Archive for October, 2011

Views on "The Distressing Gap"

Posted October 27, 2011 By Fletcher Groves

[Note: Bill McBride is the economist behind the Calculated Risk weblog. Bill regularly updates the phenomenon that he calls “The Distressing Gap”, which tracks the increasing divergence between new home sales and sales of existing single-family homes; Bill states the gap as a percentage of new-to-existing, while I restate his numbers as a ratio. Dating back to almost the mid-point of the past century, the percentage/ratio of new-to-existing has maintained a very narrow range; in 2007, the gap started to increase, and it is now triple the historic pattern. This is an excerpt of yesterday’s exchange between myself and John McManus, who is the editorial director at Big Builder for Hanley-Wood.]

JM: I’m thinking you’re thinking “scarcity” won’t likely act as much of a force of nature in this thing. Do you think there’s a point at which investor buyers of distressed properties, REO, and short sales (which count in the ratio) will start to tail-off? Or, is it worth looking at individual buyers (with a loan) of “normal” resales in a ratio with new?

Is there any learning (for new home builders) to take out of that approach on the ratio?

FG: I suppose, if what we see now is a structural change in homeownership, then there could be a persistent new normal at a significantly lower level of demand for for-sale housing. I don’t discount that possibility as much as I once did, but I don’t really know.

If I read his analysis the way I think he intends, Bill McBride tends to attribute problems in home sales – months of supply, falling prices, whatever – to oversupply. I think supply in the absence of demand is irrelevant. Or, at least, I think over-supply is secondary to insufficient demand. Right now, we are probably not even replacing the existing housing that is being taken out of stock. With one important caveat, I think the current amount of oversupply is a product of a persistent lack of demand, and that one caveat is that the supply is also heightened by economic distress.

I was speaking with a Realtor some time back, and she made the comment that – by some measure – every property for-sale today can be considered a distressed sale, because, if circumstances didn’t require it, no one would be selling homes at current prices. But, the circumstances that require owners to sell outnumber the circumstances that allow owners not to sell. So – yes – that caveat allows you to say that there is some excess supply, but that supply is also not being offset by coincident demand; except for first-time buyers (who have nothing to sell) and last-time sellers (who have no need to buy), and excluding second-home buyers, homes that are sold are normally replaced with homes that are bought. Now, they cannot or they will not purchase. So, supply lingers.

Housing (and the subset of homebuilding) is a system; systems are comprised of the cause-and-effect relationships between a system’s interdependent parts, and it needs to be understood as such.

Scarcity is a supply metric; something is only scarce because there is more demand for a product than there is availability. In the absence of demand, scarcity will not materialize, unless something dramatically reduces the supply (if no one needs to sell or wants to sell). Something is interrupting the elasticity of supply and demand. In the case of housing, why is demand so insensitive to price or affordability?

Regarding investors. Because of yields, I think investors are being driven to real estate for a portion of their portfolios. It’s not like they stand to make higher returns elsewhere. I don’t think they prefer real estate. I think the proportions are probably high, and the moment other investment yields become more viable, there will be a significant drop-off in real estate investment, and that may coincide with higher prices and lower yields on the then-available residential investment.

As far as the ratio of new home sales to sales of existing homes, I suppose, given the high proportion of sales to investors, maybe we should consider backing them out. But, cash sales are occurring with both users and investors. I think the story – the real story – of this ratio is that, for more than a half-century, this ratio remained in a very tight range (roughly, 1:5 or 1:6), through all kinds of economic conditions and housing markets; that ratio dramatically diverged in 2006, the divergence has steadily increased, and it has not returned.

Currently, the ratio stands at almost 1:16. Why?

Demand is the result of something. What drives it? Some of it is social, some of it is financial, all of it is dependent on some collective amount of individual willingness and ability.

One of my favorite scenes from “Cheers” is when Norm, being alternately threatened and bribed, declares, “You don’t scare me, and I can’t be bought”. He thinks for a second, and adds, “You put the two together, and I’m your man!” You put absence of demand with elevated levels of reluctant supply, both driven by the extraordinary economic conditions, and this picture is what you get.

I am not an economist. Bill McBride has forgotten more than I ever knew. But, I have been through every one of these economic cycles since 1974 – as a lender, as a builder, as a consultant – and this is how I see the current situation.


Part VI: Providence

Posted October 21, 2011 By Fletcher Groves

This final segment of the series, chronicling the ten-year anniversary of the “From The Ground Up” project, looks at Fidelity Homes from the perspective of providence.


