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The wild housing market’s big winner? Homebuilders

From L.A. to Tennessee, consumers and government are saying “yes” to homebuilding despite lumber crunch

HW-The-Antelope-Valley-in-northern-L.A.-county
The Antelope Valley in northern L.A. county

It’s such a great time to build a home that companies are building in oil fields. Nary an eyelash was batted last month when two of the housing market’s biggest homebuilders – Pennsylvania-based Toll Brothers and Florida-headquartered Lennar –acquired 173 acres of land in Montebello, California from Sentinel Peak Resources, a company that owns oil development land up and down the Golden State.

In a project the companies have dubbed “Metro Heights,” 1,200 homes are planned in Montebello Hills, which is 10 miles east of downtown Los Angeles and has pumped out oil since 1917. A new twist on an old, controversial project, the land is already permitted, and the companies are shopping for homebuyers.

Metro Heights website allows, “There will be some active oil wells outside the residential area.” But it assures, “No homes will be built on abandoned oil wells.”

Metro Heights is part of a U.S. home building market that is “utterly bizarre,” said Tim Costello, CEO of Bdx Inc., a listing website for new homes.

“I can’t ever remember a housing market that is remotely like this,” Costello said.

What “this” is are factors that, on their own, are extraordinary. Record-high demand partly fueled by historically low interest rates on mortgages. Low supply and public officials acknowledging the supply crunch. A shortage in materials that makes lumber prices a surprise national obsession. White collar workers on year two of telecommuting and looking for space.

The moment means homebuilders move in several directions at once and can seem like they are throwing paint at a non-wooden wall. But make no mistake – if you’re an established homebuilder, this is a roaring time.

“Simply put,” said Douglas Yearly, CEO of Toll Brothers on an earnings call earlier this year. “This is our time.”

Firing on all cylinders

Yearly is the first Toll Brothers CEO outside of the family, replacing Bob Toll in 2010. A Cornell University-educated lawyer, Yearly has described with relish his transition from the law to homes, telling Time Magazine, “I was in the field for two years, and I was in blue jeans and Timberland boots learning how to be a builder, managing contractors.”

Repeated requests to interview Yearly or other Toll Brothers officials were turned down. “It is just a really busy time right now,” a spokesperson emailed.

Toll Brothers started in Fort Washington, Pennsylvania in 1967. Though they did not build a home outside Pennsylvania until 1982, Toll Brothers now trumpets itself as “The nation’s largest builder of luxury homes.”

The company last week released its most recent financial results, and it announced a record quarterly high in the number of completed homes, which was 2,771. Toll Brothers reported a net income of $224 million for the six months of their fiscal year, compared to $133 million one year earlier. It netted $3.2 billion in revenue, a jump from $2.8 billion a year before.

Most executives give a positive spin on earnings calls, but Toll Brothers brass oozes with a particular confidence.

“Our business continues to fire on all cylinders,” declared Martin Connor, the company’s Chief Financial Officer, who on an earnings call three months earlier stated, “Our business is firing on all cylinders.”

Toll Brothers is especially confident about joint ventures, “With either Wall Street private equity or with our friends in the homebuilding industry,” Yearly said.

“We now recognize the smarter way to go is to call up one of our friends and split it and put it off-balance sheet in a joint venture,” Yearly continued, later adding, “Because all the other builders want Toll Brothers to be the partner. We are the Whole Foods of the shopping center.”

Collaborations between rival companies might sound odd, but they occur in strong housing markets for homebuilding, said Jay McCanless, of Wedbush Securities, who analyzes Toll Brothers.

“Builders sometimes want to lower their monetary exposure to a given project,” McCanless said. And in the case of Metro Heights, “Lennar and Toll focus on two distinct buyer groups. Toll Brothers’ is luxury and Lennar’s are first-time and first move-up primarily.”

Lennar also posted a record number of finished homes in its last fiscal quarter, delivering 12,398. The 67-year-old company – whose name combines that of its founders Leonard Miller and Arnold Rosen– raked in $5.3 billion in earnings last quarter.

Lennar reported $1 billion in net income last quarter, a 251 % year-over-year surge from $398 million in 2019.

If Yearly was expansive, Lennar co-CEO Jon Jaffe was restrained on the latest earnings call. Asked a question from an analyst about the surge in lumber prices, Yearly called the supply chain, “Challenged but manageable.”

Built-up demand

Let’s start with some good news: More homes are being built in the U.S. today than at any time since 2006. The annual construction rate was revised up to 1.76 million new homes in April, according to the U.S. Census Bureau, and 1.58 million are set for completion this year, per the Bureau’s annualized finish rate.

