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Strategies & Market Trends : The Residential Real Estate Crash Index
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To: Wyätt Gwyön who wrote (54640)5/22/2006 4:43:27 PM
From: Elroy Jetson of 306849
 
How does a small builder compete? They don't build in the same location as large integrated builders, unless they're offering a significantly different product type - and that often doesn't work either.

Let's compare a large builder like Centex, who bought their land in San Diego recently.

They build a pleasant 2,300 sq.ft. home selling for $1.4 million:
_Building cost is $135k or $58.70 per sq.ft. because this is the top of the line model;
_Lot cost is $650k because the builder bought recently, and the;
_Gross profit margin is 44%.

In the event of a downturn, they can choose to lower their profit margin to 4% and reduce the cost of this $1.4 million home to $840k - a 40% discount.

This is not as low as Pardee Homes can go at $410k, but it does take you through some bad times with continuing sales.

If prices tumble below $840k, this Centex-like company may choose to place their California subsidiary into bankruptcy. Their land holdings will be bought by parties like Pardee Homes with lots of available cash and no debt. Pardee is unlikely to pay as much as $210k for that $650k lot. The bankruptcy price will likely be closer to $70k.

Even though home builders can cut sales price this dramatically, they are still slashing their profit margin to do so.

Pardee Homes has had higher profits each year since 1974. How? They build condos and rent them out as apartments during good times. Then they offer them at 2/3 of then-current appraised value to the renters during bad times. Typically 3/4 of the renters jump at the chance to buy their residence at a 33% discount, and Pardee sells the rest to the public. This is called "the cookie jar". If Pardee was a publicly traded company rather than a subsidiary of Weyerhauser Corp, they would be under pressure to act like the other builders.
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