Fast Track 2007: Curve Ball

List research by Loretta Williams.

Click here to download a PDF of the 2007 Fast Track

Ah, the glory days of summer. Buyers camping out for new releases, backlogs stretching for months, and profits creeping higher and higher with every new phase that opens for sales.

Unfortunately, things have changed.

With starts down and cancellations up, builders no longer expect a home run with each new community. Now, they'll settle for base hits, for doubles, and even for walks that finally get that languishing spec house and its shrinking margins off the field. Veterans look at the rookies and shake their heads. “They've never been through a downturn,” they say, wise from years of ups and downs. “They'll never make it.”

The veterans are right, of course. Many of the rookies won't survive. “You didn't have to be a good builder” during the recent boom, says accountant Steve Maltzman of SMA Consulting in Redlands, Calif. “You just had to be in the right place at the right time.” Some new builders will go under, their companies buried by carrying costs for houses that won't sell. Others will go back to computers or sales or whatever it was they did before they decided home building was the way to get rich quick.

But they won't all disappear. Some rookies will stay, seeing this down market as a rebuilding opportunity. Even a losing season offers the chance to improve skills, reduce on-field errors, and learn from those who have played the game for much longer.

And those rookies can surprise you. As you'll soon discover on the following pages, companies led by experts and novices alike made this year's Fast Track list of the 100 fastest-growing builders in the country, as based on their three-year compound annual growth rate for revenue. To many, the presence of so many newbies will be cause for serious head-shaking. After all, the first sign of a slump was supposed to send these young, inexperienced builders running.

Talk to them, though, and you'll discover that these new builders have ideas worth considering, no matter how many years you've been in the game. The veterans also have valuable advice to share. As a group, this year's Fast Track team achieved an average three-year compound annual growth rate of 36 percent between 2004 and 2006, even as a serious slump began for many in 2005.

What do the rookies and the veterans on this year's Fast Track list all have in common (besides three-year compound annual growth rates of 10 percent and higher)? Sharp attention to market trends, from new competitors to signs of weakness, and quick responses to those discoveries.

For Cassidy Homes, the first wake-up call came in 2002, with the arrival of big builders—both public and private—in neighboring counties. “It alarmed us, because we know big companies go in to grow market share at other builders' expense,” admits Steve Cassidy, president of the Winter Haven, Fla., company, which was founded in 1980 by his father and brother. “We didn't want to be a victim in our own market.”

In response, the firm shored up its land positions, accumulating thousands of lots at reasonable prices by partnering with another builder. That decision proved to be a smart one for Cassidy Homes. With more than 5,000 developed home-sites and 18,000 undeveloped lots under control, the builder has had the land supply it needed to grow. (The firm achieved a three-year compound annual growth rate of 83 percent between 2004 and 2006.)

But the yearly growth didn't make its president complacent. “We've been riding the wave since 1993. That's a 12-year run,” Cassidy says. “We knew the market was going to correct, so we kept a very close eye on model home traffic.” When those numbers dipped in 2005, Cassidy knew it was time to regroup and scheduled a company retreat to develop its plan of action.

At Sugar Magnolia Homes, which didn't even exist the year that Cassidy began bracing for the big builders, the warning signal came later, in summer 2006. “Presales just stopped coming in,” says Derek Pommerenck, president of the Richmond Hill, Ga., company, which is located near Savannah. “Every buyer we talked to loved the product, but they had a house to sell, and they could not sell their house.”

He quickly sought more information from local real estate agents and got some bad news. “One of my communities was in deep trouble,” Pommerenck recalls. “There was a 12-month supply [of homes for sale] in there. I've still got 10 lots in [that development], but we haven't started any homes there.”

Despite such pullbacks—or perhaps because of them—Sugar Magnolia has continued to grow. Even in a rough market, the company projects closings to increase, with 30 deliveries planned for 2007 and 50 in 2008. (Revenues are projected to be $12 million and $20 million, respectively.)

“The thing that we did was that we slowed down and stopped the specs,” Pommerenck says. “It made it harder cashflow-wise, but we don't have the standing inventory others do, so we'll recover faster than everyone else.”

