10 Waves of Change for Home Builders
The end of the fall marks a time for me to review what I have seen over the past year and to also think about the longer-term changes in our industry and how they may have already opened doors of opportunity that we don’t instantly recognize.
One of the things that helps me in this exercise is to review the “By George!” writings from the past and how the reflections of past points-in-time actually played out. What did I get and what did I miss?
Back in 2010, I started musing about “Humpty Dumpty” (the housing industry) falling off the wall and that we didn’t know how Humpty would go back together again, but that the new Humpty probably wouldn’t look like the old Humpty.
I pondered the possible rise of single family for-rent as a resurgent asset category, a decline in government support for the various subsidies that had supported home ownership since the second world war, and an aversion by lenders for the real estate sector and that this would limit the ability of the private, small builder to respond to a growing housing demand.
By early 2016, the single family for-rent business had become a new asset category, several of the roll-ups had already consolidated and gone public, and new single family for-rent communities were no longer an oddity. Private builders were having difficulty getting capital as banks we dis-incentivized to lend in the real estate sector. The result was a very slow growing housing sector and a greater consolidation into the public and large private builders. Elimination of the mortgage interest deduction had become a mainstream idea being floated.
By that point, the recovery in home building was well underway, but under producing compared to demand, affordability was becoming a national issue, and labor availability was becoming a universal concern. A good reread from March of 2016 is “The New-Old Humpty Dumpty.”
Last year at this time, it was becoming evident that the labor shortages in the industry were not going away and that a response was needed in the form of figuring out how automation, technology, and robotics would be needed in increasing quantity in order to produce the level of housing we would need in the future, particularly if it was going to be affordable to the population as a whole. (The Elephant in the Room from November of 2016 is also a good reread.)
After reviewing this fall’s great conferences (John Burns’ Annual Fall Homebuilding Meeting in New York, the Housing Innovation Alliance’s Off-Site Solutions think tank in Phoenix, the Urban Land Institute’s Fall Meeting in Los Angeles, and Hanley Wood’s HIVE Conference, also in Los Angeles) a couple of observations are appropriate for thinking about where we are and where we are going.
First: Single Family for-rent is becoming main stream. Each year sees an advancement in this sector. More builders are figuring out the business model of how to make it work economically. No longer a “doesn’t make economic sense; just a one-time asset play” discussion. As policy incentives for homeownership get whittled away, more people will choose to rent and builders have to know how to have this arrow in their quiver. If you have not investigated this business, you should.
Second: Interest in the realm of “off-site solutions” (building either components or all of houses in factories) is white-hot. Nearly every meeting/conference has this as a topic now as builders begin to understand that the old methods are no longer the future methods.
There is still a lot of skepticism about economics, what happens in a downturn, who will do it, etc. that is reminiscent of the same doubts and concerns involving single family for rent. Gerry McCaughey at Entekra and the folks at Katerra are the pied pipers of this movement. If you haven’t looked at what they are doing, you are missing a telescope that peers into the future.
Third: “The profit is in the process.” Scott Sedam of TrueNorth has been preaching this for years. Entekra and Katerra are the exemplification of the idea in motion. In particular, the integration of architecture, engineering, and manufacturing in the product planning up front is the key to creating economically and quality efficient housing. This integration along with a continual focus on the improvement of the “choreography” that it takes to assemble houses, whether they are stick-built, come out in components, come out in modules, or come out as whole-houses seems to be highly important, yet is missed by most builders.
It was eye opening to see Katerra’s operation in Phoenix as part of the Housing Innovation Alliance’s Think Tank on Off-Site Solutions last month. The electronics manufacturing logic and imperatives of continually driving down cycle times and costs by understanding, innovating, testing ideas, failing and learning, and ultimately getting better at a speed that would have most builders pulling more G’s than they could handle. But this is the new standard that is needed.
It became obvious that not focusing on these things mean that margins deteriorate and the ability to invest in the people and technology that it takes to drive costs and cycle times down and customer experience and value up just cannot happen. Do it, or slowly die.
