Quantity over Quality…America’s Problem - Part 1

I’ve noticed that America seems to have a problem with choosing quantity over quality. From our food (Super Size it!!), to our cars (massive SUVs that have never seen a dirt road and never will), to our TV shows (way too much “reality” TV), to our homes (McMansions). Whatever the reason, time eventually comes time for a reckoning if this route is picked too often, especially in concert with one another. One only need look at the average girth of Americans who sit their keisters down in front of their equally massive widescreen TV to watch the latest installment of “Runway Bachelors of New Jersey” while snarfing down a KFMcWhopper.

What does this have to do with real estate? Well....how about the homes built during the Boom for starters? They were excessive in size for the most part. We only need so many home offices, libraries, billiard and mud rooms, study nooks, massive foyers and the like. Oh, and don’t forget those sanctimonious “master suites” with his-and-her closets and a bathroom damn-near bigger than the entire first floor of my grandparents’ home they raised three boys in. Does anyone really even use those Roman tubs anyway? They take forever to fill.

So the houses were big…so what? Well, I’ll tell you what. In large part, many of those homes were a classic case of substituting quantity (space) over quality (structure and finish). As the boom heated up it became increasingly difficult to sometimes even get subcontractors to call you back they were so busy. Their prices skyrocketed while at the same time their quality plummeted. Why? Simple. In order to keep up with demand they 1) hired practically any warm body regardless of skill and 2) they rushed through jobs especially as many guys are piece-workers meaning they get paid each day by the amount of work they do, not the hours they work.

While many workers in manufacturing are paid this way, they do so under much more closely supervised and rigid conditions in a factory built to make just a few things with engineered processes. A few items of every batch go through quality control and if they don't meet standards, the entire batch is discarded, recycled or sold off as seconds. 

Construction is very different in that you effectively ship the factory to the final location as opposed to shipping the product to the end  location. Plus I don't think most people have ever really thought about the fact that a house is not only a manufactured product (like a car) but it's probably also one of the last mass-produced, hand-built products in America. With so much literally made by hand in the field, construction projects - when combined with piece-work, mass production and multiple companies responsible for the final product - can be a recipe for poor quality. And I've dealt with guys from one trade f'in up another trade's work because some guy pissed them off or got in his way, or whatever. 

Most homebuilders do have some form of QC but it's not quite the same thing as in a factory, especially when the money is fast, it's easy to hide flaws, or the end-user (homebuyer) has no idea what they are looking at. If my iPod doesn't work or has a cracked case, it's easy to see the problem, but how many homeowners know if  SYP was used for the top plate framing of bearing walls as specified? Because other than the plumbing, HVAC, and electricity, houses don't really DO much. They just kind of sit there. Generally, it's hard for the homeowner to tell if the subcontractor skimped on methods and materials to boost his profit margin...until it's way too late if at all. And that's what this article is about. These latent defects often don't show up until months or years later, when very often the particular GC or subcontractor is out of business.

Where was the building inspector you ask? He was overworked during the boom with barely enough time to get through his assigned daily inspections giving maybe 5-10 minutes per house. And in some locales, more homes built and sold meant more tax revenue and with builders supporting local politicians, planning and building inspection departments were directed to make the process more efficient and not necessarily higher quality (again that obsession with quantity over quality).

During the Boom I saw a lot of poor quality work. Drywall, roofing, caulking, painting, framing, plumbing - no trade was immune. Under normal conditions this poor-quality work might not cause problems for a decade or more. But with the Great Recession and tens of thousands of Boom houses sitting empty and neglected, how long until these things become real problems? Banks are hardly spending money to perform basic maintenance as it is, let alone major repairs. Plus, home maintenance and repair is not exactly their core business. 

Look, a perfect analogy is from the tech industry - GIGO, or Garbage In, Garbage Out. What you put into it is what you get out of it. My first house was built in 1940. When I bought it in 1997, it needed some cosmetic work such as refinishing the original oak floors,  tearing out the traffic safety day-glo orange shag carpet, and p-lam counters so old they had metal edges and wear spots in the pattern. However, my wife and I could see through these surface issues and recognize a well-built home. At nearly 60 years old, that place was rock solid. I'm not too sure most of the homes built during the last 10 to 15 years will fare so well.

