This story was originally published in Builder.
It almost doesn't matter exactly when the next downturn in housing occurs.
It will occur. There's always a next one. For America's leading home building enterprises, where land investment exposes billions of dollars of capital to downturn risk, it's never too early to prepare for it, just as it's never too early to prepare to unleash growth during residential real estate's next cyclical recovery.
Leaders of the nation's top home builders face a paradox. They can neither escape residential real estate and business cycles, nor can they escape an existential need to develop business resilience across and through them.
Warning signs and signals of cyclical gravity--in spite of strong new home sales numbers for February, and very possibly, a relatively strong 2019 fueled by builders' big push versus lower-priced, entry-level, and first-time-home buyer houses and communities--are already clear.
The challenge is how many home building company leaders and strategists will hold the reins of their firms as the business climate shifts from challenged, to adverse, to that most paralyzing of operating environments--uncertain and full of doubt.
This will happen. Builders need to accept and operate in anticipation that conditions, sooner or later, will progress into and through such inhospitable turf. But what they don't need to accept--and should not--is existential risk, even personal exposure to financial ruin thanks to personal guaranties among lenders.
This paradox--resilience in spite of what may come with housing's next cycle, and the one after that, and the one following that--is at the core of our upcoming Housing Leadership Summit, May 13-15, at the Ritz Carlton Laguna Niguel. Our theme is 2020 Foresight: How Leaders Shape What's Next, and this is what we're talking about.
Many already say the next housing downturn won't--can't--be as bad as the last in part because post Great Recession guardrails against lending insanity have held and because Americans' household balance sheets haven't gotten as out of hand as they had in the middle part of the last decade.
Still, is that any way to conduct business, believing that next time is not going to hurt as badly as the last?
Check out this timely piece from Harvard Business Review contributors from Boston Consulting Group's Henderson Institute, Martin Reeves, Kevin Whitaker, and Christian Ketels, "Companies Need to Prepare for the Next Economic Downturn."
The case they make is not simply about preparation of a firm's business model and capital structure to weather progressively harsh operating and trade circumstances ahead, its about fundamentally altering some of the enterprise DNA.
It's not just about what you do to respond, it's about who you are that allows your response to reflect agency in shaping what's next. It's not about simply navigating clear of existential peril, but rather it's about setting an intentional course toward greater value creation, higher performance, and sustainable growth. They write of current risks across the economy:
Economic forecasting is an inexact science at the best of times, but views are particularly divergent today, ranging from the possibility that the worst may already be over to the prospect of a more severe recession in the near-term. The uncertainty is driven by elevated risks on many fronts: technological risks, including cybersecurity and trust; economic policy risks, including challenges to international institutions; social risks, including increasing inequality in many countries; and planetary risks, including climate change. As Christine Lagarde, Chair of the International Monetary Fund, said recently, “The global economy is facing significantly higher risks … [and] these risks are now increasingly intertwined.”
We organize the current critical risks to the economy into these categories:
- Technology, including AI governance, data privacy, and trust
- Economy, including growth, uncertainty, trade, U.S. versus China
- Society, including the future of work, inequality, inclusion, and cohesion
- Planet, including plastics, global warming, clean water
In many past downturns, falling economic growth was the dominant issue. In the next downturn, however, decelerating growth should be thought of as only one disruptive force — and probably not the most important one. Leaders will need to continue contending with technological disruption and its effects on competition, supply-chain disruption driven by trade barriers, and competitive disruption driven by players with new business models.
Builders--especially high-volume production builders--can relate. Economic challenges, especially as they expose large amounts of invested financial capital on land to wide swings in the win and loss column, tend to claim most stakeholders' attention in the home building business.
But at the Housing Leadership Summit the subject matter, the peer-to-peer connection, and the training sessions will focus on some of the other disruptive challenges and opportunities as well, ones that matter a great deal to the future well-being of many firms.
People, for instance. Home builders and their lending and investment partners commit more money, time, and focus on land capital costs than people costs, but as intellectual property value, the value of experiences, the value of homes as connection, comfort, privacy, health and well-being services all start to elevate as more significant factors in home valuation, home builders will do different things, need to know different things about they do, and, with their partners, will matter in entirely new ways than they do now.
Home building, development, and residential development are, in fact, people businesses that mask as capital and real estate and manufacturing and tooling businesses.
From another HBR piece, "The Surprising Economics of a People Business," this one more than 14 years old from Felix Barber and Rainer Strack (also, ironically BCG advisors when they published this June 2005 article):
Most diversified companies [including home building enterprises] have large units engaged in employee-intensive activities—for instance, sales and customer service—that give those units many of the economic characteristics of a people business.
These characteristics are often ignored or unappreciated by top managers. Companies mistakenly focus on capital productivity rather than employee productivity and rely on capital-oriented metrics, such as return on assets and return on equity. These aren’t much help in assessing a people business, as they tend to mask weak performance or indicate volatility where it doesn’t exist.
A few companies in home building recognize that 90-something percent of their peers of all sizes, capital structures, customer segment types, geographies, and skill-sets are looking ahead defensively in hopes of timing the cyclical turn correctly, precisely, by way of limiting damage to their ability to survive.
Those few companies also recognize that an economic downturn--as harsh as it may be when it arrives--may not be the biggest test to viabilty over the next five years.
Here's what we'll fanatically focus on during the two-and-a-half day HLS event coming up in 39 days.
Invest in growth. Downturns make growth more difficult in the short term, but they should not undermine the potential for long-term growth—unless leaders starve their companies of the necessary investment. Sustained growth is more difficult to achieve than ever, but our study shows that companies that continue to invest in R&D and innovation will have the best chance to successfully grow in the long run.
Don’t lose sight of your long-term transformation agenda. As economist Paul Romer once said, “A crisis is a terrible thing to waste.” Downturns can shine a spotlight on the long-term health of a business, revealing vulnerabilities that might not have been as visible in good times. Leaders should use the downturn as an opportunity to create a sense of urgency within their organizations, helping drive the large-scale change that will be necessary to succeed in the future.
Focus on technological competitiveness. Technological change is reshaping all industries and causing competitive positions to become more fragile. Downturns also tend to amplify competitive volatility, which means the next downturn is likely to increase the potential risks and rewards of digital disruption even further. Technological progress will not stop during a downturn; neither, therefore, can companies afford to put their digital change agendas on hold.
Contribute to common problems collaboratively. Today’s pressing technological, economic, social, and environmental risks cannot be solved without collective action. However, the next downturn may inflame social tensions and reduce governments’ ability to act on such issues. Business leaders need to play a proactive role in addressing the biggest challenges of our time, collaborating with all stakeholders and moving from discussion to pragmatic action.
Still, don't take it from me. Take it from those few companies that are already strides ahead, the few home building peers who can look at the imminent downturn as a moment to go on the offensive. Those are the leaders who'll shape what's next. They'll be at HLS. Register here now.
This story was originally published in Builder.