forward, Reichardt and Goldberg said that land development might eventually be conducted by developers partnering with “land finders” — people with enough money to invest in land development. Both said there were enough land investors waiting for the market to turn...

Goldberg said the tighter lending standards now in effect will drive less liquid builders out of the industry, but that the public builders will be able to survive.

Reichardt said the downturn is pushing the big builders and the home building industry into a period of slower long-term growth and lower returns. "The growth phase will be much slower,” he said.

In the short run, Goldberg and Reichardt both expect the big builder share of the market to shrink, but they said that, over time, their share would begin to increase again.

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