Homebuilders Hoping Size Doesn't Matter

This post first appeared on Minyanville and Cirios Real Estate.

After nearly 3 years of bleeding cash, US homebuilders are on shaky ground.

The market for new homes is being decimated by rampant overbuilding during the boom, and by the flood of bank-owned properties now being sold on the cheap. Prices remain in free fall. Even as labor expenses and materials costs hover around recent lows, the business of building new homes is still broken.

But after 2 “positive” datapoints last week, and KB Home's (KBH) narrower-than-expected loss, many are wondering if the worst is now behind the beleaguered industry. Government-backed efforts to keep mortgage rates low and encourage home buying could save the builders. Maybe.

New home construction, for all its complications and intricacies, is a rather simple business: Sell homes for more than it costs to build them.

New homes have traditionally carried a premium to “used” ones; the median sale price of a new home is currently about 20% higher than that of one that's been previously owned. Builders relied on this premium to cover their construction and financing costs, not to mention to generate a healthy profit. But now that buyers can buy barely used houses at fire-sale prices, the allure of the brand-new is on the wane.

Here in the San Francisco Bay Area, banks are said to literally be giving land away for free: Builders will have nothing to do with it. The costs associated with owning improved lots (in other words, lots ready for the construction of a house) are too high for - even if they're offered for free. Building just isn’t an economically viable option - and it won’t be until housing prices rebound.

And that could take years.

Meanwhile, homebuilders like KB Home and rivals Centex (CTX), Lennar (LEN) and DR Horton (DHI) are struggling to rid themselves of unsold homes. Builders large and small are slashing prices, trimming staff, hawking vacant land for pennies on the dollar, and doing anything else they can think of to stay alive.

Many face an additional headwind this year: Tax rebates from previous operating losses will be drying up. Debt remains high, and cash is barely trickling in.

Ultimately, some big builders won't make it. The market, both for equities and default protection in the form of credit default swaps, is betting on Hovnanian (HOV), Beazer Home (BZH) and Standard Pacific (SPF) to be the first of the big dogs to fail.

Those hoping to survive are rapidly adjusting their strategies to adapt to the changing demands of the American homebuyer. As Minyanville's Terry Woo noted on Friday, KB Home's better-than-expected earings were partly a reflection of a switch to smaller, cheaper homes.

This is a positive trend: it's yet another indicator that Americans have a newfound love affair with thrift. And while we may lose a few builders along the way, I doubt we'll miss all those identical, pre-fabricated houses that had come to litter our landscape.



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Keepin' It Real Estate: Homebuilders Facing Extinction

This post first appeared on Minyanville and Cirios Real Estate.

For as bad as things are in the housing market, it’s remarkable that none of the country’s big homebuilders have gone bust. The industry’s resilience is a testament to how much money the firms raked in during the boom.

Just ask guys in charge.

The Wall Street Journal reports many homebuilder CEOs socked away such obscene amounts of cash over the past 5 years that they out-earned their Wall Street counterparts. As profits soared, Toll Brothers (TOL) CEO Robert Toll and his brother Bruce together took home $773 million, while Dwight Schar, chairman of Virginia-based NVR (NVR) earned more than $625 million from stock sales.

By contrast, vilified Countrywide CEO Angelo Mozilo earned a mere $471 million during the same period.

Sitting on huge -- but dwindling -- stockpiles of cash, big builders like DR Horton (DHI), Lennar (LEN) and Ryland Homes (RYL) have thus far ridden out the bloodletting. According to JPMorgan analyst Michael Rehaut, these 3 may yet see positive cash flow in 2009.

Their smaller rivals, however, may not be so lucky.

Rehaut predicts that Pulte Home (PHM) and KB Home (KBH) could see negative cash flow next year - and some analysts believe 2009 could finally be the year that weaker hands start to fold. Credit protection for Hovnanian (HOV), Standard Pacific (SPF) and Beazer Home (BZH) is trading like the companies’ failure is a foregone conclusion.

Meanwhile, one key characteristic of market bottoms is notably absent: Consolidation.

Just as strong American banks have swallowed up the weak, no meaningful housing market bottom will be found until homebuilders begin to feast on one another.

Let’s face it: We don’t need 10 different multi-billion dollar companies churning out indistinguishable cookie-cutter "mansions" on tiny lots in cramped subdivisions miles from the nearest grocery store. We’ve got our hands full already, thank you very much.

Yesterday, the Commerce Department said October housing starts registered the lowest reading since 1959. Since just 4 of the 10 builders mentioned in this article existed 50 years ago, it looks like 6 are pretty much dispensable.

To Bulldoze or Not to Bulldoze

The Wall Street Journal reports the idea of bulldozing vacant homes is starting to gain a bit of momentum ... below is a poetic take on the idea.

To bulldoze, or not to bulldoze, that is the question
Whether 'tis nobler for the financial system to suffer
The slings and arrows out outrageous building
Or to take tractors against a sea of unwanted McMansions,
And by destroying end them? To raze: to flatten;
No more, and by a bulldozer to say we end
The foreclosure and the thousand unnatural homes
That Stockton is heir to, 'tis a consummation
Devoutly to be wish'd. To raze, to flatten;
To raze, perchance to demolish: ay, there's the rub.
For in that shoddily constructed spec home what dreams may come
When we have siphoned off this mortal glut,
Must give us pause: there's the respect
That makes calamity of so long a bubble;
For who would bear the whips and scorns of oversupply,
The homies wrong, the proud homeowner's contumely,
The pangs of dilapidated roofing, the hot water's delay,
The insolence of reckless building and the spurns
That patient destruction of the unworthy takes,
When he himself might his demolition make
With a bare tract? who would writedowns bear,
To grunt and sweat under mounting debt,
But that the dread of Centex (CTX) after death,
The undiscover'd courtroom from whose bourn
No builder returns, puzzles the will
And makes us rather bear those abandoned homes we have
Than erect others that we know not how to sell?
Thus conscience does make housing experts of us all;
And thus the unnatural hue of vinyl siding
Is sicklied o'er with the pale cast of rows of twins,
And urban sprawl of great pith and moment
With this regard their profits turn awry,
And lose the name of action. - Soft you now demand for spec!
The fair Beazer (BZH)! Nymph, in thy orisons
Be all thy sins remember'd.