Banking on Builders

SHEA HOMES CFO BRUCE VARKER REMEMBERS THAT IT was just before Christmas in 2001 when a deal for 150 lots for luxury homes suddenly became available. The catch? The deal had to be closed quickly or the lots would probably be sold elsewhere. Varker knew exactly who to call. Having partnered with IHP Capital Partners on several previous ventures, Varker turned to them to help finance the deal. In fewer than 10 days, IHP put the money together. Varker signed the final documents on Christmas Eve. “They are able to react in an incredibly timely fashion,” Varker says. “They’re nimble and flexible.”

San Francisco-based IHP Capital Partners may not be a household name among leading lending or investment institutions. And other companies might have been able to finance the Shea Homes deal just about as quickly. But for many home builders and residential developers, IHP has become a major player in financing expansion and development plans. That’s in large part because, for IHP, there are more important things than time or money. The firm’s predisposition to be a financial partner—not merely a lender or investor—is one reason the company has earned a prominent spot in the Rolodexes of top home building executives such as Varker.

“Most people see money as a commodity,” says IHP co-founder and executive vice president Donald Grant. “If it’s a commodity, then anyone can do it. Some people just want to rent money. Our people are partners.”

IHPS Bill Albers (top left), Partner and Senior Vice President; Douglas Neff, President and Managing Partner; and Donald Grant, Executive Vice President (seated). Larry Webb, who has been doing deals with IHP since “the minute” he became CEO of John Laing Homes in 1995, is one of many builders to appreciate the difference. “We view some financial organizations as just sources of money,” he says. “I really care about these IHP guys. They’re part of our team.” The two companies have participated in land development, joint ventures, and entitlement ventures. For the entitlement deals, Webb says, “We buy up unentitled land together or land not entitled for development, get new entitlements, close on the property, and sell the venture to our own company or to another one at market price.” He looks back at the relationship, noting, “We’ve had a wonderful decade with IHP.”

Industry Insight IHP’s business approach is rooted in the 30-year careers of Grant and co-founder Douglas Neff, IHP’s president and managing partner. Neff learned the ropes as treasurer of master developer Irvine Co. He later managed a portion of Wells Fargo’s Real Estate Industries Group before becoming a partner in a commercial real estate development firm. Grant, a former Wells Fargo senior vice president, eventually became CEO of that same real estate firm. Both men understood residential real estate from the ground up. When they started IHP in 1991, they’d already been thinking about ways to provide equity financing for home builders.

The company’s success, however, can also be traced to a fortuitous event: The decision of the California Public Employees’ Retirement System—also known as CalPERS, the largest pension fund in the world—to enter the realm of residential financing. Neff and Grant, who had also worked with institutional investors, recognized the opportunity and seized it. Twenty companies competed for CalPERS backing, and five were selected: IHP, Hearthstone, Prudential, Bankers Trust (Deutsche Bank), and Wells Fargo. Each company got $75 million in CalPERS money and put up an additional 10 percent of their own. Neff says, “It may be the only time in institutional investment history that five companies were chosen to manage the same amount of money in the same region on the same day to do the same thing.”

With the CalPERS money, IHP had considerable investment latitude. But Neff and Grant had a unique attitude about who they wanted to finance. “Our philosophy is aimed at finding high-quality, enduring relationships with builders and developers,” Neff says. “This only works when both parties feel each understands the other well, and both parties add to the process by figuring out how to take advantage of opportunities instead of arguing. Most people in the financial business aren’t suited for partnerships.”

Michael Kahn, founder of home building industry mergers and acquisitions consulting firm Michael P. Kahn and Associates, has worked closely with IHP on a number of deals. He attributes much of the company’s success to the way it builds partnerships. “They’ll start with a project, then a couple, then a few more, and maybe then they’ll do a partnership,” Kahn says. “If all you’re doing is one project, then you focus mostly on underwriting the project. If you’re going to get in bed for a long-term partnership, you will underwrite the people more than the project.”

They developed a proprietary research system that looks into regional housing economies. It incorporates a variety of factors such as regional employment and resale values to give IHP a powerful view of the best places to invest.

In 1992, housing prices in California were severely depressed due largely to the savings and loan crisis of the late 1980s. Conventional wisdom was that luxury properties in Silicon Valley were a waste of time. But IHP’s research showed that these properties were the best investment opportunities. “Our first property there was $540,000. We made more than pro forma and generated more than a 40 percent net return to CalPERS,” Neff says.

In Orange County in the same year, housing prices were also down. Neff and Grant determined that smaller projects of 40, 50, or 60 units were likely to do best and so they invested only in those. Later, in 1997, conventional wisdom was that Orange County was glutted with lots. IHP’s research showed that the glut was limited to lots smaller than 5,000 square feet. “Above that, the market was untapped,” Neff says. “We bought bigger lots, and they sold like hotcakes. We had no competition from anyone.”

From doing deals like these, IHP earned a reputation for making unusual—if not unique—investments that counter conventional wisdom and succeed handsomely. Neff says, “We try to add value to our partners in ways they’re comfortable with. We ask that both have a reasonable proportion of the up and the down sides. And we do insist that our partners be able to withstand a downturn.”

