They Can't Build 'em Fast Enough

For the nation's home builders, what a difference a decade makes: When the economy plunged into recession in 1990, much of the industry was caught unprepared. Vast holdings in raw land and unsold houses eventually drove many home builders into bankruptcy. Now fast forward to the present: Despite a recession, many builders are boasting record profits, lean inventories, strong balance sheets, and hefty order backlogs that portend a strong 2002 as well. "The best is yet to come for us," says Robert I. Toll, chief executive of Toll Brothers Inc., a Huntingdon Valley (Pa.)-based builder which on Feb. 26 reported an 11% rise in earnings for the quarter ended Jan. 31.

If the economy recovers as expected, many economists are predicting that new-home sales could eclipse the record 901,000 homes sold in 2001. Still, all troubling signs haven't disappeared. Although highly volatile, the monthly new-home sales figures for January fell 14.8%. That could simply reflect a statistical fluke during what is typically one of the industry's slowest months. Or it could portend the onset of a cooling-off trend in the market.

Wall Street has long been skeptical of what could happen when the housing boom slows. The publicly traded builders trade on average at just eight times their projected 2002 earnings--about the level where they've been for the past three years. That's just a fraction of the 20 times projected 2002 earnings that Standard & Poor's 500 companies trade for.

Clearly, it wouldn't take much to reverse the industry's good fortune. Some developers admit that backlogs--homes secured by downpayments, often refundable, of as little as 5%--may not be as solid as they seem. "If the economy were to weaken, backlogs could dry up," admits Stuart A. Miller, chief executive of Miami-based builder Lennar Corp., which nonetheless boasts nearly $2 billion in booked orders.

Still, even if sales slow, few are predicting the kind of builder bankruptcies associated with past recessions. Analysts credit a combination of regulatory and zoning trends for helping to smooth out the boom-and-bust cycles long associated with housing. For one, a series of moves during the 1990s by bank regulators to tighten capital standards discouraged banks from financing speculative building. That in turn has prodded many builders to break ground only after they have a buyer in hand. Tougher land-use restrictions in many Sun Belt markets, a backlash to the sprawl of the 1990s, have also helped serve as a brake on overbuilding.

Structural changes in the industry have also helped. A wave of industry mergers has given larger builders more geographical diversity and the financial scale to tap the cheaper public debt markets. That lessens their dependence on more costly--and more fickle--bank lending. A merger boom has also given many builders more purchasing clout with suppliers. Bruce Karatz, chief executive of KB Home, whose 1999 acquisition of San Antonio-based Rayco made it the nation's largest builder, notes that the resulting increase in purchasing power has helped KB lower its cost of construction by as much as $2,000 per house.

A new crop of executives may also be showing more financial sophistication than in previous recessions. The industry's debt-to-capital ratio, historically above 70%, has dropped below 50%, as builders who once stockpiled land for future developments are taking cheaper options to lock up that same land. The result: Merrill Lynch & Co. analyst Joseph Sroka estimates that home builders are sitting on an average four months' supply of unsold homes, vs. a seven-month supply in 1995 and a nine-month supply during the 1990-1991 recession. That should leave them better prepared to weather an unexpected drop in demand. "The industry has been uncharacteristically disciplined," muses Miller. The infamous boom-and-bust mentality of home builders may now be a thing of the past.

By Dean Foust in Atlanta

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