Consolidation Is Temporary

This article is part of a Point-Counterpoint report on consolidation in the home building industry. To see the Point, click here.

The Andersen Corporate Finance paper on housing industry consolidation and the conclusions it reaches fly in the face of recent data, years of study by industry economists and the history of past rounds of consolidation — all of which ended ignominiously.

The contention that the top 20 home builders will soon produce 75% of all new single-family homes is hard to fathom. Only about 1,000 builders in this country are producing more than 100 homes a year, and they represent only 39.9% of single-family housing starts. Small companies building fewer than 25 houses a year account for 38.8% of single-family starts, while midsize builders (25 to 99 homes a year) account for 21.3% of the total. Unless the top 20 acquire large numbers of builders doing fewer than 100 houses a year, in addition to all of the Giants, it’s hard to see how they can get to 75%.

Beyond that statistical quandary, it’s hard to view super-builders as the bastions of efficiency Paul F. DeCain describes. He writes that “operating and overhead efficiencies” and “significant land control” contribute advantages to large national builders over smaller regional competitors. To the contrary, operating inefficiencies, overhead burdened by excessive layers of management and large land positions are the Achilles’ heels of the big national builders, weaknesses that become more acute with every acquisition and that likely will doom consolidation when a major down cycle in new home sales tests the top 20’s mettle.

History supports this position. The top 10 builders’ share of single-family starts increased from 4.4% in 1974 (after the oil embargo re-cession) to 8.6% just be-fore the 1982 recession. The 1992 recession nipped consolidation in the bud, holding the top 10’s share to 4.7% that year. Since then, the top 10 have gained share — to 6.8% in 1996, 8.0% in 1997 and 13.4% in 2000. Meanwhile, the top 100 builders’ share of single-family starts increased from 19.2% in 1992 to 27.6% in 1995 and then declined to 25.8% in 1996 before increasing again to 28% in 1997 and 30.5% in 2000. When deep recessions hit, national builders hurt. The Andersen paper says Pulte now owns 87,700 lots, D.R. Horton 62,094, KB Home 46,705 and Lennar 57,817. That land will be a heavy weight when (not if) housing hits a wall.

The bulk of market share recently gained by the top 100 is concentrated in the top 10. The rate of growth demanded by Wall Street has forced public builders into acquisitions. The average annual production of the top 10 builders is now 11,000 units. The average acquired company does 200 to 500 homes a year. But such acquisitions might become more difficult to do. Many large regional builders recently have developed succession plans to transfer ownership to the next generation or key staff members.

Meanwhile, many public builders are facing desertions by division presidents who use the high salaries and bonuses paid by the publics to get into the building business for themselves. This argues against the efficiency advantages claimed in the Andersen paper.

Regional builders and small builders, with low fixed costs and smaller land holdings, are better set up to survive an economic cycle. Large land holdings can be a problem for any builder when sales hit the wall. History shows that recessions hit the public builders hard. Look at the Giants in 1970, 1980 and 1990, and count the names of those no longer setting sales records.

The Andersen paper’s claims of advantages for the super-builders in purchasing land are also questionable. Many regional builders have better contacts and longer relationships with local landowners. For the public builders to get those parcels, they have to outbid regional Giants. More often, local or regional builders beat the national builders to the deal because the publics have lengthy internal approval processes.

Dealing with municipalities, city councils and planning commissions is often easier for a local or regional builder that knows the political landscape better than a public builder’s imported division president. Large land developers, stewards of master-planned communities, often favor local and regional builders to get diversity of product. Public builders often migrate to the price and product with the largest demand.

And while the cost of capital for large public builders might be less than that for regional and local builders, it’s often not enough less to offset bloated and bureaucratic organizations stifled by functional hierarchies. Moreover, the cost of capital assigned to a public’s regional operations is typically comparable to that of local competitors because the national firm needs an adequate return on those assigned assets.

Cost of construction as a percentage of sale price is comparable for both public and private builders, at about 59%, but many regional builders have become very efficient in their use of materials and labor and are reducing that number to 50% or less. Many of the regionals also have developed superior “partnering” relationships with trades to become the builder of choice in a local market. The efficiencies of their operations reduce the need for extra trips by the trade crews, and that is reflected in the bids they receive.

Public builders also have a tendency to concentrate on the largest housing markets. But a large (and growing) segment of the national market is represented by smaller cities and towns. St. Louis, Kansas City, Indianapolis and even Atlanta have long histories of being dominated by local builders.

The advantage ascribed to nationals for their brands is also open to question. Real estate markets are local, and the local and regional builders probably have an edge in most markets. It’s hard to picture a national in Texas with a better brand than David Weekley.

Bottom line: It’s doubtful that the industry ever will reach the point at which 20 companies sell 75% of the single-family homes. And whatever the level is before the next major market meltdown, it would be surprising if it’s not much lower after the bloodletting.

This counterpoint view was written by senior editor Bill Lurz based on a critique of Paul F. DeCain’s report by Charles C. Shinn Jr., Ph.D., president of the Lee Evans Group, Littleton, Colo.