Housing Recovery Comes Too Late for Private Builders

A funny thing happened on the way to the housing recovery: The public homebuilders got bigger, and the private construction firms disappeared.

Well, not all of them, of course. A significant number, however, have been driven out of business by a perfect storm of economic and financial turmoil. Now, even as the economy appears to have turned a corner and housing starts are picking up, they are losing their fragile grip on the housing market. The house-building climate is warming up, but the private guys are increasingly being left out in the cold as the biggest players in the industry sop up all the gravy.

Is the upturn for real?
Although some analysts have pooh-poohed the recent run-up of public homebuilders' stocks, there is plenty of evidence that home construction is on the mend. Big builders such as Lennar (NYSE: LEN  ) showed definite improvement in the Q4 earnings report, with solid increases in new home orders and forward motion on backlog. PulteGroup (NYSE: PHM  ) , easily the largest homebuilding consortium in the country, beat estimates for last quarter for both earnings and revenue.

It was party time at the recent International Builders' Show in Orlando, Fla., last week as builders and attendant industries discussed the rosier days ahead. The CEO of the National Association of Home Builders noted that attendance was up from last year, and the atmosphere was "buoyant."

A barometer of just how important housing is to the fledgling economic rebound is the fact that Federal Reserve Chairman Ben Bernanke made an appearance at the show. His speech to the association members underlined the need for looser credit for worthy prospective homeowners and for those building those homes. Of course, he spoke at length regarding the large number of foreclosed and soon-to-be-foreclosed homes that are flooding the market and making new home sales stagnate. Another of his dominant topics, though, was the resistance of the banking industry to resume making qualified loans for buyers and builders.

Increase in housing starts floats only the largest boats
It's a valid concern and one of the heaviest weights crushing the smaller, privately owned homebuilding companies. All the confidence in the world isn't going to line up building jobs if credit dries up. The deep recession, financial market crash, and housing crunch of the past few years would naturally have weeded out the weakest from the ranks of homebuilders, a club that expanded exponentially during the housing boom of the late 1990s to 2000s. While larger homebuilders were also affected to some degree, they were able to weather the economic storm more easily and with less permanent damage. Tight credit policies have actually helped the big players as smaller builders went under without access to business loans, thus taking competitors off the board without the big boys lifting a finger.

You would think that the increased activity on the housing front would be a boon to these small entities, but this is not turning out to be the case. To stay afloat, some of these builders took on smaller jobs, building one home at a time, waiting out the downturn. Now that the tide is turning, they have been unable to expand into larger development projects because of the inability to access credit. Meanwhile, public builders are buying land with cash they squirreled away during the recession or are able, because of their size and clout, to secure traditional financing. According to Wade McGuinn, proprietor of McGuinn Homes in South Carolina, big builders easily outbid smaller outfits almost every time.

The big boys have other tricks up their sleeves, as well. Gibraltar Capital and Asset Management, the financial arm of Toll Brothers (NYSE: TOL  ) was created by the company to "provide a broad range of real estate acquisition and investment opportunities," according to corporate literature.

Obviously, small-scale builders don't have subsidiaries like this one, ready and able to snap up troubled properties for a song. As if that weren't enough, Toll Bros. also has a bit more than $1 billion in cash lying around, socked away when times were lean and there was less demand for their McMansion-style houses.

Good news for big builders may slow the recovery
What does all this mean, exactly? For the economy overall and housing in particular, it may be a less-than-perfect scenario. As pent-up demand heats up, there will be fewer enterprises solvent enough to take on the scope of work that will soon be available. This means fewer buildings completed, ready to be sold -- as well as many fewer jobs.

For mammoth homebuilders, however, it means more profit going forward, as housing claws its way back to viability. Each of these housing stocks is positioned to reap the riches of a newly invigorated economy, particularly Toll Brothers, which caters to a high-end clientele. Each of these companies has used the recessionary years to streamline operations, reduce debt and shore up their piles of cash. PulteGroup, as the largest of the three, faces the stiffest headwinds but has recently proved its ability to toe the mark, announcing a nearly $14 million fourth-quarter profit in comparison to its loss of $165 million one year ago.

Despite naysayers who feel that housing stocks' trend upward is based more on a wing and a prayer than on reality, there will always be a demand for housing as people retire, change locations, and move out of the rental market. It's hard to believe that stock value increases of 25%, 30%, and 55% for Toll Brothers, Lennar, and PulteGroup, respectively, over the past three months are based on nothing more than wishful thinking. The recovery is coming, housing starts are up 1.5% in January, and it's a good bet that the biggest players will profit handsomely. After all, they're the only ones left in the game.