Providence is an interesting term in the English language. Mostly used as a noun, there are also variants used as the other parts of speech. As a noun, it can be either proper or common; there are towns, colleges, ships, and churches with Providence in their names. The inclusion of the word providence in proper nouns aside, it can also denote ideas as diverse as caution, discretion, fate, fortune, and foresight – ideas that are largely secular.

The more pertinent idea for David Hunihan and Todd Menke is the one that connotes divine care and direction. For them, providence is the foreseeing care and guidance that the Creator of the universe exercises over the affairs of that universe and the lives of the people He created to inhabit it. The name Fidelity Homes – as Bill Lurz, then the senior editor at Professional Builder in charge of the “From The Ground Up” series, noted – was chosen because it denotes the desired state of being faithful. Given the vision and dream that it was, the name of David’s and Todd’s start-up homebuilding company could have, just as appropriately, been Providence Homes.

That dream – that vision – did not turn out the way David and Todd intended. This retrospective series on Escape from Averageness® has discussed the factors and circumstances in-play, David’s and Todd’s resolve in dealing with the outcome, the business lessons learned in all of it, and the enduring value of true friendships. For David and Todd, it is about leaving a legacy.

From a grammatical point-of-view, this has been a discussion written in third person, both singular and plural.

Now, it is more first person plural.

We – folks like David, Todd, and me – long to see the handprint of Providence in our lives, but not merely for the obvious reason of needing to ensure for ourselves the outcome of a safe, comfortable, personally-satisfying life, or wanting to avoid responsibility for outcomes. Providence is important, because we need evidence that our lives count for more than personal success over whatever the period of our lifetimes are. That desire pulls us towards something more, pulls us towards something deeper, towards something transcendent.

“After Fidelity closed, I went to work for a company for three months before taking my current position”, David said, recalling what he considers to be a blessing in all of this. “I met a man there who described himself as an atheist. I developed a friendship with him, started meeting with him once a week to discuss the Bible, and within a year, he accepted Christ. That may never have happened had Fidelity not failed; at least, I wouldn’t have been part of it.”

Circumstance is a part of life.

The point of providence is not that God would only engineer good circumstances or would prevent all bad circumstances. It is that – regardless of the particular circumstances – He uses those circumstances to work His will for our lives, and to demonstrate His love, grace, and mercy towards us. Although it foresees, providence is not fate. God’s active involvement in our affairs is not always completely clear, and, therefore, involves faith – in His divine intentions, in the attributes of His divine character.

Was Fidelity Homes a failure? Clearly, there was disappointment in the outcome. What are we to make of it? Did God simply not care about this particular set of circumstances? He couldn’t have been bothered with anything so trivial? Was He powerless to prevent it? Was He playing favorites? In any event, should David and Todd have just shrugged, and drawn the conclusion that – when it came to making the choices and the decisions that affected the outcome with Fidelity – they were really on their own? And – many years from now – would they have been left to wonder if that’s all there is? Are we on our own? Is this all there is for us, whatever we can manage out of life?

Fidelity is not the only casualty of this recession. It has affected all of us. This housing recession has been the source of unprecedented frustration, bordering on despair, encompassing anger.

We all have circumstances. Such is life.

We make a mistake when we focus on our particular circumstances, rather than focusing on God’s immutable character.

God fully knows – He fully understands – our circumstances. He knows our disappointment, when outcomes are not what we want them to be, not what we expect them to be, not what we presume them to be, not what we counted on them to be. The attributes of His character certainly give Him control over our circumstances. At the same time, it is precisely those attributes that allow us to trust Him in outcomes – often determined by the circumstances – that we would never choose to face.

Our circumstances – good or bad, easy or difficult, successful or unsuccessful (in terms of their outcome) – do not control anything. They do not determine our lasting value. They do not alter the love of God for us and towards us; they do not change His grace or His mercy. Our circumstances do not change His purpose in our lives.

Our circumstances do not change anything that lasts.


Part V: Friends

Posted October 18, 2011 By Fletcher Groves

This next-to-the-last part of the series chronicling the ten-year anniversary of the Fidelity Homes “From The Ground Up” project simply looks at friendship.

Before they were business partners, David Hunihan and Todd Menke were business associates in a hierarchical relationship at another homebuilding company; before they were business associates, David and Todd were friends. Married within two years of each other, the friendship extends to their wives Lauren (David) and Kellie (Todd).

More than friends, David and Todd see the important aspects of life through the same spiritual lens, as brothers in Christ.

