Here’s How To Manage a Top 50 Home Builder

Implications:  Let’s suppose you bought an 8 year supply of land at the historical peak of the market both as to land prices and annual housing production.Further, let’s suppose that you have positioned yourself to develop a wide spectrum of commercial and industrial property types in many multi-phase developments of generally world class size.This housing market and any coming slowdown in commercial and industrial development are going to lengthen your estimates.Looks like you’re going to be working on these deals across a number of economic markets before you’re done maybe as much as twenty years out.Now from time to time too you may not have ready to go land inventory or local conditions may not be favorable for development where you chose to buy some time ago.You may have to dip into the then markets for even more land because some if not most of your former plans didn’t pan out.That old inventory you bought is beginning to smell a bit and if not is sure getting old, but you may be generally underwater on most of it so a disposition is out. The one thing you must always have is current earnings.Once you lose momentum, it’s over for you.So what to do?

Analysis:

Well, what you do is do it all over again times 2 or 3 so you can outrun that old stuff which is holding you back.Since you’re a high adrenalin type and pride as well as the financial markets and other factors will not allow you to back away to live another day or to let the next generation live another day, you go for it.You get a hold on your board and you kick it up.A good PR Guy and a willing auditor will get the Press talking about you as a hero.You agree that assessment is true and go even harder for it.After all, you’re reporting good numbers and you’re going to fly right over and past that old nasty stuff.You’re a hero again and seen as a man who can rise above adversity.After all, there are any number of investors who will disregard the underlying if you can get the revenues rising and the earnings up to boot.

Here’s some history.The cross-collateralized, corporate credit, full recourse Canadians burned the West over 30 years ago to their chagrin.The Japanese followed up with nationalized and interlocked credit to spend on concepts so foreign to the market in the States as to be laughable.The Savings and Loan hysteria followed close behind and the FSLIC/FDIC swept up somewhat later.Each of the periods has been characterized by one or the other modification of the situation painted in the paragraph above.Pride and ego cannot be overcome.The current equivalent to the Canadians, Japanese and Savings and Loans are the top 50 Home Builders and their investors.Adrenaline is flowing and the teams are running hard to overcome a market which gets less attractive every moment.I notice that the Press is recording every nuance as being the tipping point to housing health.If willpower alone will do it, we’re a cinch to overcome.

I don’t think it’s going to happen.Our country’s financial condition is not good and getting worse.We’re not paying the bills on a current basis and we can’t sustain interest rates at the current low levels.Granted that the Democrat in the White House if elected may not be able to raise taxes much without knocking the whole thing out, we just are going to have to address our issues without continuing to promote housing, automobiles and consumerism as the solution.Raisng tax revenues through non-consumer business profits is probably the only way to really do it.

The affordability issues in our housing markets can be solved by raisng wages.But we’re not competitive internationally now and our weak dollar is only beginning to bring our balances closer to favorable.If we accelerate housing to sustain the current price levels, we will just delay the inevitable.

So how does it all end?In another time and another although related industry, I’ve been near there.Back around Jimmy Carter time, Charlie Knapp left as I remember Salomon Bros. like a lot of other smart, successful guys, and took over as CEO at a small financial conglomerate in West Los Angeles.The company was at best a lackluster hodgepodge - almost every one of the various businesses was going to fail or grow slowly.Charlie developed a plan which was to get rid of all but one of the businesses, a mid sized Savings and Loan.He would grow the Savings and Loan right past the problem of borrowing short to lend long which was going to bust the thrift anyway if he did nothing.He had to do it quickly and he didn’t have much to do it with except the capital from the sales of the other operating entities.So he went to the wholesale markets for insured deposits at any price and to the residential and commercial real estate loan markets to generate the fees which would sustain earnings.He’d worry about loan quality and continuing loan production volumes and cost of funds later.Charlie’s board stamped the plan and the auditors agreed and the Press was full of “typically brilliant Charlie”.That running took about 4 years and Charlie got the assets up from about $ 1.8 billion to $ 32.5 billion.The loan portfolio was chaos, the loan growth slowed, Charlie’s barking didn’t get the cost of funds down and profits ended.The resulting failure was then the largest historical failure of a financial institution.The equity investors lost their position to the FSLIC and the country paid off the insured depositors.

I don’t really see any difference between Charlie’s plan and the plans of the aggregate housing market.The die is cast – you’re going to fail if you sit still with a big land inventory – so the only solution is to outrun it with a bigger bet.I think lots of the top 50 are making that plan in some manner and will execute it as 2008 nears or begins.I don’t think the housing market will support any but the occasional isolated such plan.So I see a failure of the builder community in general as 2008 proceeds.That failure will bring a sizable residential land inventory to market and the inventory of existing homes listed for resale will climb.As I’ve written before, home prices and land prices will adjust by a significant factor, we’ll recapitalize, pick up the pieces and restart again.The old equity will be lost and the new opportunists will be large and in charge.  So be it, I believe.