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
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
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.