And this is just not a problem with residential buildings; I've seen it in commercial and institutional ones as well. Much like a lot of businesses these days, it seems the bottom line is the most important thing, quality and pride be damned. We select designs, materials and methods for "lowest first cost" over lowest life cycle cost. In other words, we pick what's cheapest to build now and not what will last the longest and kick the can of repair and replacement down the road to future generations - if the buildings even last that long. Hmmm, sounds familiar. 

Where do we go from here? I'll discuss that in my next installment. 

Whither Goes the Gated Community?...Part 3 - Wrap Up

In part 3, I wrap up my discussion of the golf course community and suggest alternate approaches.

______________________________

What should the Industry do to Survive?

First, let’s decide which industry we are – Homebuilders? Golf Course Managers? Hospitality? The remains of companies that tried to expand too far outside their core business litter the history of commerce. 

Regardless of how we define ourselves, community residents will continue to spend a large portion of their discretionary income outside the gates of their communities and look for a variety of activities that do not get

stale. Recognize and accept it. The opportunity to increase resident spending inside the gates is limited – people simply do not want to spend all their time and money in one place. Instead, look for opportunities to capture more of the residents’ “discretionary wallet” by providing services to residents outside the gates and maintain flexibility with respect to the offerings inside the gates.

For example, assume the typical couple eats out twice a week. It is highly unlikely they will want to eat at their club twice a week, every week. Accept it and move on; after you have done all you can with special events, dinner specials, and the like residents will still want to go downtown to stroll around and sample other fare. What to do? Establish a dining program with some of the better restaurants in town. Develop value-added

programs that cost you little-to-nothing but are highly valued by club members like preferred reservations and other special services. In return for directing traffic their way, ask the restaurants for a finder’s fee or an in-kind exchange. 

A big, luxurious clubhouse can be a major trophy and selling point, but it is also a money pit requiring a tremendous upfront capital expenditure as well as ongoing maintenance costs (Typically in order to sell the community the clubhouse has to be built prior to most of the homes being built and memberships sold. Thus it operates saturated by red ink in the first few years. One option among others is to provide a temporary clubhouse until a certain home sales goal is reached). They often have highly specialized spaces that cannot be easily reconfigured such as commercial kitchens, theatres, locker rooms and spas. And once spent, that money is, for all intents-and-purposes, illiquid. It is locked up tight by more than just the physical

gates surrounding it.

There is an option to spend just as much, or maybe less, on hard amenities like this albeit in a somewhat more liquid fashion. Purchase existing “one-off” facilities in various locations for use by members when they vacation and travel outside of the community.

For example, instead of building a large clubhouse buy

• An apartment in NYC
• A flat in London
• A chalet in Vail
• A cabin in the Smoky Mountains, and
• A beachfront home on the Outer Banks.

Should any particular property not prove popular, it is far easier to sell a single ski chalet in Vail than an entire gated community….and it would seem far easier to sell (to the homebuyer) a community with an international presence over one with only what is right in front of them. There are of course operational challenges to overcome with respect to maintenance, guest services and how reservation priorities are set. Companies that

provide this type of service are out there, like Abercrombie & Kent, so a model to deal with these operational issues exists.

However, there is a basic level of facilities your buyer will expect, depending on your target market. A modest clubhouse with flex space is a minimum with a well-equipped fitness center (and not the afterthought, hotel-type that no one really seems to use). A pool helps too but save money and go for a standard shape without all the bells and whistles like waterfalls and fountains (and a regularly shaped pool can be covered at

night, resulting in tremendous savings in water, heating and chemical costs).

Forego the theatre (most people have large-screen flat TV’s with surround sound at home anyway), the billiards room, luxury spa, business center, and other highly specialized spaces unless you are trying to offer a particular angle for your community. Do not offer them simply because everyone else is…it only becomes an expense that does not set you apart from your competition. Think very hard before providing a full-blown restaurant as opposed to a grill room or even snack bar. The kitchen equipment alone can cost $500,000 or more, not to mention the headaches involved with maintenance and inspections. Also not cheap is the cost of an executive chef whose salary (excluding benefits) will run close to $100,000/year.

