“We have builders that want to sell.”
This was word this week from an executive well connected to mergers and acquisitions transactions and discussions going on now, who sought entree to points of contact at some of the China-based organizations we hear are gearing up for real estate investment in the United States.
But wait a minute, aren’t conditions supposed to be looking good for a strong 2017 for home building? Home builder sentiment (due out this morning at 10) has been downright plucky. Credit access for borrowers shows signs of easing its ironclad grip on mortgage financing; would-be borrowers themselves are making gains shedding college debt, increasing their household income, and improving their scores with the credit raters.
And with broader, more robust economic growth, better earnings power, and a promised adrenaline-shot to the arm of until-now un-recovered heartland economies and industry sectors as part of the new administration’s policy blueprint, demand fundamentals look even brighter.
Too, financing–at least on a project by project finance level for vertical construction–is available on terms builders can live with, and lenders are even venturing into the land acquisition and development business with a bit of temerity here and there.
So, why are home building organizations–ranging from single-market operators, to mid-sized regional stalwarts, to some of the less-deeply resourced publicly-traded companies on the block right now?
In two words, we’d say it’s mostly about this: 2019 and 2020.
The period beyond 24 months from now is what a lot of the m&a activity in 2017 will be fueled by. Housing and business cycles behaving as they tend to do, the executives, principal owners, founders, and strategists who head up organizations right now face tipping-point scenarios as they look at opportunity and risk beyond the near-term horizon of their current vacant developed lot supply, owned and controlled.
They face hard facts of real estate life, one of which is that paying high prices now to put future home sites on the balance sheet can be perilous to future returns on that upfront investment. Companies that, because of their lesser heft have to pay more per lot expose themselves to greater risk than deeper-pocketed companies who wield lots of cash and cheaper capital in the land game.
So, what do you want to do?
For those “of an age” who’ve been to this party before, it’s a tough quandary. For any principal company owner who’s got to weigh what looks to be a steady–possibly even exuberant–couple of years ahead, driven by a long-awaited release of pent-up home buying demand among young adults, and by Baby Boom retirees wanting that house they’ve felt deserving of for some time now, vs. the “unknown unknowns” of an expensive lot pipeline, complete with carrying costs, financing expense, regulatory fees, etc., and a relatively modest balance-sheet to absorb all of that, it’s a queasy feeling inside. Especially for people who are entrepreneurs at heart.
And it’s also tough for folks to look their companies in the mirror in the harsh light of high finance reality. That book value, stripped down to its barest essentials of a three-year pro forma and an owned land asset pipeline, doesn’t much resemble the organization one’s put heart, and soul, and blood and sweat into to make a name for itself and operate profitably through these challenging times. That book value may do a disservice to the human capital, the processes and systems, the relationships with land sellers, with real estate agents, with tradesmen and women, with finance sources, and with home buyers one has fully infused into the company to make it work, to make it different, to make it what it really is.
This is, given the way housing cycles and housing markets track, that book value may be worth more now than it will be a year from now, particularly because there are not one, not two, but three distinctly motivated, well-resourced, and potentially like-minded stripes of acquiring organizations active in the m&a marketplace right now.
So, the sellers look like this:
- They’re mid-50s to late-60-year-old principal/founders who look ahead, see an eventual down-cycle, and want a graceful planned exit, succession plan, or legacy.
- They’re rambunctious, capital-starved younger companies who see opportunity, perhaps, to retain the reins of their division or region while giving over equity control to a well-heeled new ownership that desires operational autonomy–for the time being, at least.
- They’re public “mini-me” home builders, whose “dry-powder” coffers are constrained, whose lot pipelines are scarily finite, whose share prices are getting hammered, and whose ability to throw off profits may get cloudier as the buyer mix shifts from higher-end demand to higher-volume, lower-priced homes for the entry-level market.
- They’re public and/or private builders who re-structured debt into equity ownerships during the tough times, whose private equity owners now want to exit, and re-invest new funds with better return expectations keyed to today’s opportunities. Those exits may trigger sales.
- They’re builders who look ahead at 2019 and 2020 and think, “the moment to act is now.”
They may be right. If housing’s business cycle inflects in the next three years or so, and gets tough enough that land assets purchased in today’s tight market lose value rather than escalate, then it’s going to be harder to leverage intangibles like human capital, building processes and disciplines, relationships, and organizational capital in the bargain.
This is why we’re going to see a good number of deals go down in the next 12 to 24 months.
