Today’s building industry executive is generally nothing like his or her predecessor. A college-educated executive who understands the importance of research, efficient processes and effective leadership has replaced the entrepreneurial framer/deal maker who built a large company based on good instincts.
In the 1970s and 1980s, home builders made decisions based on gut feel and experience, and their capital providers made loans based on trust. In today’s environment, those who relied on instincts alone are gone, and trust is just one of four factors that capital providers consider before making a deal.
Today’s successful building industry executives rely on people, processes and research to minimize the risk of making a mistake. We have defined a five-step process we call the Building Market Intelligence Process, but the exact process varies from builder to builder. What they all have in common, however, is an increasingly thorough, methodical approach to all major decisions. The process helps executives make decisions with more confidence, minimizing the ratio of risk to potential reward. Our process is as follows:
The Thirst for Knowledge
At the International Builders Show in January, the thirst for knowledge was everywhere. More than 100,000 attendees jammed the educational seminars and trade show floors to learn more about how to run a more profitable business. The educational seminars were packed with builders taking notes and asking great questions. Exhibitors focused more on educating potential customers than on building a relationship over drinks. The building industry has finally joined the “Knowledge Economy” we read so much about in the 1990s.
Superior Knowledge
Today’s executives, who are generally Baby Boomers, are more competitive than any group before them. Because of the size of their generation, they have faced more competition during their lives than any prior generation. They know how to compete and they know how to win.
Most executives have learned that superior knowledge translates to better decisions and less volatility. Builders and capital sources have taken it upon themselves to gather the knowledge they need to make decisions with more confidence. While the “old school” of management can’t believe the prices builders are paying for land, or the cash that builders are devoting to process improvement, the “new school” knows that they are more prepared than ever to make money, regardless of future market conditions.
Process Improvement
From land acquisition due diligence to home design to the warranty period, executives are spending much of their time focused on eliminating waste in the system and building a company culture that proactively plans for changing market conditions. The tremendous war chest of cash, which was used in the last several years to finance acquisitions, is now being turned internally to focus on building better companies. Builders plan to stay one step ahead of customer expectations.
Reducing Volatility
We all know the principle that high risk should be rewarded with high returns, but we sometimes forget that low risk produces lower earnings volatility. In today’s environment, with record home sales and home price appreciation, builders are planning for a downturn. They are not expecting a downturn, but they are planning for one. They have high cash balances to take advantage of opportunities. They have diversified market segments and geographies, with experts in each managing local operations. They are conducting research so their communities will be based on what will sell in the future, rather than what sold in the past.
Capital Providers
While builders used to rely on free tickets to ball games or connections with a Board of Directors member to raise capital, they have found that these relationships are no longer sufficient. Because capital providers are providing debt and equity at historically low interest rates, they know they cannot afford to make any mistakes. To raise capital today, it takes:
Trust – the relationship is still important, but it is not the only factor.
Cash – “Equity value” in the land is not enough, as capital providers expect co-investment.
Research – “Gut feels” need to be supported with solid research. In the defense of the executives from the past, much of the data that we can analyze today was not available 15 years ago.
Processes – Capital providers want to partner with builders who have all of the processes in place to react to unexpected changes.
Conclusions
Determine your company’s appetite for risk versus reward. Ask the following:
Chances are that your management team will not agree on the answers to the questions above, but achieving a consensus will be critical to the success of your company. Build yourself a management team with a cohesive view of the company’s appetite for risk, and execute your objectives with precision.
John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis.
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