Two things stand out to me when reading the article by Kris Hudson in the Wall Street Journal titled "Home Builder Clinches $2.7 Billion Deal."
The first is that the amount of home building taking place in the United States is way below its historical average. Hudson writes that current home building volume is around 600,000 single-family units per year. The historical average is around 1.2 million units. And, "the market has slowed since the summer due to a steep rise in home prices earlier this year and a one percentage-point rise in interest rates from May to September."
That is, there is a lot of extra capacity in the housing industry at this time as we are traveling in the fifth year of the economic recovery.
Second, we read that "numerous private-equity firms are holding stakes in home builders that they amassed during the recession and its aftermath. Firms often seek to exit their investments within three to ten years."
In other words, not only is there excess capacity in the housing construction industry at this stage in the economic recovery, but the ownership of construction firms has changed over time as private equity funds moved into the industry seeking a chance for a rapid turnover of investments and a quick return on their money.
Mr. Bernanke's bid for a buoyant economic recovery depended upon the creation of a "wealth effect" as home prices rose due to the stimulus of the Federal Reserve. This "wealth effect" would then translate itself into more consumer spending and this would spur on the economy to more rapid economic growth.
And, what has happened?
As we read above, private equity funds have appeared on the scene and in other cases hedge funds have moved into the purchase of single-family homes. And, these players represent "big" money. And, these groups are not only buying single-family homes, they are creating new financial innovation, securitized debt connected with the rental payments on the homes they have acquired, in the process.
Blackstone Group LP, for example, has acquired more than 40,000 homes in the past few years. And, others have followed them.
Prices have risen, and, as is reported above, it can be argued that prices have risen rapidly enough in recent months so that it has slowed down the new construction of single-family homes.
Households are not the players in the housing market these days, it seems as if the market for single-family housing has been taken over by fund managers.
Fund managers don't stay around for a long time if the "deal" they are working on does not play out exactly as they would like it.
In the situation we are reviewing today, it seems as if the construction industry is ready for a wave of mergers and acquisitions. The larger construction firms need some kind of scale. If there are only 600,000 single-family homes being constructed yearly, one could make the strong argument that a lot of construction companies are operating below their optimum capacity.
But, these construction firms are not owned by families or local owners interested in keeping their firm going. These construction firms are owned by "greedy" private equity people that do not stick around if the deal does not seem to be working as originally planned.
The "exit" strategy for these firms is to sell out and there seems to be a lot of buyers around that are interested in helping the construction industry to consolidate.
In the Wall Street Journal article we read that in January "private-equity kingpin" Barry Sternlicht took a small California homebuilder, TRI Pointe Homes, Inc. (TPH), public. The plan was to expand TRI Pointe as the housing market recovered. However, Sternlicht produced a $2.7 billion deal with a home-building division of Weyerhaeuser, Co. (WY). Now TRI Pointe is "one of the country's top 10 publicly traded builders in terms of its market value."
Other builders have raised money in the capital markets. "Five builders conducted initial public offerings in the first half of this year-the most since 1993-and another three now are awaiting IPOs."
These monies are not being obtained just to scale up alone. There seems to be a substantial movement toward bigger mergers. For example, Hudson reports in the Wall Street Journal article that the California housing developer Shapell Homes, an organization that "controls 5,000 lots in pricey California markets" is looking for a suitor. It is reported that Toll Brothers Inc. (TOL), Brookfield Asset Management Inc.'s (BAM) Brookfield Residential Properties (BRP), and Standard Pacific Corp. (SPF), are interested in acquiring Shapell. Note that all of these potential bidders are public companies whereas Shapell is not.
Thus, it seems as if the home construction industry is in for quite a re-structuring over the next couple of years. Will this re-structuring help to stimulate housing construction and thereby spur on economic growth?
Not likely, because consolidations generally lead to a rationalizing of an industry, a downsizing in terms of potential output, rather than an expansion of productive capacity. And, historically, this is true of any industry going through a consolidation period, not just the housing industry.
So here we are discussing another industry situation, this time we are discussing an industry that politicians and policy-makers have used as the engine to get the economy moving again, in which actual economic output is low and the easy money policy of the Federal Reserve, QE3, is resulting in funds just traveling between wealth groups with very little production and employment being created.
Furthermore, given the players I have written about in this post, it does not seem likely to me that this outcome will be changed much, if at all, over the next couple of years.
So, deals are plentiful. They just won't help economic growth and employment much.