Building on the Bust

Not the Worst of Times

In the past 10 years, ending in 2006, Rottlund’s revenues grew at an average annual rate of 7 percent. And Rottlund did well during the recession of 2001–2002.

“Homes soon became the lead investment for people,” Rotter notes. Mortgage products pulled first-time buyers forward by offering them zero-down products; these buyers no longer had to spend years saving for a home. The boom was so strong and lasted so long that even casual investors began to speculate on housing, buying a home and selling it shortly thereafter at a profit. Builders did their own brand of speculating—constructing homes without selling them first.

Rotter got his first indication that the housing market had reached unsustainable heights in late 2005, when he saw that the inventory of unsold new homes was piling up. The sales downturn hasn’t let up much since then. According to the U.S. Department of Housing and Urban Development, sales of new single-family homes were down 10.2 percent in July 2007 compared to July 2006 (though those July 2007 sales were up 2.8 above June 2006). Existing home sales were also faltering, meaning fewer buyers for new homes. Sales of all single-family homes in the U.S. fell at an annual rate of 30 percent in the second quarter, the steepest decline in 28 years.

Rottlund’s numbers have paralleled the downturn. The company’s revenues peaked in 2004, at $326 million. In 2006, revenues had fallen to $258 million. The company’s total home closings, which include both attached and single-family homes, fell from their 2003 peak of 1,520 to 1,025 in 2006. Rottlund expects to end 2007 with revenues of $200 million. In the last 18 months, in order to trim costs, the company cut staff by about 40 percent to 135 people—80 of the current total are located in the Twin Cities.

Much of that lower revenue number has been due to the overall climate in the U.S. housing industry and the company’s conservative approach to acquiring land and building spec inventory.

“It made no sense for us to be building speculative inventory when we knew that demand had slowed dramatically,” says Todd Stutz, who became Rottlund’s chief operating officer in June following the death of Bernard Rotter. “We don’t have outside shareholders or analysts looking at whether or not we are growing, whether it’s a good stock to buy. To force growth when you know it doesn’t exist makes no sense.” Builders, he adds, “get in trouble because they are focused on the top line, or revenue growth, and they lose sight of cash flow. Problems are created by excessive land inventory as well as unsold speculative inventory.”

While Rottlund’s drop in revenue sounds significant, George Karvel, professor of real estate at the University of St. Thomas in Minneapolis, says it’s all part of the cyclical nature of the homebuilding business. Steep revenue drops can mean the end for small builders, he says, but Rottlund is big enough that its strategy to cut inventory and staff should keep it afloat. Retaining capital, which Rottlund is doing, is also key. “They know full well that real estate is cyclical, and that this cycle is really no different than past cycles,” Karvel says. “They actually are expressing faith in the future by their strategy.”

The layoffs and the revenue drop have been no fun, but Rotter shakes his head when asked whether the current slump is the worst his company has experienced. Rottlund was a much smaller company in the early 1980s, when U.S. mortgage rates hit historical highs. Data compiled by Virginia-based lender Freddie Mac show that the interest on 30-year fixed-rate mortgages averaged above 10 percent from November 1978 to April 1986, with the all-time high hitting in October 1981 at 18.45 percent. (The average rate for 30-year fixed mortgages in June 2007 was 6.6 percent.)