by Catherine Reagor – May. 31, 2009 12:00 AM
The Arizona Republic
Home builders who three years ago were selling new homes at record prices must now overhaul their entire operations to survive.
Downsizing until the market recovers is not enough. Valley builders have to adjust to lower prices, cope with a glut of foreclosures and find buyers eligible for financing.
That means different ways of doing business at each step of the home-building process. Those who can find the right formula now for even modest profits will be ready when the market comes back. Every builder hopes to be in that position.
Meritage Homes of Scottsdale seems close. Having cut prices on its new homes by more than 50 percent, Meritage is attracting buyers in a punishing market.
Housing is metropolitan Phoenix’s biggest industry. This is the first in a periodic Republic series on how key players in the housing industry are reinventing themselves to work toward a recovery. An essential part of that industry is home building, a segment battered worse than most by the downturn, and the challenge to lower new home prices.
During the housing boom, metropolitan Phoenix led the nation in home building. More of the nation’s big builders were constructing homes here than any other metro area. In 2005, 64,000 homes were built across metro Phoenix. Last year, that number dropped 80 percent to 12,500.
During the past year, several home builders here have gone under or filed for bankruptcy. Others have lost development land to foreclosure. National builders have pulled out of metro Phoenix to focus on other markets.
Three years ago, Meritage Homes was selling dozens of $250,000-$300,000 homes in the Maricopa area southeast of Phoenix. Then came the crash. Demand plummeted. Prices dropped. Foreclosures climbed, as they did in all the newest edge suburbs.
Meritage executives have spent the past six months overhauling their entire business model. They now are building and selling homes for less than $100,000 in the same Maricopa neighborhood.
For Meritage and other builders, such an overhaul means:
• Reduce land costs.
• Design smaller homes with fewer amenities.
• Reduce construction costs.
• Market specifically to buyers who can afford the houses.
“Home building is a survival game in Phoenix now,” said Tim Sullivan, a national analyst with San Diego-based Sullivan Group Real Estate Advisors. “The market won’t recover to the boom years, but it will recover. Smart builders will find what buyers are willing to pay for and where.”
With the new operation in place, Meritage has sold 45 new homes in Maricopa since February. During all of last year, Meritage sold an average of 25 homes in each of its dozen Valley developments.
Land
The price of a home starts with the lot.
Overhauling a home-building operation requires reduced land costs. Valley home builders went on a land-buying spree during the boom anticipating they would need more lots within a year. The cost of lots shot up 50 percent in newer communities such as Maricopa.
In 2005, Meritage partnered with Scottsdale-based Hacienda Homes to purchase 640 acres in Maricopa’s Lakes at Rancho El Dorado development.
As 2007 arrived, the housing market cooled and Meritage and Hacienda couldn’t sell homes in the Lakes development. Together, the builders had sold fewer than 100 homes among 2,200 lots. Neither could afford to hold on to the land. The land was lost to foreclosure last year.
Meritage is the Valley’s only local, publicly traded builder. As a public company, it had more financing options than privately held Hacienda. Meritage raised money from a stock offering and bought the land back for about $20,000 a lot, about one third what it paid in 2006.
Lots are a bargain now around the Valley, but few builders can afford them, because they lack the cash or financing to buy.
Many private builders had their loans called by lenders and lost land to foreclosure. One of the Valley’s biggest private builders, Fulton Homes, filed for bankruptcy in February. Hacienda and other prominent private builders have gone out of business.
Meritage is now buying the lots of builders that have gone under. Last month, Meritage bought 80 lots in a gated Chandler community for $35,000 a piece. Those lots last sold for $190,000 a piece.
Home design
With land to build on, Meritage threw out the original home designs for its Lakes development in Maricopa.
The company focused on smaller homes that first-time home buyers could afford, said Steve Hilton, chief executive officer of Meritage. New designs were a balancing act between economy and popular features. “We aren’t completely stripping down the houses,” Hilton said, “because we still have to compete with those foreclosures that have all the amenities.”
Meritage’s smallest home in its Maricopa neighborhood shrank from 1,800 square feet to 1,100 square feet. The biggest home for sale in Meritage’s Lakes development is now 3,100 square feet, compared with the 4,000-square-foot homes it built there during the boom.
To save space and reduce costs, dining rooms were replaced with great rooms that combine the kitchen, dining area and living room. Big entryways and two-story ceilings were scrapped. Laminate kitchen countertops replaced tile or granite. Some appliances are no longer included. Buyers, for example, now have to purchase their own refrigerator.
Builders used to be able to count on buyers upgrading countertops, tile and appliances to boost their profit on a house. During the boom, Meritage home buyers spent another 30 percent on top of the home’s base price to upgrade amenities. Now, most home buyers are upgrading by less than 10 percent.
The Maricopa development doesn’t have a community center, swimming pool or a golf course. This keeps homeowners association fees about $52 a month.
“It’s all about the payment now,” said Fred Hermann, Meritage’s Southwest Valley president. “We include HOA fees in the price. People are cautious about spending and any extras. Buyers are much more concerned with what they can afford now. “
In Maricopa, Meritage is now selling a 1,100-square-foot home with basic amenities such as carpet and vinyl floors for $96,900, or $716 a month, including HOA fees.
