Original article by: BUILDER Online
While going public can generate cash for growth, it's unknown how long the 'window' for builder IPOs will last.
In 2017, the executive team at Dream Finders Homes in Jacksonville, Florida, began to put the infrastructure and processes in place to eventually launch an initial public offering (IPO). Over the next three years, the company worked toward that goal, but it wasn’t urgently striving to hit the public markets by a certain target date.
But in June 2020, Dream Finders executives decided it was time.
While it may seem odd to kick off the IPO process in the middle of a global pandemic, Dream Finders’ management team determined that the market was open for the company because of its asset-light model focused on entry-level homes in the Southeast. As the firm went through the process, home building multiples were improving through the pandemic.
“We always had it as a three- to four-year goal, but coming out of COVID, we realized the acceleration in the housing sector probably presented a good time to move forward with it,” says Rick Moyer, senior vice president and chief financial officer at Dream Finders, about going public.
After completing the Securities and Exchange Commission (SEC) process to become a public company, Dream Finders stock began trading Jan. 21, under the ticker symbol “DFH,” becoming the first home builder IPO since Century Communities in 2014.
When the shares were released, investors snapped up stock like it was a hot tech innovation from Silicon Valley. On its first day of trading, Dream Finders’ shares closed 61% higher.
The reception surprised many longtime public home builder watchers. The market is usually more cautious when small-cap builders, like Dream Finders, go public, according to Tony McGill, head of investment banking at Zelman Associates.
There’s little doubt that other private builders have taken note of that strong debut. “There are a handful of groups that are giving it a hard look,” McGill says. “Nothing is imminent, but that can change quickly. Dream Finders has a lot of people thinking more seriously about it.”
As other private builders look to accumulate land, scale up, and cash in on robust demand for new homes, an IPO could be one way to generate cash for growth. But there are questions about how long the IPO window will remain open and how many builders might try to push their way through.
Strong Investor Appetite
Dream Finders, No. 24 on the latest Builder 100 list, isn’t the only company to benefit from the white-hot home sales market of the past year. Since the stay-at-home orders were issued across the country in March 2020, home builder valuations have jumped. Two indexes that show the health of publicly traded home builders, the iShares U.S. Home Construction Exchange Traded Fund (known as the ITB) and SPDR S&P Homebuilders Exchange Traded Fund (known as the XHB) have jumped 184% and 187%, respectively, from March 23, 2020, to March 26, 2021.
While the strong home sales market is pushing valuations, it’s not the only reason. “Valuations in the space are also a product of all of the Federal Reserve stimulus,” McGill says. “Liquidity and yields are so low that the investment community is willing to pay today what they ordinarily would have waited until year two or three or more in the future [to pay].”
Jamie Pirrello, president of the Southeast and Texas regions at Century Communities—ranked No. 9 on the Builder 100—sees many of the same trends driving home building valuations. “Clearly, investors have felt good about the home building sector over the last year,” he says. “If you look at home builder prices, all of them have traded very positively. In that regard, for Dream Finders, it was a good time to go and it was smart of them to go.”
There were other factors specific to Dream Finders that set the builder up well for its public debut. For one thing, it has a land-light model that boosts valuations. Just look at No. 4 builder NVR, which has been trading at a premium to the overall home building sector for years.
“Dream Finders did well because it has a unique asset-light strategy that allows for a great return on capital metrics, which is what investors like,” says Drew Mackintosh, principal and founder of Mackintosh Investor Relations. “They had that niche of having a unique business model that appealed to investors.”
NVR’s success helped potential investors understand Dream Finders’ strategy. “There were a lot of discussions about the comparisons to NVR 25 or 30 years ago and the way we’re operating,” Moyer says.
The Florida builder’s focus on entry-level and move-up homes in Sun Belt markets that have been attracting new residents throughout the pandemic—such as Jacksonville and Orlando in Florida and Austin, Texas—also helped feed interest. “Our markets aligned very well with where the migration trends were headed,” Moyer says.
Still, despite the positive initial reaction, some analysts have concerns about Dream Finders’ valuation. In February, Bank of America slapped an “underperform” on the company because it anticipated that the builder’s valuation would “normalize.”
“We also believe that the valuation premium earned by the premier asset-light home builder, NVR, over the course of 20 years was driven by much more than its land acquisition strategy,” Bank of America said in the report.
The Time Is Now
Dream Finders’ IPO success certainly opens the door for more builders to go public. “I think the IPO window is wide open right now,” says Tony Avila, founder and CEO of Builder Advisor Group. “There is a big demand for public stocks right now, including builders.”
Margaret Whelan, founder and CEO of Whelan Advisory, agrees. “If there is any home builder that is interested in raising permanent equity and going public, this is absolutely the time to do it,” she says. “The window is wide open from a capital markets perspective, and valuations are high. They also have great business fundamentals in terms of pricing power, gross margins, and backlog growth, which is driving their cash flow and their returns. So it’s a very good time to think about going public.”
In 2013, the window for home builders opened when Tri Pointe Homes went public, and firms such as William Lyon Homes, Taylor Morrison Homes, WCI Communities, UCP, and The New Home Co. followed suit. The window then closed after the Century Communities IPO in 2014, and it remained shut until the Dream Finders IPO in January.
“The window opens, but it can just as quickly close,” Pirrello acknowledges. “If you’re a builder and you’re thinking about going public, you want to go fast while the window’s open.”
Many events might close the window. Avila sees too much stimulus money being pumped into the economy as a potential issue. If interest rates start climbing dramatically, monthly mortgage payments will inflate as a result. “If we see a significant amount of inflation and high-interest rates, that will dampen the demand for housing,” he says.
Affordability is another wild card, according to Avila. “Housing prices running up too fast can create a lack of affordability and the potential for a bubble,” he says.
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