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Fool contributor Amanda Alix does not own shares in any of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (22)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 17, 2012, at 4:16 PM, rjmetals wrote:

    I work for a rough framer in Arizona. we frame houses for Pulte. Starts are indead up and increasing. RJ

  • Report this Comment On February 19, 2012, at 12:49 PM, ThePoulTrend wrote:

    There is no questions about it that many Self employed Contractors have now disappeared. However there are still some out there, and the ones that have been able to stay a float and keep customers will do well down the long bumpy road ahead of the housing market. New homes will always be built however not at the pace we saw in 2000-2005. Unfortunately builders right now need to go where the market is, and that is Studio, 1-2 bedroom apartment complex's that are popping up all over, not to mention Old Folks Apartments.

  • Report this Comment On February 19, 2012, at 1:49 PM, FoolishVintner wrote:

    I'm not sure what is newsworthy in this article. Recessions always result in consolidation. This was easily predicted, and as the recovery continues more opportunities will arise, and more small builders will start back up to meet the pent up-demand.

  • Report this Comment On February 19, 2012, at 3:29 PM, JacksonInVA wrote:

    Many privately owned companies in every sector have closed. This is why we do not have much of a middle class any more. Walmart killed a whole host of small retailers in every town in the US. Branded stores from manufacturers like Nike, Levis, and Nine West, just to name a few, have added to the retail drain. Local banks have gone too. Other services are under pressure, doctors and accountants are going the same way.

    I am saddened by these loses but I am also a realist. It is the death of the small business that is driving me to buy more dividend paying stocks. That seems to be the only answer to staying in the middle class and maybe, if my children and grand children follow along, lifting my family up to even a better life.

  • Report this Comment On February 19, 2012, at 7:11 PM, rtichy wrote:

    "It's hard to believe that stock value increases of 25%, 30%, and 55% for Toll Brothers, Lennar, and PulteGroup, respectively, over the past three months are based on nothing more than wishful thinking. "

    Kind of circular reasoning, isn't it? The stock prices are indicative of the strength of their businesses?! Get real, do real research, write about it.

  • Report this Comment On February 20, 2012, at 12:37 AM, dave665 wrote:

    The underlying issues suggest this is not a real recovery. It is due primarily to the delay in foreclosures being put on the market the last 2 years because of paperwork issues, and to the current artificially low interest rates. There are supposedly enough foreclosures (something in the neighborhood of 5 million) coming to essentially supply all sales for a couple of years even without any conventional or new home sales. And, when interest rates are finally forced up by a weakening dollar, not only will mortgage rates rise but raw materials costs (including building materials) will rise as well. To top it all off, Americans are still increasing their debt load especially if you count government debt. So I certainly wouldn't be touching these stocks right now, just my personal opinion.

  • Report this Comment On February 20, 2012, at 5:13 AM, Stonewashed wrote:

    Funny isn't it, how the very culprits that caused this problem end up on top?

    Many of these companies screwed subcontractors. That is their bank, more than the bank is. In fact some of the banks didn't pay their bills for construction work they ordered up. They used their bailout money to buy up "weaker" competitors and/or buy this land. It's not savy it's criminal. Rinse, repeat.

  • Report this Comment On February 20, 2012, at 2:05 PM, punkieboy wrote:

    I am a novice at the effects of the downswing however this struck me as a point of plight with other industries: "Tight credit policies have actually helped the big players as smaller builders went under without access to business loans, thus taking competitors off the board without the big boys lifting a finger."

  • Report this Comment On February 21, 2012, at 9:56 AM, MKArch wrote:

    Outstanding article Amanda and a subject I've been preaching for a couple of years now and profited handsomely from buying LEN at the depths of the downturn.

    I think you miss something in your description of the drivers for new home construction going forward though. Long term demand is based on population growth not people moving from one house to another. We need to construct about 1.5M/ new homes a year to account for population growth both natural and immigration as well as lost units. We built about 14.5M units in the decade of the 90's which began with low demand due to the aftermath of another construction related recession. Contrary to popular belief by the end of the decade of the 00's we built almost exactly the same 14.5M units with the excesses of the bubble years being completely offset by almost no construction in the closing years of the decade.

    Right now we are on a pace to build ~5M homes in the current decade even though we will need to build triple that or ~15M to account for population growth and lost units. You correctly note that the large public builders are the last ones standing now but they were taking massive market share from smaller regional builders even in the bubble years.

    Industry wide housing starts at the beginning of the decade of the 00's was the long term average ~1.5M. At the height of the bubble years industry wide starts averaged ~2M or ~33% increase for the industry as a whole. The large public builders revenues over the same period were up 3X-4X. Some of this out performance was due to price increases but clearly the bulk of this out performance was due to massive market share gains.

    To put this in further perspective LEN's current revenues are about the same as they were in 1999 while housing starts industry wide are ~1/3 of what they were in 1999. At some point over the next couple of years maybe sooner housing starts industry wide will normalize to ~1.5M/ year which will be near tripling from current levels. You can layer on massive market share gains for the large public builders over an industry wide tripling of sales and it's no wonder the large public builders stocks have been outperforming even as their industry has been at a near stand still for several years. Smart money knows the stats I'm citing. Just ask Warren Buffet another home building bull.

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