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Toll Brothers Inc
DR Horton Inc
CoreLogic Inc/United States
Standing on a rough plateau in the foothills of Orange County’s Santa Ana Mountains, Seth Ring swears that on a clear day, you can see the Pacific Ocean. That vista is part of what makes Ring, a vice president at the nation’s largest luxury homebuilder, Toll Brothers (TOL), excited about the land under his feet, an undeveloped 387-acre site 50 miles south of Los Angeles. Toll plans to put up as many as 1,780 houses in a joint venture with Shea Homes. Here, orange earthmovers have begun digging into the shrub-strewn soil to make way for the sewers, roads, and other infrastructure that must be in place before model homes can open in 2014. “This,” says Ring, “is our big ‘we’re back in’ play.”
The development is one more sign that homebuilders are putting the bust behind them. As a group, the 13 publicly traded builders tracked by Bloomberg Industries turned a third-quarter profit for the first time in five years. D.R. Horton (DHI), which builds the most homes in the U.S., reported operating income of $76.1 million in the period, up almost 50 percent from a year earlier. On Aug. 22, Toll announced third-quarter net income of $61.6 million, up 46 percent from the previous year. On Sept. 21, KB Home (KBH), which targets first-time buyers, reported quarterly earnings of $3.3 million—its first third-quarter profit since 2006. KB’s results, Barclays (BCS) analyst Stephen Kim wrote in a note, “confirmed that the pace and breadth of the housing market gained momentum over the summer. … We continue to believe that 2012 is proving to be the beginning of a sustained housing recovery.”
While many private builders went under during the recession, large, publicly traded builders, which construct almost 30 percent of the nation’s new homes, survived by cutting back production, renegotiating land contracts, and bargaining harder with suppliers. They used cash on hand to scoop up cheap properties and take advantage of opportunities such as Baker Ranch. Toll paid $110 million in June for a 50 percent share in the project, which city officials approved last year. Finding large parcels of buildable land in coastal Orange County is “pretty much unheard of,” Toll Chief Executive Officer Douglas Yearley told investors in August.
Builders cut back so much during the downturn that they didn’t add enough homes to keep up with population growth, Ring says. Nationally, there’s been a little more than six months’ supply of new and existing homes for sale this year—about half as much as when supply peaked in summer 2010. A June report by data firm CoreLogic (CLGX) found that inventory is particularly tight in places such as California, Nevada, and Florida, where homeowners often owe more on their mortgages than their homes are worth and therefore don’t want to sell.
Meanwhile, demand is picking up. Ring says Toll started looking at the Baker Ranch project last fall, as the company saw more visitors to its sales offices and more people buying its higher-priced homes in California. “Think about what happened to your life in the past seven years,” he says. “I got married and had two kids. Your life’s needs may outweigh your trying to buy at the bottom of the market.” Plus, there’s been an influx of international buyers. “That’s the buzzword right now,” Ring says, estimating that Chinese families make up as much as 40 percent of Toll’s buyers in some Southern California developments.
Photograph by Bear Guerra for Bloomberg Businessweek
As Ring heads north to another Toll project, maneuvering his slate-gray Prius down the hillside, it becomes clear that Toll is not the only optimist. Those hunched-over strawberry pickers in that nearby field? They’re on a corner of what will be an almost 5,000-home development financed by Lennar (LEN) and other builders. “We’re looking to buy sites here, maybe,” Ring says, before hopping on a highway that snakes north along the Santa Ana foothills. Twenty minutes later, he swings past Amalfi Hills, a 113-home site that Toll bought from a developer that mothballed it. A mile down the road is Vista Del Verde, a 1,750-home community that Toll began developing in the late ’90s. After slowing during the crisis, sales have doubled this year. Only 200 homes remain unsold. The Tuscan, Mission, and Federal-style houses max out at about 6,000 square feet.
At Baker Ranch, the largest homes will be about half that size, and those going up during the first stage of construction will be even smaller. Plans include community centers where residents will have more room to entertain. “When the economy is booming, people tend to want something bigger and better,” Ring says. Now, “people are a little more discerning. Maybe we don’t need that fifth bedroom.”
Toll signed contracts on 3,061 homes this year through Sept. 30. While more than in any full year since 2007, that’s well below the peak of 10,796 in 2005. Analysts say the going may get tougher from here. As they ramp up activity, Toll and other builders have been able to restart older projects and concentrate on prime locations. After those opportunities are exhausted, “at some point you are going to have to start going to the periphery,” says David Goldberg, an analyst at UBS (UBS). When builders move further out into the exurbs, Goldberg says, they’ll face more competition and will find their profit margins squeezed. Another concern, he says, is the overall state of the economy: “It’s going to be tough to keep growing at 20, 30, 40 percent a year if we don’t have more macroeconomic improvement.”
Investors have already benefited from the homebuilders’ rebound. The Standard & Poor’s (MHP) homebuilders index has climbed 79 percent this year. That surge has made Goldberg and other analysts cautious about the outlook for further homebuilder stock gains this year. On Sept. 26, the U.S. Department of Commerce reported August new-home sales fell 0.3 percent from July, to an annual rate of 373,000 new homes, less than the 380,000 analysts expected.
Ring starts descending from Vista Del Verde to head back to Toll’s nearby office, itself a reminder of how big a hit the company took in the bust. Toll used to occupy an entire floor of a five-story building. Now about a dozen people work in one suite, sharing the floor with a law firm and a stockbroker. Ring wears a lot of hats, and now he’s running late for a meeting with a decorator. They need to pick out furnishings for a model home at Amalfi Hills that’s supposed to open early next year.
The bottom line: A new Orange County development is a sign of a housing recovery, even as construction remains well below levels of the boom.