JUN 1, 2017
To Scale or Not to Scale: That is The Question for Market Leaders
By Joe Bousquin
What a difference a year makes. In BUILDER’S 2016 Local Leaders listing, Taylor Morrison wasn’t even among the top 10 home builders in the Atlanta market.
Fast forward to today, in the wake of its acquisition of JEH in May 2015 and Acadia in January 2016, and Phoenix-based Taylor Morrison has solidified its standing as the sixth-biggest builder in the third-hottest housing market in the country, with 528 closings in 2016, according to Metrostudy. That helped it leapfrog ahead of established Atlanta players Ashton Woods Homes (No. 9), Rocklyn Homes (No. 8) and Wilson Parker Homes (No. 7) in one fell swoop. That’s a big difference to what it would have taken to snatch up that relative market share by growing organically.
“Having that existing enterprise value in Atlanta really meant a lot for us,” says Michelle Campbell, Atlanta division president for Taylor Morrison. “Instead of coming in and having to put together a team and go out and buy land, it allowed us to start operating from day one, with people who were already in the market. Then, through the relationships our people already had, it helped us get additional land positions, which is of course the lifeblood of any builder.”
Contrast Taylor Morrison’s growth-through-gobbling-up-the-competition tale with that of Edward Andrews Homes, which, while still not in Atlanta’s top 10 in terms of closings, has weaved together a bootstrapped, organic growth story for the ages.
Starting out in 2007, right before housing’s bubble was about to burst, Edward Andrews ramped up from about 10 closings its first year to 263 closings in 2016 on $145 million in revenue—a 55% sales jump from the year before—for an average selling price of $551,000. Those numbers came on the heels of 62% revenue growth in 2015, and the firm projects another 33% revenue bump this year, to around $193 million. On a revenue basis, that puts it in the top 10 of the Atlanta market, according to Metrostudy. It achieved that growth by establishing itself as a can-do-anything custom builder, and then shifting to a more plans-oriented, semi-custom production company when it reached a certain scale.
“We’ve had an incredible growth story, and most of that growth has come in the last three years,” says Todd Andrews Hager, who notes that he and partner Paul Edward Corley Jr., now the firm’s CEO, were “broke, with lots of time to work” when they launched the company in 2007. “We started out slow, but we learned a lot. So when the capital became available to home building again, we hit the ground running. Of course, it’s easy to run fast when your pants are on fire.”
Aside from sharing the same market, Taylor Morrison’s and Edward Andrews’ Atlanta risings go beyond company- or even market-specific stories. Talk to top 10 players and scrappy private builders in markets across the country and the companies’ respective moves exemplify the hallmarks of both big and small local leaders today, and how they leverage their respective scales in home building to compete, increasingly head-to-head, in 2017.
In other words, if you’re a large public looking to establish a dominant presence in a market, you could do a lot worse than following a growth-through-gobbling strategy and then leveraging your scale to throw around your weight in the market. And if you’re a smaller builder looking to gain ground or even just defend the turf you have against the big boys, you want to focus on a specialty and leverage your smaller scale to be nimble and go where the nationals can’t.
From California to Georgia to Kansas, 2017’s Local Leaders tell us if you’re big, go big and ramp up fast to get access to the best land deals and trade contracts, but do so strategically, so that you’ve got plenty of room to keep growing without taking on too much risk. And if you’re a little guy, they say to get good at playing small ball first, with a selective skill set or market niche, so that you can compete in areas that would either take a public too much time, or give them too much brain damage from entitlements or plan changes to produce at a scale worth pursuing.
Big Builders, Leveraging Big Scale
In the Detroit suburbs, where Pulte owns 20% of the market to be the biggest fish in the Michigan (No. 39) home building pond, division president Brandon Jones says having heft gives him not only a business advantage, but also a psychological one in his marketplace.
“In many markets, home builders can be somewhat interchangeable. But Pulte was originally founded in Michigan, so we’ve got an unusually high amount of brand awareness here that helps us compete, with customers and with trades,” says Jones, whose homes have an average selling price of just under $400,000. On the trades side, he says the firm can throw its weight around to negotiate better rates from its partners, and not just because of the volume at which it builds. More important than the number of houses the company can close is how dependable it can be in forecasting its partners’ work pipelines.
“The size of our business means we are consistent, and sometimes, that’s more attractive to a trade than just about anything else,” Jones says. “When they know there is going to be a consistent amount of business that’s coming to them in a known geographical location, they assign value to that.”
The more homes you build in a given market, the easier it is to spread your fixed costs across that broader unit base. “A home building division with 100 closings a year and a vice president of sales, versus one with 700 closings a year and a vice president of sales makes a difference,” Jones says. “You’re spreading that administrative burden over more houses, which is always good.”
In Phoenix, the country’s fourth-largest housing market in 2016, Taylor Morrison division president Brad Schoenberg similarly says the company’s scale in the market—aside from it also being the firm’s hometown—gives it a legitimacy with both buyers and partners that’s harder for small builders to establish.
