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Beazer Homes Jumps Into Housing "Wild West"

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Go ahead - Make my day!!

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Without the benefit of comparing the transcript of today's call to prior calls, it is tough to catch subtle changes in the guidance or tone of management. Nothing really jumped out at me except for a generally more skeptical tone by the call participants.

There was, however, one HUGE revelation on the call, which I believe has just jacked up the risk profile for Beazer Homes (BZH) several notches: an accelerating shift to multi-unit developments, be it town-homes or condos, from single family homes.

Unlike the latter, which are started and built one at a time as orders come in, condos carry added idiosyncratic risks. The developer can't wait until the whole project is pre-sold to start building or else no one would buy into it. And once you start building, you can't build only half of it, if the remaining units don't sell. Those units hang from the developer's neck, both as to the number of units unsold and as to the price that those units might command.

If you are a small developer, with construction financing looming on the horizon, condo projects are the equivalent of playing Russian roulette: you just hope the "housing cycle" lasts long enough for the next developer to blow his brains out. The "default" risk is obviously less for large builders because they are either self-financed, they operate on revolving credit lines, or a combination of both. Nonetheless, the condos risk profile even for the big players is much greater than for single family homes. As units sit idle, the time cost of money eats away at your margins, and perversely, if an entire development does not sell ASAP, the more the units sit unsold the more they are looked upon as damaged goods. This in turn drives prices down, further eroding margins. And we won't even discuss the operating expenses ("condo fees") of carrying the empty units.

Through my real estate glasses, you can look at condo developments as having the same risk profile as biotech companies: half of the developments will be complete busts, 3 or 4 will break even and 1 or 2 will be a home run. Which ones you are involved in determines your fate.

Beazer suggested that its move is driven by ever rising land constraints in the hottest markets, California, Florida and Arizona. The skeptic in me thinks that they are chasing the hottest product (condos are still screaming price wise relative to single family homes), with the higher margins. Whether its strategy will succeed should become obvious in the next twelve months. For now the only clear conclusion is that Beazer is dramatically raising the stakes for its shareholders.
Position in BZH
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