For others, market trends presented new opportunities. In St. Louis, Highland Homes decided to blend two niches into one: green urban infill. “We saw a real need in the market to do high-quality infill homes that were affordable,” says John Cavanagh, who started Highland in 2003 with fraternity brother Bob Shallenberger. “On a dollars-and-cents basis, we don't have the buying power some of the nationals do, so we have to add value,” Shallenberger adds. “That's why we went green.”

Following the NAHB's model green building guidelines, Highland offers buyers between 1,500 square feet and 2,000 square feet of energy-efficient living at prices as low as $120,000. “It's nearly impossible in our market to find an affordably priced green home,” Cavanagh says. “The lowest green single-family home is $450,000.” Or rather it was, until Highland appeared with its wallet-friendly approach to sustainable, high-performance housing. “If it costs you money, it doesn't make sense to be green,” Cavanagh believes.

St. Louis buyers obviously appreciate Highland's emphasis on quick paybacks. The company closed 38 homes in 2006 for $16 million in revenue, earning Highland a three-year compound annual growth rate for revenue of 79 percent.

As important as market statistics are, though, they aren't the only figures that Fast Trackers follow. To survive a downturn and continue to grow, a smart player must be able to manage profit margins, sales velocity, backlogs, and more. “You've got to know your strengths and weaknesses. It's no different than a game; it's just the game of business,” says Jeff Bramble, COO of Triton Homes in Ankeny, Iowa. (The firm achieved a three-year compound annual growth rate of 75 percent to make this year's Fast Track list, delivering 400 homes for $49 million in revenue in 2006.)

Bramble may be new to home building—he joined Triton two years ago—but he's an old hand at business. For 22 years, he worked in manufacturing, an experience surprisingly fitting for his current responsibilities as COO of a home building firm during a housing slump. “The product we're manufacturing, rather than being widgets, is homes,” Bramble says simply. And the slump? “Downturns in manufacturing are nothing new,” he replies.

At Triton, which is based near Des Moines, Iowa, managing through a soft housing market means careful attention to operations. “The biggest impact to us has been in velocity. We used to sell eight to 10 homes a month; now it's five to six homes a month,” Bramble says. “We've become more prudent in starts and controlling inventory levels, but we didn't really have the opportunity to overbuild because of our systems.”

That ability to manage inventory levels qualifies as a crucial skill for this year's Fast Trackers. During the boom, builders boasted of their perpetually growing backlogs. In a downturn, though, standing inventory can destroy profit margins at speeds quicker than a major league pitcher can throw.

That's why Cassidy Homes moved fast to reduce its backlog when the slowdown hit. “We had a large backlog, and we wanted to make sure we delivered it,” Cassidy remembers. “We'd sold them at very high margins, and we did not want buyers to cancel or fall out.”

Such scenarios also illustrate the importance of achieving the oft-recommended home building gross margins of 25 percent to 30 percent. Among other things, those targets allow a builder to cut prices to move inventory without sacrificing all profits.

Steven Alloy, president and CEO, Stanley Martin Communities james kegley

Still, many longtime builders struggle to meet such benchmarks, as any industry consultant can tell you. But those who think it's impossible should consider the case of Pommerenck, who has increased Sugar Magnolia's gross margins by 2 to 3 percentage points annually for the past three years while the housing market has softened.

One strategy used by this former member of the U.S. Army Corps of Engineers: setting profit-protecting margins of 28 percent to 30 percent on Sugar Magnolia's inventory homes. “We keep them on the market for a while, and then we drop [margin expectations] to 22 percent with room for negotiation,” Pommerenck says. “We try to offer options or upgrades because we don't want to affect the price.”

Price does matter in a down market, though, which is why several Fast Track builders have broadened their product line. “In a down market, we knew that price was going to be what sells,” says Cassidy. “So we created an entry-level concept priced from $170,000 to $250,000. It proved to be a good decision to keep sales moving forward.”

