Home Builders Reluctant to Shrink Footprint

Hovnanian Enterprises (HOV) just issued 14M newly minted shares at $9.50. Toll Brothers (TOL) claims it’s financially strong, but studied with great interest another builder’s deal to sell land at a large discount to Wall Street: Lennar (LEN) sold $1.3B (book value) worth of land in 32 communities for $525M to a joint venture. Morgan Stanley (MS) holds 80% interest and Lennar the remaining 20%. Lennar gets a fee for “managing” the 11,000 lots and retains the option to repurchase the lots. A tax deduction for the loss is the kicker for Lennar.

Fine financial engineering, but why haven’t the national builders shrunk their footprint? True, they have consolidated regional operations, made jobs cuts, and started squeezing subcontractors and suppliers. I believe the nature of construction is that it is too locally tailored and once the local talent is lost, the national builder cannot easily return.

While some large builders manufacture components such as trusses, purchase some supplies under large national contracts, and run national mortgage operations, the vast majority of their operations are project management and marketing. Unlike manufacturing companies, builders cannot shut one “plant” and serve the entire country from another. Builders need local knowledge of building codes, land values and trends, suppliers, subcontractors and realtors.

I realize that it would be an extremely difficult decision to abandon a geography given how costly it would be to return. But I think the process will start soon. The large national builders will soon become super-regionals or go bust. Someone has to be the first to leave Florida.

This past boom cycle lead to tremendous expansion and consolidation of market share by the national builders. Subsequently, this bust is also the first major test of the truly national footprint.

No Disclosures.

Comments

[quality:]

Good points about the local character of the building industry. Your subject title is well supported by the text.

Some of the builders will have to cut back or I believe many of them will fail unless they are willing to add equity capital at discounts to their posted book values.

2008 May 11 10:48 AM