Capital Funds Eye Homebuilding Firms

Questions abound in regard to resuming home builder merger/acquisition activity. When, what markets and who will lead the next wave of acquisition activity is just a sampling of what's on the industry's mind.

Meanwhile new capital funds — thanks to opportunities created from soft housing market conditions — are forming every day, leading us to wonder about the role they may play. Many representatives of funds, including "vulture funds," have approached MPKA looking for builders and projects in trouble. Even more are still developing their theses for investing, and some are considering acquiring control of a home builder as an approach.

Discussions with several fund managers pose reasons for concern here at MPKA. We're worried about the impact these new funds might have on an already troubled housing industry, including:

• Most of these funds are being run by young MBAs who have little or no expertise in home building or experience with economic cycles. The best recognize the need for support by seasoned industry professionals, but others reject guidance and intend to rely upon the "law of averages" to achieve their returns.
• The funds are generally attracted to companies in distress and the opportunity to participate in the potential upside. We see little focus on evaluating the effectiveness of the management team and the market realities. One significant investment was made in a market that was lukewarm while most were booming, and there is no evidence that this market is countercyclical.
• Money managers rely on assumptions and forecasting to make their investment decisions and will likely apply that approach to home building. However, there are few, if any, sources willing to predict the housing recovery on a market level, partly due to the difficulty in quantifying factors such as the level of investor involvement and actual inventory overhang in any market at a moment in time. The most sophisticated models are only as good as the data and assumptions that are input. We would bet instead on the seasoned team that knows the market and how to manage in a both halves of the housing cycle.
• There is a real question about whether a targeted builder is better off with an investment from one of these capital funds. Several public builders have defended threats from hedge funds that pressed for actions that would benefit the funds short term but weren't necessarily in the long-term interest of the company and its other shareholders. Also, some funds may be able to improve their investment position in a private company if performance doesn't improve. Will these investors be motivated to stabilize and expand that business?

These new funds control billions of investment dollars, which will be very appealing to builders operating in tough markets. This capital will look like a lifeline to companies in trouble in the current market conditions.

Whether these fund managers will also recognize the value of investing in or acquiring well-managed builders in desirable markets remains to be seen. HG