“As a big fish, you’re relevant,” says Schoenberg. “Not just as a brand to your customers, but to your local trade partners because you demonstrate to them that you’re out there doing this every day, at a rigorous pace. They perceive that as good because it gives them visibility into their own business. That’s one benefit of the go-big strategy.”
Another benefit is that big builders get to look at the sweetest, biggest land deals first, especially when they can show they have the financing and logistical fire power to bring a deal to close through the entitlements phase.
“As a large player, your reputation precedes you,” Schoenberg says. “So in markets like Phoenix that are 90% broker controlled, those guys know that a Taylor Morrison, a Pulte, or a Lennar have the wherewithal to perform. I’m not saying we see every A+ deal first, but we do have the benefit of deals coming to us.”
Go Small, Stay Long
While big fish can leverage their size to get the best bites first in terms of lands and trades, smaller players can stand out, too, by picking their battles and strategically deploying resources where they know they can win.
“I keep telling my team we’ve got to be like the Navy Seals and go in, not with an overwhelming force, but by leveraging our resources like nobody else because we’re so well trained,” says Jerry James, president at Edward R. James Co., which has operated in the Chicago market for nearly 60 years and has been busy fighting off entrants like Toll Brothers, Hovnanian Enterprises, and Lennar Corp. to compete for infill projects in the suburbs north of the city.
With 105 closings in 2016—ranking his firm at No. 9 among Chicago home builders, according to Metrostudy—James says he’s survived and thrived by picking his battles and leveraging his deep-rooted local reputation and name. That’s been especially true when it comes to reassuring land sellers about zoning contingencies when he’s competing against the deep pockets and broad resources of the nationals. At the same time, he says going small in the current market works to his advantage, because he can change to meet the Midwest’s variable market conditions, which have shifted from greenfield projects in the hinterlands to infill projects near the city.
“We’ve managed to stay around for three generations, and I’d like to see the company continue to sustain itself,” he says. “We don’t believe in pursuing growth for growth’s sake. I’ve seen builders take on too much risk where they change the capital structure in a way that doesn’t fit, and they get loose around the edges. This is a very detail-oriented business, and it can get away from you in a hurry.”
And while James echoes the outlook of his market, where survivors of the Great Recession are happy to just maintain a steady pace today, bigger players in hotter markets aren’t throwing caution to the wind, either. This year’s Local Leaders tempered their remarks with cautious optimism and respectful deference against taking on too much risk, even as their markets recover.
Getting Big, Staying Big
Look at Sacramento, a market that’s seen both price and sales acceleration as a ripple effect from the San Francisco Bay Area’s ever-higher cost of living. There, Taylor Morrison is No. 2 in the market, behind only Lennar, and has had a presence in the area dating back to the 1970s. But while Sacramento jumped up four spots in this year’s Local Leaders rankings, and the top 10 home builders there increased closings by 17%, Taylor Morrison—which currently enjoys 9.2% market share—is still mindful to not get out too far over its skis in California’s capital. The company has owned Sacramento’s Elk Grove market for the past decade, and it recently made forays into the hot employment corridor havens of West Roseville and Folsom.
“Growth is great,” says Aren Bazzocco, Sacramento division president for Taylor Morrison. “It will always help your cost structure. But for us, there’s a sweet spot. For the last couple of years, we’ve had about 10% of the market. Right now, Sacramento’s doing about 5,000 units a year, and we’re doing 400 to 500 units. If the market grows to 7,000 units, we’d be fine doing 700. But we don’t want to overextend ourselves.”
For Jones and Pulte in Detroit, there comes a point when having the leading market share can stymie your ability to grow faster. “It can be difficult to get bigger in a small pond because sometimes you’re already consuming a disproportionate share of the resources,” Jones says. “If you’re already consuming 40% of the trades or the municipalities’ capacity to process permits, you’ve got external constraints that are beyond your control.
Growth = Risk
That kind of measured reasoning was echoed in markets throughout the U.S., where builders big and small who made it through 2009 to 2011 and survived to tell their tales haven’t forgotten that, in a business predicated on buying the land first, the flip side of growth is risk.
“We took a lot of lumps during the recession, just so we could still be around afterward,” says Jeff Benach, principal of Lexington Homes, which ranked No. 10 in Chicago closings in 2016, according to Metrostudy. “When prices plummeted out here between $50,000 and $100,000, most builders walked away. We finished our projects and took big hits because we wanted to make it square with our banks, which is why we can still get financing today.”
For Benach, who’s worked for public home builders in the past, balancing how much he takes on when he decides to go up against the publics is a tactical decision. For example, smaller players often lament that when they go into a project, they don’t have a lot of wiggle room in the numbers. That can make for tough sledding when they’re up against a public who’s trying to boost community count or volume to satisfy Wall Street.
“We have to make money on every house we sell, and every project we go into,” Benach says. “The nationals want to do that, too, but they also can spread it out on a larger base, where they say if they have X minimum margins at Y number of communities, they know they can pay their overhead. We can’t do that.”
