Market Improving For Well-Positioned New Home Builders

Geoffrey Schiering — Wed, 26 Aug 2009 18:41:56 +0000

One of the standard results of industry downturns is consolidation, and the recent housing slump is predictably leading to consolidation of the new homes building industry. Heading into the current recession, the top dozen home builders in the United States controlled about 25% of the new homes market. The slowdown of sales and the tightness of credit has driven many of the smaller builders out of business and led to a handful of mergers and acquisitions. A report from Credit Suisse suggests by end of the recession the largest home builders will dominate 35% or more of the market.

Toll Brothers is emerging as one of the strongest players. The publicly-traded company is located in Horsham, PA and listed on the New York Stock Exchange (“TOL”). Toll Brothers was ranked seventh in the top ten home builders of 2009, with earnings of $3.2 Billion, closely trailing K Hovnanian Homes (#6 with earnings of $3.31 Billion), and NVR (#5 with earnings of $3.1 Billion). The new home builder in the top spot at the start of 2009 was Centex Corporation based in Dallas, TX, with earnings of $8.41 Billion.

California New Homes by Toll Brothers

Shrewd business decisions stand to move Toll Brothers up in the building industry rankings. Toll Brothers was one of the few home builders that decided to stop land acquisitions early in the downturn, around mid-2006, choosing instead to accumulate cash. Now that land prices have fallen sharply, Toll Brothers is using the cash to acquire land at deep discounts. When the economy improves they will be in a better position to sell new homes at lower prices and/or with higher margins.

On August 12 2009, Robert (“Bob”) Toll, hosted a conference call to discuss Toll Brothers Fiscal 3rd Quarter 2009 results. Despite 22% fewer selling communities, gross signed contracts for Toll Brothers homes are up by 16% compared the third quarter 2008. But more importantly, the number of net signed contracts (new contracts minus cancellations) at Toll Brothers has increased for the first time in 16 quarters. Net signed contracts for the 3rd quarter exceeded 2nd quarter net signed contracts by a whopping 44%. The cancellation rate fell to 8.5% compared to 19.4% in fiscal year 08 3rdquarter. The cancellation rate has dropped to very near the historic average of 7% since the company went public in 1986.

Mr. Toll feels that consumer interest has regained momentum, and the company has renewed hopes for stronger demand among new home buyers. He feels that price is no longer the dominant signing factor. The company is discovering increased pricing power and it reducing incentives in many markets. Prices are down, but Mr. Toll says it’s a better market now with more serious home buyers looking at new homes. “They fear missing, and we fear not selling.” That combination is leading to more signed contracts.

Referring to the HVCC appraisal rules, Mr. Toll noted that “One of the more significant problems is the change in the appraisal game.” The builder sales strategy for years had been to offer new home buyers incentives of builder upgrades and extras, such as upgraded flooring, swimming pools and the like. Recently appraisers have stopped acknowledging the full value of these upgrades, leading to under-valued appraisals and contract cancellations. Mr. Toll says that his company is now “guiding option selection down to make it easier on appraisals for ourselves.”

Toll Brothers currently builds homes in twenty one states. Their largest markets in terms of the number of new home communities are New Jersey (33 communities), Florida (31 communities), and Virginia (28 communities). The fourth largest market for Toll is a tie with 26 communities of new homes in California and in Pennsylvania. In the past several years Toll has reduced the number of communities under development and offered for sale. With the improved outlook, Mr. Toll says his company plans to re-open some of the “mothballed” communities in the coming year. “I don’t know if that means next quarter or the quarter thereafter, but we have a mindset to do that now.”