M&A Update: a bifurcation in buying trends, as a tale of two consumers is emerging
By Margaret Whelan
The long-awaited cyclical downturn appears to be upon us, as early signs of slower housing demand have appeared. While the Federal Reserve’s goal in raising rates so quickly was to curb inflation, these higher mortgage rates combined with record home prices have contributed to a spike in monthly payments. This is translating to a bifurcation in buying trends, as a tale of two consumers is emerging.
In some markets, the cost conscious entry-level buyer is moving to the sidelines, which is reflected in slower traffic, lower order rates and some creep up in cancellations from historic lows. On the other hand, there are several robust drivers that continue to support demand, including demographic-driven household formation growth as millennials become homebuyers. Demand for larger move-up homes remains strong, supported by cash rich international buyers moving to the U.S. and dual annual income families migrating to less expensive states.
In early 2020, amidst the uncertainty of an unprecedented pandemic, the U.S. housing market emerged as a bright spot in the global economy. International consumers moved to America in search of better healthcare and more affordable housing options, while an increase in interstate migration was driven by the need for bigger homes to support emerging hybrid work solutions. Consumers started to favor bigger homes with more flexible design, to allow for work, education and working out from home. It appears that many of these trends are now being adopted permanently. Retail demand was not the only source of growth as Single Family Rental (SFR) operators had already started to invest in new homes versus older scattered-lot homes. This trend accelerated during the pandemic to meet growing demand by tenants for professionally managed new rental homes in desirable neighborhoods. For any private builder that is willing to transact, demand is deep and wide ranging. Even tertiary markets are active as larger builders are now entering the markets given limited market share opportunities in the more concentrated MSAs. Asian buyers have acquired 25 housing-related companies in the last decade and continue to engage with us actively. Our team has advised on three of these transactions in the last two years alone and on 12 closed deals in the last 18 months.
While the supply of finished lots has never been robust, it was already highly constrained before the pandemic-related demand surge started in early 2020. As of the spring of 2022, there are barely a couple of months of supply of vacant developed lots in the largest MSAs, and no sign that supply constraints are going to be alleviated any time soon as capital investment in land development continues to be limited. The drivers of price inflation, which the Fed is targeting with the recent spike in rates, extends to all things construction related. On average, sticks and bricks represent half of the cost of building a new home, and these materials continue to be in short supply despite several rounds of price increases by the manufacturers. Labor challenges, while not a new issue, remain pervasive and are further exacerbated by low levels of unemployment. Limited developed land, supply constraints and a tight labor market all contribute to our assumption that we will see a soft landing for housing this cycle, underscored by a shortage of new home supply and robust demand. Well capitalized builders will navigate strategically and successfully, as they have many times before.
That was a long preamble to get to the crux of this discussion, about M&A in the industry! As an investment banking boutique that represents the owners and sellers of housing companies, we have never been more active.he range of buyers is wider than ever, from larger public and private builders, to Private Equity firms, international real estate companies and SFR REITs. Buyers are focused on opportunities in high growth markets, looking to find the right fit with a seller that has deep local expertise, a reliable lot pipeline and a strong team that will stay with the company in such a labor constrained market. While public builders favor the simplicity of a 100% purchase, foreign buyers appreciate a structured transaction, where the founder will stay on for a couple of years and work through an earn out. Basic tools required to consummate a successful transaction include having reviewed or audited financials, a strong CFO or finance professional to produce a multi-year growth model and an experienced transaction attorney who will focus on getting to the closing table.
Much has changed, but most stays the same. We welcome a confidential conversation to discuss your transaction goals.
Margaret Whelan is the Founder and CEO of Whelan Advisory Capital Markets, a boutique investment bank that represents owners and founders of housing companies as they pursue growth capital or M&A opportunities.