Home Builders Take Note: Aim to Emulate the NVR Model
These 'just-in-time' theories can help you stay the course.
It is very clear to me that once we're back to a more normal market environment the NVR Model will be the model most, if not all, builders will try to emulate.
Best described, “The NVR Model” is the equivalent of “just-in-time” now fully subscribed to by manufacturers throughout the world: required parts show up just in time to be used.
Builders, especially those in markets where option lots have traditionally been readily available such as in Houston and Dallas, have already been applying at least parts of the NVR model. However, between 1995 and 2005, because demand for lots were strong and it was a seller's market, builders were forced to take down a significant number of lots at a time and hold them. In its purest form, the NVR model permits the builder to take down the lot required when the building permit is issued and construction is to begin.
It is equally clear that Centex and Lennar as well as many other builders have sold off substantial quantities of finished, partially finished, platted and even entitled lots to adjust their lot pipelines to today's reduced lot requirements. Lot pipelines that were assumed to be a five-year supply of lots became supply of 10 years or more. Their goal appears to be as “land light” as possible, and over time, move as close as possible to the NVR Model, which home building analysts hold up as the epitome of good lot management and control.
Over the past 18 months I visited 36 vulture funds recently set up by hedge funds and private equity groups to purchase lots at 20 percent to 40 percent of existing debt value. I strongly urged them to bear in mind the need to calculate additional holding time into their calculations to consider both reduced permit activity as well as builders' desire to emulate the NVR Model. I counseled that 20 percent to 40 percent might be too pricey and that they can't assume buying lots at even a significant discount-to-loan value makes any sense.
If house prices stabilize, as conventional wisdom assures us they will at 2001-2002 levels, there is no question that land and lot values will have to decline to a level that will permit a builder to build a house that's salable — using realistic absorption rates on top of its being bought at retail — to return again to an acceptable level of profitability. The discount required will be different in each market. To an extent it will be based upon the amount of builder house inventory overhang, as well as vacant investor and existing home resales that need to work their way through the market so that housing stock will once again return to acceptable normalized levels.
So when you make it through the current housing crisis, remember “land light” will make a great deal of sense from a risk management standpoint as well as help you maintain inventory levels at reasonable levels, reset your debt to equity ratios, reduce your senior bank debt levels and improve your balance sheet overall. It may just keep you out of trouble.
|Michael P. Kahn & Associates, a financial advisory firm specializing in housing industry mergers, acquisitions and capital formation.|