Capital Allocation and Its Ramifications | John Burns Real Estate Consulting

Capital Allocation and Its Ramifications


We get asked all the time, “Which markets are going to stabilize first?” We have a whole series of metrics we use to answer that question and project market conditions through 2015, but that is not the subject of this note. What I want to talk about is the ramifications of the answer to that question.

The answer to this question is very important to home builders and land developers, both big and small, for reasons that are far more than just the answer to “where can I make the most money?” When a consensus view develops, such as the current consensus that Washington D.C. will stabilize first, there are a number of ramifications. Here are a few:

  • Oversupply of Capital: The market that most companies believe will stabilize first is the market where big builders and big equity funds will allocate capital. The high number of investors, coupled with the bullish view on the future, will cause land prices to rise. Right now, DC is clearly that market as we have done more work in DC in the last year than in any other market. Thankfully, our clients are wise and structuring deals that make sense based on reasonable projections, but we are worried that unrealistic deals will get done sometime in the near future.
  • Blindsided local builders: While most small builders don’t think nationally, they should, because their competitors are national. If you are wondering why the national builders are making such bullish plays in your market, maybe it is because you have the best market in the country. In these tough times, no market feels great, but you should ask yourself what you would do if you were running a large, publicly traded company with too much cash and quarterly pressure to turn a profit – any profit. You would deploy capital in your best markets and you would be willing to take a subpar return because that return exceeds the interest rate on your cash in the bank and because you could turn a profit by covering more of your fixed costs.
  • Stock price envy: We have a lot of stock investor clients that listen to every public builder conference call. Investor perceptions of the health of a home builder’s footprint play a huge role in whether or not investors want to buy or short the stock. In our experience, when one builder’s stock rises much more than others, the remaining builders wonder why. Then, when the CEOs get asked by investors why they aren’t doing the same thing as the builder whose stock price has risen, the CEOs are pressured to follow suit. Today, the CEOs are being asked about the size of their presence in DC. Does that mean the big builders will tend to allocate more capital to DC? I think so.

In conclusion, while the housing industry is a very local business, there are an increasing number of big picture issues that are impacting every local market in the country. Those who understand the big picture will be much better equipped to make great decisions in 2011.

 


John Burns If you have any questions, please contact John Burns at (949) 870-1210 or by email.

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