The increased cost of lumber as well as crude oil, copper, and other materials pushes the average time it takes to build a home from five or six months to about seven months, said John Burns of John Burns Real Estate Consulting.

But builders are more enticed by high demand than deterred by higher costs.

“Builders have no idea today what the cost will be,” Costello of BDX said. “One way around that is to simply build the home.”

Builders also aren’t entirely sure who they are building for, or what exactly they are building. Take custom builds, homes in which the prospective owner provides instructions. About 17 % of U.S. homes now in construction are custom builds, said Robert Dietz, chief economist for the National Association of Home Builders.

That’s the lowest figure in over a decade, Deitz said, and compares to 32% in 2009, at the height of the Great Recession and low of builder confidence.

By contrast, 26% of the present market is spec homes, Dietz explained, or homes finished before they hit the housing market. But, the economist added, “One should think of that number as the floor,” as many homes are nearly spec – sold a few weeks ago before construction is completed, and after home builders know construction costs.

“Builders are offering homes for sale closer to when they are being completed,” said Burns, whose Irvine, California-based company issues reports on the residential building housing market.

Another trend: “Construction is definitely picking up dramatically from the job centers with permission to work from home,” Burns said.

It’s happening in Shelbyville, Tennessee – a town of 20,000 people more than an hour’s drive from Nashville. Of the Shelbyville homes that are available, “People are coming from California and doing cash buys,” said Cindy Barnes, an agent at Heritage Realty. “We are seeing 30 offers per home.”

There is an influx of new home building south of Nashville, Barnes said, including projects by D.R. Horton, the most prolific home constructor in the country, according to Builder (Lennar is #2).

“They seem to be building less built-to-order homes,” the agent observed, adding that often the buyer, “is just choosing the color of paint and picking between a couple of kinds of carpet.”

It’s also happening in John Burns’ neck of the desert, where local developer Five Point Holdings plans up to 10,000 homes on a former Irvine marine base.

Five Point’s most ambitious project is “Valencia,” 21,500 homes amid the Antelope Valley, the arid, northern tip of Los Angeles County.

The homes are anticipated to cost an average of $700,000, said Emile Haddad, CEO of Five Point, on the company’s most recent earnings call. 

Valencia is an hour’s drive from the city of Los Angeles on a day when every single L.A. resident stays home or takes public transit. But on the earnings call Haddad touted his project as not just benefiting shareholders but addressing a Los Angeles social problem.

“Everybody’s looking at this as a big answer to the housing market crisis that they have in L.A.”

In the mouth a desert

The approval of proposals like Metro Heights and Valencia do not happen overnight, at least not in California, and iterations of both projects faced environmental and regulatory challenges dating back to the 1990s.

The Los Angeles chapter of the Sierra Club spoke out against a past version of Metro Heights, arguing that residents may grow ill from inhaling nitrous oxide emanating from the operating oil wells. 

And local residents filed an unsuccessful lawsuit against a past Montebello Hills developer, Cook Hill Properties, but have not spoken out against Tolls Brothers and Lennar. (Among the past charges was that Cook Hill Properties violated open meeting laws by rendezvousing with Montebello officials at the Quiet Cannon banquet hall instead of City Council chambers.)

What may be partly different now is the savvy of the builders involved. Jaffe of Lennar (Lennar declined to comment for this article) rose the company ranks by brokering the acquisition of California builders like Greystone Homes, and meeting with California legislators and regulators. 

During a 2016 panel at the Stanford Institute for Economic Policy Research, Jaffe described spending 17 years wrangling with public officials to build Hunter’s Point Shipyard in San Francisco. With matter-of-fact calm, Jaffe called the California Environmental Quality Act, the primary law invoked to challenge real estate projects in the state, “Just the worst legislation that has ever been on the books.”

Government’s attitude toward homebuilding is also different today. The Biden administration has proposed $318 billion in its infrastructure bill towards the housing market, and some local governments have switched from quizzical to cheerleading for mammoth housing projects. For example, Haddad of Five Point (the company did not return requests for comment) refers to the L.A. County government as “partners” in the Valencia project.

“There’s just such a shortage of housing in general,” said Wendy Devine, a real estate agent in Santa Clarita, a few miles south of Valencia. “That it is easier for builders to jump through the right hoops.”

All building cycles must end. Costello of Bdx noted that it was all of 13 months ago that builders were stalling projects and laying off workers, wrongly assuming the market would freeze amid the pandemic. But for now, Costello said, expect the frenzy to continue.

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3d rendering of a row of luxury townhouses along a street

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