This story was originally published in Builder.
A theme that ran through our program for the just-concluded Housing Leadership Summit this year was Collaborate to Accelerate.
Meaning that, to grow, to keep pace with the fast-moving dynamics of externals, fundamentals, and Black Swan type play of unpredictable forces in today's housing market, and to remain resilient as conditions turn more adverse, home building companies have to bring rigor to unpacking who it is they partner with, why, and how they might expand the pool of those partners.
Whether it's to learn to improve on what the firm is already doing, change to doing something brand new by abandoning practices that stifle progress, or begin to grasp how to deal with the unknowns of what comes next, builders need smart new connections with trusted new partners. Otherwise, how are they going to jump the fences of reliably acquiring lots, getting them permitted in a timely way in hairy local jurisdictions, accessing capital for operations, acquisition and development in a smoothed way across the housing cycles, designing homes that buyers in different segments want, value-engineering and pricing homes to the market, equipping them with smart, sustainable technologies that excite buyers, gaining access to construction workers on predictable schedules at predictable costs, engage with prospects and buyers-to-be at a precise moment in their journey, and hiring a next generation of leaders?
We heard repeatedly over the two-and-a-half days of HLS that, although times are good now, and demand is solid for whatever builders can deliver to an inventory-starved market, clouds of uncertainty have begun roiling up on the not-too-distant horizon. This uncertainty makes bigger builders queasy about the investment of capital they have to make to secure inventory turns beyond the next 18 to 24 months. Uncertainty, in its early manifestations, becomes a telltale inflection point that signals it may be time to reduce leverage, to harvest cash, and preserve money as dry powder for leaner days, weeks, months, and possibly years ahead.
Although the onset of the last downturn--the Great Recession that took down housing--is more than a decade hence, home builders, their investment partners, and their associated business ecosystem remember one aspect of it as if it were yesterday. They remember that their early-warning systems failed, and they remember that the models to detect what was really going on versus what was "fake news" of demand were broken.
This time, though, models to understand real demand, real impacts of supply constraint, and real measures of pricing elasticity and rigidity, come only through a sounder network of partners--collaborators--in the marketplace. That said, here's 10 take-away observations that struck us as critically relevant to the current climate and the future outlook for builders large, medium, and small.
- Collaboration is hard: As much as the concept of forming dynamic new partnerships makes intellectual sense, builders by nature of their personalities and experience tend instead to see outsiders strictly as competitors, as opposition forces, as enemies to viability and success. Trusting people from other organizations is a leap-of-faith they're unaccustomed to, even in the face of the very real risk of disruption. Still, we learned, pockets and bright spots of partnership, integration, and collaboration are going on in varied ways among progressive players. "It doesn't always have to be a win-lose equation," says Dan Ryan, ceo of Dan Ryan Builders. "Sometimes, both sides can win."
- A challenge to pivot from cycle-timers to masters of vertical value generation: As the current cycle ages, supply constraints and challenges intensify, and consumer behavior pivots toward technology in buying discovery and decision-making, builders must decide who and what they are. Are they land arbitrage specialists, or are they professionally disciplined integrators of manufacturing, logistics, design, and development, or are they, at heart, retailers of the home buying experience? Real estate cycles are by nature boom, bust, rinse and repeat parabolas that prove to be unsteady ground on which to build a great business model. So, more companies are trying-for-size a greater business model focus on operational excellence in going vertical, the way, say an NVR makes money. Rather than "asset light" as a business model, we'll likely see greater concentration on inventory-turn-centric practices aimed at removing all possible expense that does not drive value to the buyer customer.
- Diversity is not an option: The big consultants like McKinsey show extensive evidence that companies that are more inclusive--from the associates' ranks to the corner executive office to the boardroom--are more successful. Now, investors are making it policy to deploy resources only among organizations that are diversified in gender, ethnicity, in culture and leadership. What's more, consumers are increasingly able to and prone to choosing what they buy based on the same kind of criteria. Thirdly, young adults, our next generation of home building, investment, manufacturing, and distribution leaders, also pick where they want to work based on their research into the business culture of a hiring organization. They, too, expect firms to be inclusive in their diversity policies for the workspace, the executive suite, and the board. Diversity is a non-negotiable when it comes to resilience over the next five years.