In the initial article in the “From The Ground Up” series in Professional Builder, much was made of the shared dreams, the shared values, mission, and goals, of the two friends-turned-partners in the formation of Fidelity. So – what happens when the music dies? What happens to the friendship when the shared dreams, vision, and mission don’t pan-out?

Clearly, friendships – both real and supposed – do founder on adversity. There are no deeper wounds than the ones inflicted by the people we most trust; there is no deeper disappointment. However, by both of their accounts, that is not the case with David and Todd. As I said in the first “Escape from Averageness” post on the ten-year anniversary of Fidelity, David and Todd started as close friends, they parted as close friends, and they remain close friends.

Despite the pressure. Despite the undesirable outcome. Despite the shared disappointment in that outcome. Despite what are likely dissimilar consequences.

“For me, looking back, the period that I worked with my best friend were some of the most enjoyable times that I ever had in my career”, Todd said. “We were learning together at the same time as we were doing it. We did have our hurdles and there were times after 9/11 that I didn’t know how we would make it, but when one of us was down, the other one was there to pull us back up.

“David and I still talk and see each other regularly, not as much as we both would like, but our paths have followed different directions. He is still one of my best friends in the world and I know he will always be there for me when I need him. It’s nice to have that kind of friend in life. From our spiritual paths as Christians to raising kids and running businesses, we can talk about anything and everything when we get together.”

“In my heart, he will forever be an integral part of the company and its vision and any success it had”, said David. “I miss Todd.

“Lately, especially. I remember our times together at the company where we worked before, and then at Fidelity. Although Todd was only at Fidelity for a portion of the time that I was, he was still such a big part of it. I still think of him as my partner for all of it. He really is a great friend. I thank the Lord our friendship continues as strong as it is, even if we don’t get to see each other as much.”

Next: Part VI: Providence


Part IV: Lessons Learned

Posted October 13, 2011 By Fletcher Groves

This fourth part of the series chronicling the Fidelity Homes “From The Ground Up” project – Ten Years After – looks at the lessons that can be learned from the Fidelity experience, in terms of what worked, and what didn’t work.

Admittedly, lessons always flow retrospectively from a specific set of factors and circumstances (the subject of Part II). Different times, different opportunities and challenges, would likely produce different results, and those results would likely yield a different set of lessons. That said, David Hunihan and Todd Menke hope that their own experience of success and failure in the extraordinary circumstances faced with their start-up company will prove beneficial to other young, entrepreneurial future homebuilders, who might one day choose to set out on their own journeys, to pursue their own visions and dreams.

For his part, Todd sees the most important lesson of Fidelity as the adequacy of capital and cash flow. “Make sure you have a good base of capital to start”, he wrote, and then, “Pick a safe opportunity that doesn’t put you at all or nothing risk, and then manage your cash flow. I learned a great deal about external market forces and their impact on cash flow planning, and I believe those experiences helped me to think about real estate projects in terms of what could go wrong and how can we prepare for those possibilities. Those lessons have proved invaluable to me during the latest financial crisis.”

David focuses on the type of capital, as well as its adequacy. “DEBT IS BAD”, was David’s first statement. “When we were first going into business and we were interviewing anyone that would talk to us, a developer friend told me that we couldn’t possibly underestimate the cash requirements of this business.”

Thinking about David’s upper-case emphatic on debt, I well remember the wisdom my dad shared with me, one banker to another – one lender to another – before I became a builder, before I became a developer, before I became a consultant: “Son”, he said, simply, straightforwardly. “Leverage is something that makes good times better and bad times worse.” Like I said, lessons flow from the context of the circumstances. Possibly more than in any other industry vertical, leverage cuts both ways in homebuilding; its lure is enormous.

David also says that you have to measure the cost. “I learned that I loved being a builder”, he said, “and I loved creating something that never existed, with other people; I loved sharing a dream. I wouldn’t ever trade the experience of Fidelity Homes, but looking back, I don’t think I could ever repeat it. The price my family continues to pay was too high.”

The lessons came from Fidelity’s team of experts, as well: In retrospect, David Weekley’s admonition – “hope is not a strategy” – is one lesson. Scott Sedam’s counsel to resist being opportunity-driven, to find what you do well, and to align opportunities to your talents and passions is another. There would likely have been accord between Weekley and Sedam in Fidelity’s West of the Trail infill activity, as an example of the type of narrowly-focused, exclusive, niche’ proposition that would have worked, and would have set the enterprise apart. Instead, Fidelity became broader – less focused – and more opportunistic, less strategic in its choice of projects.

