Strategic guru George Casey sees a tipping point moment for operators as forces of exponential change converge. Game on!

We are at a crossroads in the new housing business. Many of the mysteries of several years ago about what the “new shape” of housing would look like have now been revealed.

We now live the new reality, with both its benefits and its challenges.

So, what does the topography look like?

• A plow-horse business. New housing starts are double their recession-bottom lows, but still only about 65-75% of what we need to produce. There are multiple reasons why, but the truth is that the current growth rate is nowhere nearly sufficient to get us to the level of production needed any time soon.
• A capital market landscape that favors the largest players and leaves the smaller players struggling for capital. This has limited the ability of many small and middle-sized builders--ones who typically produce about 75% of new homes--to add production. The large builders have gained market share, but of a smaller market. The historic support from community and regional banks for the small and medium-sized builder has been crimped by Dodd-Frank. This might change in the future, but for now, it is still the terrain.
• It is still tough to get a mortgage loan. Recent data on FICO scores for new mortgage recipients shows that, even though they have dropped slightly, average scores of qualified borrowers still sit 50-70 points above the norm that persisted before the “crazy times”. This has driven demand into non-ownership (rental) forms of both multi-family and single family as well as a variety of co-ownership structures. A plus is that new non-bank players have entered the space with some interesting innovations.
• Labor, including skilled labor, is in short supply. The combination of baby-boomers aging out of the workforce, a distaste among younger millennials, and those laid off from manufacturing for the construction business the way it has historically operated, and an immigration policy that is both sending the current immigration workforce away and not letting new immigrants in have led to a bottleneck for production, even at its current levels.
• Decades of creeping NIMBYism, mandated “included items” in homes and developments, and expensive impact fees have limited lot supply and density on land in areas where jobs are, and made housing costs grow at rates significantly faster than wages. There is no wonder that both “affordable” and “workforce” housing are in short supply and that values of existing housing stock have risen past the affordable range in areas where people want to live and the jobs are. Simple supply and demand at work.
• The gross margins and un-leveraged returns on assets for builders are worse than they were at similar points in past cycles. And this is theoretically the “best of times” when either marked down land or land bought at the bottom of the cycle should be running profitably through the income statement in a much better market.
• Productivity in construction is really not improving. The McKinsey white paper this past winter opened eyes: construction productivity has not budged since 1945, while most other major industrial sectors have increased 1500%. McKinsey believes that there is a 5-10X opportunity for productivity improvement in construction via the adoption of automation and factory technologies. Every month that goes by, the opportunity for disruption increases to take advantage of this opportunity.
• We are seeing non-traditional players enter the industry. Clayton dipping its toe in by purchasing several traditional home builders; Japanese builders looking at and purchasing US home builders; Silicon Valley players trying new and disruptive business models.
• The experience of buying a home has not improved significantly, despite the introduction of advance websites and other elements of front-end technology. Compared with every other part of the consumer’s daily experience with other purchases, both big and small, the new home buying/building experience looks like a throwback and is excruciatingly painful for most people.

This spring, I had an opportunity to attend a variety of conferences and meetings where these issues were laid bare: The Housing Innovation Alliance Summit (Denver in April), the Urban Land Institute Spring Meeting (Seattle in May), the Housing Leadership Summit (Laguna Niguel in May) and the Pacific Coast Builders Conference (San Diego in June). These meetings provide an interesting cross-section of builders, developers, finance, architects and planners, consultants, and thinkers about the industry, each with their own prism (innovation, land development, design, and building).

Out of these meetings, I can at least begin to formulate a point of view about what comes next and what the upcoming topography will look like for those in the new home creation business.

First, we are in a frantic battle for human talent with other builders and other industries.

In this battle, culture, vision, leadership, and willingness to change are critical. At the builder level, companies with fabulous cultures and leaders who care attract the best, not necessarily because of the money, but because they exude passion and mission and really care about their employees, trade partners, and third-party partners. Larry Webb at The New Home Company, Bert Selva at Shea, and Gene Myers at Thrive Homes are great examples to study. Millennials flock to these companies because they are cool places to work and have well defined visions of who they are, why they do what they do, and show they care deeply about people.

Second, and as an adjunct to the first point, the way we treat our trade partners has to be the way we treat our most valued employees.

We are in a battle to get and keep the best crews of the best trade partners. Scott Sedam of TrueNorth has great information on this topic, and Glenn Cottrell of IBACOS has the data on the cost of quality when the thinking is based around the lowest initial cost rather than having experienced crews and well-defined processes. It is in the tens of thousands of dollars per home. On the average home, that is about five to seven points of gross margin and, flowing through, about double the current pre-tax net income of most builders. Duh!

Third, it is becoming more obvious that the current business model of relying on a subcontractor on-site method of production is a major inhibitor to the productivity and profitability improvements that McKinsey highlights as possible. Builders no longer have reasonable control of their supply chain.

There is a lot of controversy and testing beginning to go on in this space. Does a Clayton, with its existing national footprint doing manufactured housing become a module supplier to current stick builders? Do they become a fully integrated national builder using factory built components? Does the Japanese fully integrated model become adopted and implemented by Woodside Homes? If so, how quickly? Does the FIOSS (Fully Integrated Off Site Solution) model that Gerry McCaughey’s Entekra is bringing to California (and based on the model used in the UK and Europe) become adopted quickly and broadly? Do builders bring critical trades or all trades in-house and adopt the DiVosta model in order to prosper? Will Kanterra’s business model and Silicon Valley backing be the real disrupter?

I don’t know the right answer, but what I do know is that we are going into a period where we are going to have parallel and different business models being tested at the same time builders try to get more out of the current subcontractor site-built method. The real question is who will adapt and navigate this landscape best, for the interim answer will probably be some combination of “all of the above”.

One disconcerting observation from the spring was that too many builder CEOs, when asked what they are doing about innovation in business model answered “nothing”. They mostly said that they were just too busy doing what they are doing and were too short-handed to take on such a major project.

Another observation that was interesting is that many leaders felt that the changes would happen so slowly that they would stay with the current methods and organization and when a new method had proven out, then they would look to adapt.

However, when presented with the proposition that a competitor showed up offering a system where homes could be bought on-line and delivered in less than 60 days, their eyes lit up. The thought that time could be a competitive weapon and a customer might put high value on an experience more similar to ordering from Amazon was a driving concept worth going for now.

It is going to be interesting and exciting watching this next period as innovation and globalization hit the industry full force.

Ignore the battle at your peril.

Getting into the fray, failing forward if necessary, but creating the excitement of competing for a piece of the new industry will be the best draw to attract those who think that kind of challenge is what makes life worth living. Those will be the people who get you there.

Game on!