- There's data and there's data: Real estate, retailing, and business are each spaces where there's a crushing weight of data; too much data; and ultimately, scarce really helpful data. Data on who will buy, when, for how much, and what they want--these measures are buried, camouflaged, drowned out amid enormous troves of statistics that amount to noise. Helpful data that allows sellers and buyers to engage at precise and meaningful moments will change business models in home building in ways we can't even yet imagine. But it will happen.
- It's hard to make money: Margins... [See bullet two]. When builders acquire land at distressed, below replacement cost, levels and lots of it, they can build profitably, which we saw during the first leg of the recovery. But when expenses--lots, capital, regulatory fees, materials, and skilled worker pay--are all getting more expensive, and builders try to offer homes at lower price levels, making money is hard, and losing money fast is relatively easy. Particularly as land costs and financing expense disadvantage smaller builders, we're guessing we'll see highly motivated company acquisition conversations among builders who either want to grow or exit.
- Labor capacity is not going to get better ... ever: Today, for every young individual who enters the construction labor workforce, five are aging out of the field. Further, immigration policy under consideration at the Federal level looks like a hindering rather than a helping factor when it comes to mitigating the age demographics impact. Conservatively, it would take 15 to 20 years--a generation--to replenish and retrain the skilled associates necessary to bring housing activity back up to historical levels. No one expects that to happen. Being builder of choice is a best option of the moment, but it's going to prove to be a bandaid at best as the trend plays out. Hence, the next bullet point.
- Offsite's moment of truth is nigh: The smart money is betting that 2018 is an inflection point in the single-family for-sale embrace of offsite construction as an essential, non-negotiable dimension of new home building in the United States. True, even amid the hype, less than one in 10 new homes avails of offsite, factory-fabricated construction of parts or systems of homes to be assembled on site. Two forces--both of them considered to be intractable challenges in today's housing and broader economy--mean that this business model will pivot, the affordability crisis, and the labor shortage. In our opinion, although it's still early in the process, the "tech tipping point" has arrived, and 36 months from now, construction operations among higher volume home builders will be profoundly impacted by a new infrastructure of geographically dispersed offsite manufacturing facilities. One pushback among builders who say they're not likely to vertically integrate such factory capability into their business models: migrating the variable costs of doing business--purchasing materials and products, stocking that inventory, labor costs, etc.--to a fixed cost basis would make those firms too rigid in a downturn. They would not be able to reduce those costs the way they can now if business slows down in a cycle. The answer to that is that builders cede the manufacturing and construction capital expenditure to a third party, buying those services the way they'd take down lots from a land bank.
- Cities and other local jurisdictions can be your friends: Even for profit-making for-sale home builders, the finiteness of greenfield resources, and the general availability of first-band urban infill tracts that need revitalization make for an opportunity for developers and builders to work productively with local officials to bring more affordable housing access to towns' and cities' essential workers--teachers, fire fighters, police, rescue workers, sanitation workers, etc. We're seeing, even in some of the nation's most land-constrained, heavily regulated jurisdictions, public-private ventures that regenerate value on otherwise languishing property, and create new housing options without disrupting the values and preferencees of incumbent residents and voters. We'll see more of this.
- Having a core purpose and culture is not an option: A business culture and a business model are two different things. The practices and processes that helped companies succeed in the past up to now will not be enough to continue to thrive in tomorrow's dynamic, rush-rush world of consumer behavior, economic volatility, and policy transformation. "The why" is as important for builders to focus on as "the who." And both "the why" and "the who" out-prioritize the what and the how of a business model. Builders need to focus on their culture, especially since what they need to continue to do, as they've done so well up to now, is to learn to out-perform other options--apartments, resales, single-family rentals, etc.
- Competing and collaborating don't have to be mutually exclusive: After all, builders love to compete, with each other, with the economy, with land sellers, with capital partners, with manufacturers, with construction trades, with everybody and his or her brother and sister. It's part of the home builder DNA to look at just about every moving part or process or person in his or her value chain and see a competitor. At the same time, we're seeing recognition that coopetition or collaba-tition might be a way forward, not just to survive but to thrive.
We so enjoyed our immersion with friends and associates at the 2018 Housing Leadership Summit. And for those of you who could not make it--some of whom had to be in New York City for important meetings with institutional investors--you were missed, conspicuous in your absence. We hope to have you back with us next May at the Ritz Carlton Laguna Niguel, which one of our sponsor partners dubbed, "The Davos of Home Building."
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