Fourth: We are continuing to under-produce housing of all kinds and that this is exacerbating the affordability issues all across the country. People are staying in their homes longer as reasonable move-to options just don’t look like good deals. Inventory levels stay stuck at historic lows. Yet millennials are looking for their first house and can’t find anything that they can afford in a place they want to be. We are also seeing renovation and remodeling booming in this environment as people opt to improve what they already have instead of moving to someplace new. Add on the adaptive re-use of outmoded commercial space into residential and mixed-use forms and residential opportunity a popping up in unexpected places.
This opens a huge opportunity for improvement and profit in the remodeling industry. Who is going to grab it?
Historically, this has been a mom and pop business with very little scale to it. (Kind of like the single family for rent business before some of the national roll-ups started.) I believe there is opportunity for someone to do a national scale business here taking advantage of purchasing power to drive down costs, technology to work faster and with higher quality, and to make what might be better profits than some of the existing home builders are making today.
For people in more house than they need, they could downsize in-place and create (where zoning permits) rental apartments or other living accommodations of the multi-generational type.
Maybe Archie and Edith are being reborn with the current day Meathead and Gloria living with them.
Fifth: Our local governments are becoming one of the major inhibitors to affordability and abundance of housing. It ls looking like the NIMBYs have won across a wide swath of the country and that has led to higher costs, fewer homes where people want to be, and declining affordability. I don’t see this changing any time soon, which means that the pickle we are in probably continues. It also means that you will see even more regulation trying to force affordability by tactics such as inclusionary zoning, which tends to drive supply down even more over time.
Sixth: The changes to the tax laws are going to have impacts that we are not foreseeing. It takes a year or two for adaptations and strategies to evolve in response to these kinds of changes, many which do not encourage homeownership on an individual level the way they have done since the 1930s. My sense is that rentals may become marginally even more attractive, perhaps with longer-term triple net leases. But, that’s just a guess.
Seventh: Builders are going to have to have organizations that are different in order to survive. Process control and improvement, research and development, industrial engineering and data to make the various processes more efficient will be the necessities of survival.
The off-site manufacturers are doing some of this already and reaping time and cost savings. It will be one of the drivers that make the off-site model more compelling. New organizational models, more rapid adaptation of technology, and a speed level of execution that is orders of magnitude higher than the current will be required. I don’t see many builders either understanding or knowing how to strategize and execute in these realms and that is a real problem.
Eighth: New players will continue to come in and force the hand. If there is one lesson from the past year, it is how fast and creatively some of the “outside” entities have come into the business. Not all will succeed, but they are demonstrating both new ways to do things and an urgency that is significantly higher than most builders demonstrate. The timetables and expectations that come out of tech and other startups are forcing the issue.
The days of thinking that your competition is the other builder like you down the street are becoming numbered.
Ninth: I can begin to see a bifurcation of the detached housing business into a true production model and a bespoke/custom model.
In the true production model, there will be very little choice for the customer individually, but that simplicity will drive greater consistency and predictability of production, lower cost and higher speed. Think the Levitt model from 1946 to 1960+. This will be an area where replication of designs designed for specific segments are repeated because they are really on target for that segment and are way up the learning curve on efficiency, both in cost and speed, and that will be passed on to the consumer. This model loves the factory environment.
The bespoke model will in its turn be divided in two.
A semi-custom model with some degree of optionality and selection more extensive than the production model and a truly custom model that is truly a one-off. In the semi-custom model, this, too, can take advantage of the off-site solution model, but there will be more customer decisions, more time in manufacturing set up, and more opportunity for inefficiency and miscommunication, with the costs of money and time inherent therein.
In the truly custom model, it will really be high-cost and artisanal; this will be the home of the remaining highly trained framer and design build firms. A lot of inefficiency, but those wanting the ego ride will pay anyway for exactly what they think they want.
Tenth: Diversity within a model will be helpful. Doing production homes, both for sale and for rent, for example, will help smooth some of the cycle ups and downs. They are different business models, but can live under the same roof.
Those who choose to invest in creating the off-site factories would be well positioned to be able to do single family for-sale and for-rent, multifamily, and commercial structures in order to not ride just one cycle. Many of the lessons of failure from the last boom times involved builders who built factories and focused just on the single family for sale market, rather than a diverse set of users.
No matter what the trend, the qualification for success will continue to be great leaders who drive their companies to new places to take advantage of these opportunities. Leadership, organizational innovation and flexibility, great culture, and positive urgency will all be necessary.
This is going to be a bumpy, but exciting, ride into 2018.