Housing's Underdogs Live On: Part 2

In the April column I tackled the notion popularized by some housing industry analysts and the popular press that large national home builders have advantages destined to render local and regional builders helpless and unable to compete. A couple of writers had suggested that by the end of this decade the nationals would own 75% to 99% of the new home market.

Also claimed is that the nation’s largest builder in 2012 might deliver more than 20% of new homes sold. That could mean 250,000 units or more. Given most large public builders’ habit of jamming at least 50% of their units into their fourth quarter, this would mean our largest builder would close about 10,000 homes per week for the final three months of its year, or 2,000 per working day!

Are these projections realistic? Could a new world order of total domination by national builders come about? In this column, second in a three-part series, we continue to examine key determinants of builder success in a market and assess who has the advantage, national builders or strong local and regional builders. Last month we looked at financing and people/ talent and established that overall, local and regional builders have the upper hand if they are willing to take advantage of it. This month we examine purchasing power, supplier/ trade relationships and land acquisition.

Purchasing Power

Let's first look at labor, an area most people don’t think of first when it comes to purchasing power. Here, the nationals have little advantage as not much true volume discounting goes on. The economies of scale normally found in manufacturing and distribution channels generally are not found on job sites. Besides, so many trades are tapped out. They can't take on more work. If you need significantly more labor, you usually have to hire another contractor. Life is certainly easier in the labor arena for the builder doing 250 units a year than the one doing 1,000. Smaller builders can be more selective as they rarely are forced into taking "what they can get." If anyone has an advantage here, it's the local builders, based on stronger long-term relationships.

When talking purely about supply of materials, volume does count. Most manufacturing plants operate under capacity these days, so ramping up is easy, and many manufacturers will do so at an attractive price for additional marginal income. Greater volume spreads their overhead costs and boosts their purchasing power. Likewise, any distributor or local supplier set up to deliver materials in quantity usually can deliver more volume without much pain.

For a vivid demonstration of this, simply pick the next five panel trucks that arrive on one of your sites. They will average about 75% empty. What does that tell you? So here, the nationals should have an advantage. If they buy 10,000 faucets versus the small builder’s 500, they get a better price, don’t they? It turns out to be a curious question because local and regional builders consistently tell me that they buy just as well as the nationals. They don’t feel they are at a disadvantage at all. The bottom line: A couple of percentage points on fixtures or carpets aren’t a huge factor in the overall equation.

Advantage: Nationals for materials (maybe), Locals/ Regionals for labor

Supplier/Trade Relationships

Where I see the major difference these days is in relationships, and I really hope the large national builders will read this and pay attention because few of them get this point and its implications. Generally, local and regional builders develop and maintain much stronger, more productive relationships with suppliers and trades than do national builders. The result is that local and regional builders often get first pick of the best trades and the best crews as well as significant additional "total cost/highest value" benefits.

This factor can add up to significant advantages in total cost to the builder. The nickel a sheet or dime a square foot that your hard-line negotiating strategy won can be lost 10 times over in quality, rework, warranty service, disappointed customers, lawsuits, etc. Further, the value added in terms of product and process improvement, trade-to-trade cooperation, training for your people, co-marketing strategies, etc., that you want and need (if you're smart) won't be forthcoming from your suppliers and trades. You don't get it without strong relationships built on trust.

Unfortunately, strained relationships and the lack of trust between builders and their suppliers and trades are still prevalent. I have written about this ad nauseam, so I won't belabor the point beyond this—the "my way or the highway" philosophy is just dumb. It's self-defeating. Any short-term gains are paid back in the negative many times over.

It seems that the locals guys - being, well, local guys - are much more attuned to this than the large nationals. They grew up in the community and have deep roots there. They don't expect to move on. They have to live with whatever they create. The result is that more and more, with a few notable exceptions, the best suppliers and trades prefer to work with the best local and regional builders.

Advantage: Locals/Regionals

Land Acquisition

Perhaps the biggest advantage of all falls here to local/regional builders. Three factors are at work - relationships, local knowledge and speed. Generally, locals have better relationships simply because they are, again, local. They get better inside information, and they get it sooner. And often greater trust exists among the local builders, brokers and land sellers in the community, not unlike the situation with trades. As a result, the locals often get the early line on the best parcels and maintain superior negotiating positions. A rather extreme example of this was Salt Lake City in the 1990s, when a large number of national builders arrived and departed in fairly short order primarily because of their failure to crack the local land network, which some have described as a cartel. They didn't have a chance.

The feasibility pro forma requirements of the nationals often translate into a speed advantage to local builders as well. Locals have little paperwork and no one in an office 1,500 miles away reviewing and approving their land purchases. They can move today! I am in no way advocating land purchase without a well-done feasibility study, but a local builder's process is less encumbered than the typical large national builder's.

Another significant advantage goes to locals in their willingness and ability to do smaller infill pieces. As people more and more resist moving farther out to mega-projects, infill is becoming a bigger factor. Anti-sprawl is a force to contend with. The smaller builder is thrilled with a few 20- to 50-lot hunks of dirt. Most of the large nationals are not interested.

The one clear advantage in the land arena that goes to the nationals is their ability to buy huge parcels for projects of 1,000 units or more. And a 1,000-lot parcel doesn't take 10 times as much work as 10 100-lot parcels. Some of this advantage is given back, however, through the nationals' desire to do such deals on a "take-down" basis, trying not to tie up capital in too much land inventory. Many land sellers abhor such deals.

Advantage: Nationals for mega-parcels, Locals/Regionals for infill and smaller parcels

So it looks like local and regional builders still hold the best cards. But we need to look at a few more important factors, such as market segments, performance culture and the impact of an entrepreneurial approach. Finally, what about the bottom line? At the end of the day, the key question is, "Who's making the most money?" You might ponder that and make your prediction.