Marketing
To sell a new home for less than $100,000, Meritage also had to cut the cost of selling.
Meritage dropped its full-page advertisements in magazines and newspapers and canceled its $500,000 annual marketing contract with the NBA’s Phoenix Suns. Public-relations staff and glossy home brochures were cut.
The company spent $15 million on advertising in 2008, down from $31 million in 2007. Meritage now markets new homes primarily on its Web site and with new signs and banners in subdivisions.
In the Lakes development, big green and blue signs direct potential buyers to the Meritage sales center. Meritage used to have three or four sales offices in a community the size of the Lakes, each with its own staff and model homes. Now there is just one in each of Meritage’s 12 active Valley developments.
Once they arrive, buyers will notice significant changes. Model homes used to be decked out by interior designers with the highest-priced upgrades and no signs pointing out the extra costs. Buyers had to sort that out with sales-center staff.
In the Lakes, each Meritage model home has a big, brightly colored sign on the garage listing the monthly payment. The lowest priced home sits on the end of the block for prospective buyers to see first. Homes are arranged by ascending price. Buyers can see what an additional $100 a month in mortgage payments will get them by going to the next model home.
Displayed on a full wall of the Meritage sales center are detailed breakdowns of home designs, costs for upgrades and what each means to monthly payments.
Inside the model homes, each feature – from appliances to lighting fixtures – is listed by price on color plaques strategically placed at eye level. The plaque comparing the cost of the three-car vs. two-car garage includes average yearly costs for car washes for a car left outside.
Meritage has cut the cost of selling a home by 40 percent.
“We are doing NASCAR-style marketing,” Hilton said about the bright-sign approach. “Buyers want to know prices and what they are getting right away. It’s like BAM, WOW, when you walked into one of these model homes.”
Buyer financing
Meritage now markets homes on the basis of monthly payment, just like apartment complexes have done for years.
By focusing on monthly payment vs. overall home price, Meritage hopes to attract first-time home buyers, especially renters.
“Most of our buyers in Maricopa are renters,” Hilton said. “The average apartment rent in the Valley is less than $800. We knew in order to sell to renters, we had to get our prices below rents.”
First-time buyers have the best financing options and incentives now through the Federal Housing Administration’s lending program, loans that require only a 3.5 percent down payment. Through the federal housing plan, first-time homebuyers also receive an $8,000 incentive until Dec. 1, which can be used as a tax break or for closing costs.
The $8,000 incentive shows up in Meritage’s marketing. Signs in the sales center and on the lawns of model homes read: “Ask us about the $8,000.”
Joy Nuang recently looked at Meritage’s Lakes neighborhood.
“We could afford a home here,” Nuang said.
She and her husband were renting in the Los Angeles area and are now saving money for a home by living with her parents in Mesa. “I was just driving around and I saw Meritage’s signs. We want to buy before the $8,000 plan goes away.”
Construction
The biggest costs in home construction are labor and materials.
Meritage can cut land costs, design smaller homes and reduce marketing costs. But this would still not be enough for the builder to cut the cost of its homes by 50 percent in Maricopa.
Here’s where the down market actually helps Meritage price homes below $100,000: Lack of demand has driven materials and labor costs in the Valley to the lowest levels in a decade.
Home building is at a 30-year low in metro Phoenix, with about 350 going up each month, compared with 5,000 a month in 2004-06. Arizona has lost more than 100,000 construction jobs since 2006.
“We can get the best trade contractors now,” Hilton said. “We can hire the best construction foreman. For a builder actually building now, there’s the cream of the crop to choose from for people.”
Meritage has cut building costs by 30 percent by renegotiating deals with contractors and suppliers for everything from drywall to toilets.
Meritage is also able to build homes faster because of the ready availability of labor and materials.
“We can deliver a home in less than four months in Maricopa,” Hilton said. During the boom, homes took nine months or longer to build.
Home building is a production business. Big builders make more money through volume. For example, a home builder may pour the foundation for five homes in a week to save money on concrete, as it’s more efficient and less expensive to buy and pour all the concrete at once.
By selling five homes a week in Maricopa, Meritage can start construction on those five homes at the same time and save money at each stage of construction.
Shrinking profits
All of these changes in building and selling homes affect the bottom line for builders.
During the boom, home builders enjoyed profits of 10 to 30 percent on houses. A more typical profit margin is 5 to 10 percent. Now, if builders are making 1 to 3 percent, they can brag.
Hilton said Meritage is “eking out” a profit on the homes sold in Maricopa. But he’s counting on increased volume to improve profits in the coming months as the Dec. 1 deadline on the tax credit approaches.
Meritage is banking on its new low-cost, high-volume strategy to work through the housing crash and what is expected to be a slow recovery. The builder has overhauled all 12 of its developments in the Valley to focus on first-time buyers, and it will do the same with developments in California, Nevada and Florida.
Few major U.S. home builders are making a profit now. Meritage thinks it can be profitable again by next year. The company lost $292 million in 2008 after making a profit of $225 million in 2006.
Hilton said, “We think we have found the sweet spot in home building now.”