One-Stop Capital Through CalPERS and its other institutional investors, IHP today has access to about $600 million in capital. “Builders need money for land development and building homes,” says Kahn. “It can be bank debt, subordinated debt, mezzanine financing, or whatever. But IHP can finance an entire project,” he says, adding, “They’re one-stop shopping for all your capital requirements.” That has allowed IHP an unusual degree of flexibility in its deals.

Fieldstone Communities, of Newport Beach, Calif., has taken full advantage of IHP’s capital flexibility. Currently, the two companies are involved in at least four housing projects. Frank Foster, Fieldstone’s president and CEO, says he doesn’t even know how many endeavors the two companies have partnered on since they started working together more than five years ago. For these undertakings, IHP has provided both debt and investment capital. In typical financing deals, a lender advances a builder some percentage of development costs. The builder must make up the rest himself or find a partner who’ll put up the money. With IHP, Foster says, “Both partners put equity in the project, and IHP also provides the loan dollars. So it’s a partnership between the builder and IHP.” According to Foster, such financing arrangements make IHP nearly unique.

Shea Homes, having done at least 10 deals with IHP since 1998, has also used several types of arrangements with IHP. “We’ve done everything from full partnerships in home building and land development to pure equity financing,” Varker says. “Projects have ranged from 100 or 150 lots to larger transactions.” One of the larger transactions by the Walnut, Calif.-based builder is Forster Ranch in San Clemente, Calif., in which Shea Homes bought four tracts of land from IHP totaling about 600 lots. “We co-developed some of that,” Varker says. “Then we turned around and built housing on some of the developed lots in cooperation with IHP. We sold some of the rest of the lots to other builders.”

Standard Pacific Homes, based in Irvine, Calif., has been doing business with IHP for about five years. Right now, the companies are engaged in three joint ventures. Two of the projects are at 4S Ranch in San Diego. One of those involves developing about 65 single-family homes; the other is a 206-townhome project. Both are 50/50 projects. The third project—Black Mountain in San Diego—is actually a three-way partnership: Standard Pacific and IHP each own 25 percent; St. Paul Insurance, which originally owned the land, is a 50-percent partner. Black Mountain is a 3,000-lot master planned community where land development will be a joint effort. Standard Pacific has the right to buy half the lots. “This is our biggest relationship with IHP and one of our most significant ventures,” Standard Pacific CFO Andrew Parnes says. “It says a lot about our confidence in IHP and our comfort in working with them.”

Eastward Expansion Until Bill Albers joined the company, IHP’s focus was almost exclusively on California. Albers says he joined the company to help it expand east.

Albers had been the CFO of Centex Homes until his decision to retire in 2000 to stay at home with his kids. On his last day at Centex, Douglas Neff asked him to come to work for IHP. Albers refused. But Neff kept asking. Finally, after three years, Albers changed his mind and joined IHP as a partner and senior vice president. Albers, a Texan, opened up a Dallas office. Since then, IHP has done deals in Florida, Detroit, and Texas.

Albers also saw a lot of opportunity in “entity” deals—buying portions of companies. In 2003, Albers arranged a 50/50 entity deal with Gary Tadian, CEO and founder of Detroit-based Tadian Homes. With Dennis Bailey as Tadian Homes’ president, the company met IHP’s requirement of having a strong management team. Tadian had been seeking financing to help his company grow, but most options had involved selling out. He wasn’t ready for that. Mike Kahn mediated the deal that has allowed Tadian Homes to rise to one of the top builders in the Detroit market today. “The partnership with IHP has allowed us to compete in the marketplace at a different level,” Tadian says.

IHP wants good partnerships not ownership. Partnerships also let IHP move into new geographical areas with fewer risks. “The reward is better because you don’t pay the ‘dumb tax’ of a company coming into a new market,” Albers says.

Investing In Human Capital IHP’s partners and competitors agree that the company’s integrity and its deep knowledge of the industry have helped it become a pivotal financial force in the residential home building industry. “IHP is different from other investment/finance companies in their unique ability to craft a deal that meets the specific objectives of the builder,” says Tadian. “They have a very good understanding of the business as a whole and have a keen perspective of how they can help a private owner of a home building company meet his specific goals.”

Even Jim Pugash, CEO and chairman of CalPERS partner and IHP competitor Hearthstone, acknowledges that, “IHP has a very fine reputation. They do more investing in terms of their business as principals than Hearthstone does. With few exceptions, most of the companies in this business are Johnny-come-latelies. IHP and Hearthstone are among the few finance companies that are both broad and deep.”

But ultimately, it’s the company’s focus on partnering with builders and developers that most differentiates IHP from other investment firms in the industry. “There are two main constraints in business: money capital and human capital,” says Albers. “We have virtually unlimited capital through CalPERS. So we’re primarily interested in matching up with human capital.”

Vested Interest
IHP Capital Partners IHP provides equity, debt, mezzanine, and other types of financing for residential builders and developers. In the past 12 years, IHP has built a client list of 33 builders and 16 developers. Of those, nine have each done more than 10 deals with the company.

Learn more about markets featured in this article: Los Angeles, CA, San Francisco, CA.