Instead, Benach focuses on going after projects that are too small or too painful for the publics to go after in his area, with a focus on townhome and single-family homes with an average selling price of $350,000 in closer-in locations. And yet, as the Chicago market has thawed slightly, he’s been looking at larger lots, farther away, in places like Naperville and Warrenville, where he knows he’s going to bump into other builders.
“I’ve really got to be confident and sure about my numbers going in there,” he says. “I might be able to do better on price going in, but if they decide to drop their prices later, that could be a problem.”
A Prudent Approach
Yet, just because big builders can leverage their scale by distributing their overhead to more units, they never look to lose money on even a single home.
“My background is in accounting and finance, and I’m a big believer that projects need to stand on their own,” says Campbell at Taylor Morrison in Atlanta. “Yes, we can definitely spread our overhead among more outlets, but we’re not going out and saying we can go with a loss leader if things don’t go our way. While we might not hit a home run on every project, we put a lot of thought into our communities up front to avoid that kind of scenario.”
Campbell also weighs which projects are worth her team’s time and which ones she can leave to the pickup-truck builders that are well-known in Atlanta. “If it’s a 10-home townhome community, we’re going to look hard at that before we go in to see if it’s on a scale that we can justify doing,” she says. “Because I could probably get in there and do it, but I’ve got to consider whether it’s worth it to spread my team that thin.”
Leveraging Small to Get Big
Small builders who have successfully managed growth without overextending themselves to become more dominant players have done so by deliberately planning for it—not just in terms of the land acquisitions and trade partnerships, but in the very core of how they run their businesses. Take Edward Andrews’ growth story in Atlanta. Initially it served as a semi-custom builder that catered to clients, which set it apart from regional production builders in its market. Once it reached 100 closings per year, it changed its building system and options selection, still offering customers more choices than the competition, but in a way that was standardized among its plans.
“We want to project the image of a local, semi-custom builder who builds like the nationals from a production standpoint, because when you get to a certain size, you have to be able to get your houses done on time, and get them done quick,” Hager says.
Instead of letting clients decide window placement or the width of a room, they now have a set menu of options from which to choose. By limiting the number of choices, Edward Andrews has been able to make clients happier while avoiding myriad headaches that come from one-off construction.
“We don’t make it up every time anymore,” Hager says. “We know the cost, and we know how to price it, and we build it the same every time, so we don’t have to go through some big pricing exercise every time a customer wants something new.”
For Will Holder, president of Houston-based Trendmaker Homes, scaling up means setting deliberate thresholds, growing past them, and then aiming at the next level. “There are thresholds of efficiency at each stage of growth,” he says. “You want to operate at the top of your current range for maximum efficiency. If you’re going to grow again, you need to scale up to the top of the next range. We build our company around the current market and around our plan.”
Small Fish, Big Pond
There are other smaller builders who focus on giving customers what they want—for a price—and who are just fine staying their current size.
“I had an almost visceral, negative reaction when I saw your question about getting bigger,” says Bob Kleiman, CEO of Woodland Hills, Calif.–based high-end custom home builder Structure Home. “We absolutely do not have any interest at all in scaling up. We would rather stay small and specialized and be the best at what we do than to grow. It’s a whole different philosophy, but it’s a philosophy that my organization has adopted.”
Since his firm builds just 10 to 14 homes a year, with values from $4 million to $15 million in the upscale neighborhoods of West Los Angeles, Kleiman can afford to stay small. But even at the upper echelon of the market where he builds, Kleiman has carved out a niche that will be hard for others to take away from him, large or small.
“We’ve become highly specialized in marketing ourselves to a buyer who desires predictability in an industry that’s fairly unpredictable by its nature,” he says. “We have a very systematic process that enables us to hit the budget and schedule every time.”
Being small and finding your niche, or being big and trying to maintain your scale or grow it in a measured way, are the two dominant ends of local markets across the country. For some, the place to get squeezed—and a spot where it may be hard to leverage any scale at all—is in the middle.
“Right now, for the midsize builders it’s really difficult,” says Hager at Edward Andrews. “You’ve got to be a significant size so that you can leverage scale, or you’ve got to be small so that you can be selective and move quickly. But if you’re building 200 homes a year, at least in Atlanta, I think it’s going to be tough.”
Whatever the size of company, the real key to being a local leader in today’s market is picking spots wisely and being the best at what you do, whatever that is.
“It comes down to the consumer segments you’re trying to serve,” says Schoenberg. “I think you can be a successful midsized builder, at least within Phoenix, and the same principles of real estate always apply. If you’re finding the right locations with your land acquisition for your buyers, you’re going to be successful. The key is to size your business appropriately to whatever market you’re serving, and to be fine with that.”
Or, as Scott Lehner, CEO of Wichita, Kan.–based Perfection Builders, puts it, “Find what you do best, and then do it.”
That’s a one-size-fits-all approach that any local leader can apply.
"Last summer, when our family home was on the market, we were looking for a townhouse close to family and friends where we could enjoy our retirement."
- Diane and Jim Krupa