When a private home builder sells their company, there are numerous qualitative and quantitative factors that affect the price buyers are willing to pay.
Which Attributes Increase Buyer Demand When You're Selling Your Company?
Qualitative Valuation Factors
As a seller, you want to attract as many qualified bidders as possible. Multiple bidders create competitive tension that typically results in increased valuations and better transaction terms for you. Some of the key attributes of your business that will increase demand include:
1. Markets
Builders in primary markets such as Dallas, Atlanta, Phoenix, Charlotte, N.C., and Orlando, Fla., will draw the most bidders. In addition, large-volume builders have recently shown interest in the rising popularity of secondary markets, such as Huntsville, Ala., and Greenville, S.C. Recent deals in those and similar markets further underscore the consolidation trend and have created a window of opportunity for private builders in secondary markets to monetize their businesses.
2. Product and Price Point
You may be in the hottest market in the country, but if you’re building custom homes you will have a limited number of interested buyers and they will not pay aggressively. By contrast, builders that develop homes for entry-level or first move-up consumers appeal to a larger pool of buyers. Builders delivering homes between 80% to 120% of your market’s average new-home selling price will typically experience the most demand.
3. Your Team
A quality team always enhances a sale and is particularly valuable given our industry’s currently constrained labor pool. For buyers entering a new market, the quality of your team is critical to the prospective buyer for its existing relationships with local land sellers, trade contractors, vendors, and regulators.
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Quantitative Valuation Factors
After evaluating the qualitative aspects of your business, a potential buyer will use numerous valuation methods to determine the price they are willing to pay. These methods range from broad “back-of-the-napkin” calculations to detailed cash-flow models for each community and land parcels you own or control.
Typically, these methods triangulate to a valuation range that determines the price a potential buyer is willing to bid. Each buyer focuses on their preferred methods and metrics, but all are based upon key drivers that will determine valuation, most notably:
1. Margins
Profit margins absolutely matter. We are at a point in the cycle where builders of all sizes are currently delivering strong margins (see graph, below).
Source: S&P Global Market Intelligence and JTW Advisors – as of 8.31.22
But while profit margins play an essential role in a builder’s value, it’s not as simple as a higher margin driving a higher price. For example, a high-margin builder with just one to two years of land inventory may be worth less than a builder with average margins and six to seven years of supply. (For reference, U.S. public home builders currently have an average of 7.2 years’ supply of land.)
It is worth noting that once a big company purchases a smaller builder, the buyer takes advantage of its economies of scale to improve the smaller builder’s margins. The CEO of one large company told us they typically save 10% on “bricks and sticks” costs after purchasing a private builder.
2. Inventory and Pipeline
A builder’s land inventory is essential in determining the purchase price. Finished lots (owned or optioned) are more desirable to buyers than raw land … and buyers will pay a premium. Similarly, the majority of buyers prefer finished lot takedown deals to self-development deals.
Self-development will often result in better margins, but this comes with considerable risk and capital requirements for the buyer. Some foreign buyers are willing to assume these development risks to realize outsized margins, whereas most domestic buyers are not.
Owners of home building companies often ask us if they should tie up a bunch of land prior to selling their company. The answer is, it depends. Having a large pipeline does not ensure a significant premium. Remember, profit margins matter. If you rush out and overpay for land, no one wants to pay you a premium for that same land.
However, a buyer will be willing to pay you a premium for your lots and land if you contracted them off-market at attractive prices, created value through the entitlement process, or simply have a good basis because you acquired the lots and land several years ago and lot prices have risen.
Whether you are looking to sell today or simply considering your options for the years ahead, keep these factors in mind as you manage your business to maximize enterprise value. Private home builders that possess more of the positive valuation factors identified above will achieve a higher price in the market when the time comes to sell.
Chris Jasinski is managing partner and co-founder of JTW Advisors, a mergers and acquisitions advisory firm focused exclusively on the homebuilding industry. He may be reached at [email protected].
Ken McWilliams is senior vice president of research at JTW Advisors. Reach him at [email protected].