Homebuilder Investment Methodology Explained

Home builders are poised to take advantage of soft market conditions to bridge a stronger, more successful company.

One-size-fits-all advice on managing your way out of the soft conditions isn't useful, as the markets and builders are experiencing different levels of pain. Public builders are absorbing their losses against years of accumulated profits, while private builders are writing checks to move inventory. The private builders therefore tend to procrastinate in making the corrections needed to improve their position and ready themselves for growth. But procrastination prolongs the agony and may also sideline builders from participating in the eventual return of mergers and acquisitions.

The acquirers are motivated by their desire for growth, and builders saddled with an inventory of overpriced homes and lots will not be attractive candidates. The most desirable candidates will have trimmed their inventory, reduced their staff while retaining key personnel for the growth mode, accessed capital for opportunistic buys that position the company for strong growth and demonstrated the ability to respond to market conditions.

Investors are looking at buy-ins in which they recapitalize the company based on its real value today at better terms than bank debt. As pricing adjusts, some will also provide funds for opportunistic land buys. The exit strategy can be a sale of the company to a third party, or either party may buy out the other. In these deals, a solid management team is essential.

Also, principals need to evaluate their commitment to the business and consider spending a portion of the retained earnings or even liquidating semi-personal assets bought when the business was flush with cash. We urge our clients to proactively meet with their lenders to review strategic plans for bridging the slowdown and renegotiate borrowing terms.

In good times, making decisions with old data isn't great, but in a soft market it could be disastrous. Decisions need to be reviewed daily, and managers need one- or two-page summaries to monitor the company's vital signs. Use this time to upgrade reporting capabilities.

Our consultants advise frequently updating the competitive analysis and pricing one home at "ugly" to test the market. Pricing can then be increased in $2,000 increments on successive homes until the house doesn't sell. This approach is superior to dropping prices $1,000 at a time until something sells if you want to find the market price and move your inventory.