My perspective: As one lesson that should emerge, I would repeat (from Part II: Factors and Circumstances) that industry ease-of-entry didn’t demand rigor commensurate with the risk – a risk obscured, in this case, and in this era, by presumptive assurances of business-as-usual.

And, I would add one more lesson: Fidelity’s TQM grounding emphasized quality, not speed. The velocity side of Return on Assets is where the hard work of carving out sustainable competitive advantage needs to be done. Not because good product design, construction quality, and customer satisfaction – hallmarks of TQM – are not important (they are), and not because the margin side of ROA is not equal in importance to velocity in terms of generating economic return (it is), but, rather, because the competitive advantages that those attributes produce are not as sustainable over time. Moreover, achieving very fast – unprecedentedly fast – cycle times would have gone a long way toward reducing working capital requirements in support of operations, critically important with a building company as highly-leveraged and capital-starved as Fidelity was.

Finally, were there any lessons learned from the effects of the “From The Ground Up” project itself, and its team of industry consultants?

“The experience with “From The Ground Up” was both amazing and challenging at the same time”, said Todd. “To meet and work side by side with some the most brilliant minds in the homebuilding industry was a dream come true. However, the ideas from each consultant were sometimes in conflict. Also, the schedule commitments that required us to meet with each consultant and follow-up on their critical to-do lists were at times, burdensome.

“Looking back, it was beneficial because we learned a great deal, but I believe it was probably too much, all at once.”

David agreed: “We couldn’t wait to implement all that we had learned, but I feel it was a double-edged sword. Most entrepreneurs are too busy working in their business to work on their business. The reverse was true for us. In the beginning, we had so much help working on our business that after the PB articles had run their course, we had to focus on working in the business and getting it financially sound.

“Overall it was beneficial. It was just too much, too soon, all at once.”

Next: Part V: Friends

Part III: Resolve

Posted October 6, 2011 By Fletcher Groves

This third part of the series chronicling the Fidelity Homes “From The Ground Up” project at its ten-year mid-point anniversary delves into the closing of Fidelity. Not from a mechanical standpoint, but from the standpoint of dealing with the death of a vision.

Visions are always personal. The early installments of “From The Ground Up” in Professional Builder highlight the large expectations that David Hunihan and Todd Menke had for their start-up homebuilding company. We remind our clients that the goal of each of their enterprises is to make money, and that everything else is a necessary condition to fulfilling that goal. However, a goal is not the same as purpose.

In the case of Fidelity, clearly, there were financial expectations, but that is not the sense that a reader gets about what most motivated these two, young building company executives to start their own company; David and Todd had proven track records, secure futures, and successful day-jobs with a well-known, highly-regarded Florida Gulf Coast homebuilder.

Fidelity was about desire.

In the beginning, the story is much more about the desire to pursue a set of values, about being able to personally authorize the effort to realize the dream those values represent, and about being responsible for the outcome. In the end, the story became one of summoning resolve in the face of disappointment, when the exhaustive, all-consuming effort to fulfill a dream did not work out the way David and Todd planned.

Resolve coincides with optimism, until optimism ends. At that point, resolve has to find its own way. In the end, summoning resolve doesn’t prevent or remove disappointment, but it does provide satisfaction.

Whence cometh resolve?

Part of it is courage. Part of it is sheer determination – sometimes, it is resolve alone that keeps us from quitting, when quitting would be the easier, perhaps more rational, course. Part of it is integrity, a reflection of what we think is right and honorable, a decision to act in-line with what we promised to do.

Regardless of where it comes from, it is resolve that gives us the strength to do the right thing, to use our best efforts. Resolve is what enables us to live up to responsibilities and meet obligations, regardless of the cost. Resolve is what it takes to make decisions that are not in our personal best interest. Resolve is what gets us to the finish.

It carries a price: “It is still difficult”, David said. “We closed Fidelity’s doors for good in November of 2008, but [three years later] I am still battling to put it to rest. There are still issues – with banks, attorneys, accountants, condo associations – that I am doing my best to settle.”

But, there is peace, there is closure: “I had [surprising] peace once we made the decision”, he continued. “As it got harder and harder to survive, it was actually a relief to finally close the doors and move on. I really had closure, however, when we leased our office and I had to clean everything out and split it between the dumpster and storage, just me and my dad.”

That last part is a worthwhile picture, an enduring one, really. Regardless of what generates it – courage, faith, determination, honor, integrity, loyalty, service – resolve is an acquired trait. It is demonstrated to us, developed in us; and it is subsequently passed on by us.

Next: Lessons Learned