In Reston, Va., Stanley Martin Communities made a similar decision, beginning designs in 2005 for a “jewel box collection” of homes with fewer square feet and lower prices than its customary move-up and luxury product. In 2006, with the slowdown evident, Stanley Martin decided it was time to introduce its new eight-home product line to the Washington, D.C., suburbs where it builds. “We were the first to roll out a whole smaller line of homes that was more affordable,” says Steven Alloy, president and CEO. “We didn't need to redesign the whole product.”

Other Fast Trackers are going even further in pursuit of diversity. In South Carolina, The Mungo Cos. has expanded into HOPE VI and affordable housing, creating a new revenue stream for the family-owned enterprise. “It's not market- or economy-dependent,” says CEO Steven Mungo, who'd like public-sector work to eventually represent as much as 25 percent of the company's net revenues. With projects underway in Columbia, Spartanburg, and North Charleston, S.C., the new subsidiary is moving that direction, contributing 14 percent of Mungo's net revenues in 2006.

Overall, The Mungo Cos. closed 1,083 units for $122 million in 2006, which represents a 37 percent three-year compound annual growth rate.

When Fast Trackers aren't establishing new revenue sources, they're concentrating on improving their business practices. “I still have 75 percent of my staff, and I need to keep them busy,” Cassidy says. “So we're streamlining our systems and procedures.”

For some Fast Trackers, that means back-office improvements. Cassidy Homes is automating its accounts payable process for trade contractors. Triton is slicing cycle times and organizing operations for maximum efficiency. “One of our core values is system solutions and repeatable processes in every phase of building homes,” Bramble explains. “It's served us well. We're becoming more and more efficient.”

Triton certainly is, moving to a 65-day production cycle at its newest developments in Northwest Arkansas (down from Triton's 75-day target) and restructuring processes so that a superintendent can manage three to five communities, rather than just one as in the past.

Such efforts represent smart investments in a company's future, according to Maltzman. “Now that it's slow, you really have to get back to basics. It makes sense to keep personnel on to implement systems so that when the market turns, your systems are tight.”

Ah, the upswing. Fast Trackers, regardless of whether they've built a handful of homes or hundreds, are as eager as any other builder for the housing market to rebound.

FAST TRACK STATS

Unlike their counterparts, though, these Fast Trackers never forgot that housing is a cyclical business, no matter what the big builders say, and they planned accordingly. A housing recession is “always worse than you've ever planned for,” Alloy says. “Fear in planning is good. Fear in planning keeps you alive.”

Alloy has decades of home building experience, but even rookies who have known nothing but the boom say they have done their best to safeguard their firms against a housing bust.

“Raleigh's always been a good market. It hasn't gone up and down as much as the rest of the country. But I said, ‘Hey, we need to have enough money in cash so that if 9/11 happens or there's a housing slump we can stay in business for 12 months,'” remembers John Heidel, president of Homestead Building Co. in Wake Forest, N.C., who formed his company just four years ago, in 2003. (Homestead closed 19 homes for $10 million in revenue in 2006, up from five homes and $1.7 million in 2004.)

Veterans have done the same thing, only in more sophisticated ways, to ensure liquidity at their companies. “In 1991–1995, we realized the first thing that we did not have was money. All the banks had shut down,” remembers Alloy, then in his twenties. Now Stanley Martin's chief executive, he was determined to avoid a replay of that scenario. “During good times, raise as much money as you can,” says Alloy, whose firm obtained $150 million in 10-year bonds and a $150 million syndicated line of credit in recent years. “Now we're in a terrible recession, with millions and millions of dollars at our disposal. It's a comfortable place to be, and it keeps you from making a dumb decision for cash reasons.”

Fast Trackers have relied on simpler tactics as well. Mungo, for example, has opted to limit leverage and build equity in his company instead. “You've heard of OPM? That stands for ‘other people's money,' and when things turn down, those people want that money back.”

That certainly represents a conservative strategy, especially given the ready capital and record-breaking home sales of the recent boom, but that's just fine with Mungo, who plans to manage his company and its growth for years to come. “No one ever went broke preparing for a recession,” the veteran builder points out. “I've worked way too hard to give it all back to my creditors at the first downturn.”

Alison Rice is a freelance writer based in Arlington, Va.