Look to build space which can be used for a variety of activities and provide plenty of storage to put away equipment and furniture not used at the moment. Operable folding partitions offer a sound way to easily reconfigure a large space into multiple smaller rooms or vice versa.

The big-ticket item to reconsider is what, during the Boom, seemed to be almost sacrosanct – the golf course. The outlook for golf has already been discussed and plenty of those course-side homebuyers spent their extra funds on a lot premium for a view of open space instead of a golf membership. An 18-hole golf course at the low end is going to cost at least $10 million to build and $500,000 a year to maintain (in  warm-weather climates). Move up the scale in quality and bump the construction price to $20 million and annual maintenance easily to $1 million +. Even an executive course takes a significant amount of capital and land to build and operate.

If you open up the course to semi-public play to help with revenues, the ability to market it as a private course goes out the window. And despite their lush, green look, golf courses are an environmental challenge due to the amount of fertilizers, pesticides, fungicides, herbicides and huge quantities of water they require. Finally, you purchased a large amount of land that is only actively useable by a relatively small portion of the community.

What do you offer your community members instead? Simply preserve multiple-use open space with pathways, water features, and other amenities that take up far less space like tennis and basketball courts. Even a driving range is an option since it does not require that much land or maintenance relative to 18-

holes. Consider “soft amenities” like travel clubs or a cooperative agreement with a local university so residents can take non-matriculated classes, bring in guest speakers on a wide variety of topics. Bringing in a full-time coordinator to keep things lively and their finger on the pulse of the community is far less costly than a golf pro, assistant pro and the pro shop staff. Should a particular program be more popular than planned for, it is easy enough to scale it up – or eliminate it altogether if necessary. Taking advantage of the latest trend is also simple with a soft amenity program. And because people like to stay involved, having members organize and run many of the clubs is another way to keep operating costs down.

____________

Long story short...the gated golf course community crowd (i.e. Boomers), while they may still retire to FL, NC or wherever, have a lot more options at their fingertips when it comes to how they will spend their discretionary income. This is why the gated highly amenitized, golf course community as we now know is

doomed to go the way of the dinosaur. A few will continue to exist for those that want that lifestyle, but expect their number to be far fewer than has been planned for. In order to compete, country club-style gated communities are going to need to start thinking very creatively with respect to the amenities and services they offer.

Sources:

National Golf Foundation. Golf Participation in the United States, 2010 Edition.

National Golf Foundation, Minority Golf Participation in the United States, 2010 Edition.

National Golf Foundation, Minority Golf Participation in the United States, 2010 Edition.

National Golf Foundation – Golf Participation in America, 2010-2020.

US Census – Table 4. Projections of the Population by Sex, Race and Hispanic Origin for the United

                States: 2010 to 2050 (population numbers have been used by author to calculate %).

Whither Goes the Gated Community?...Part 2 - Demand and Golf

In the previous posting, I presented the problem of the highly-amenitized gated golf community and looked at supply issues. In installment 2, I continue with a discussion of the demand challenges and the game of golf.
____________________________________________________

Demand

The demand side is just as challenged. Why is the Internet killing the highly-amenitized gated community model? Because it is now easier than ever to spend your discretionary income via the Web. It is a mistake to think that only other gated communities are your competition when it comes to people buying club memberships or even current members spending money there.

With a wealth of information at their fingertips, people can find the latest “hot” restaurant, get reviews, make reservations, buy movie and concert tickets online and find a whole host of other things to do than spend yet another Friday night at the club. This is particularly true of the Baby Boomers who are used to trying new things and going new places. Anyone can go online and in 10 minutes have plane tickets and hotel reservations to spend this weekend in Paris, next weekend in Vail and the following weekend at some

spa or buy an iPad. Consumer purchases in general were simply not that easy a generation ago.

Why buy a house and spend $50,000 or more on a club membership + annual dues when you can spend that same money traveling to exotic locations or doing something different each month instead? A limited club membership would seem to be much more appealing than a full one. The consumer wants variety in their leisure time and it is easily available. Provide it or get out of the way.

Even jet travel is more commonplace than ever before. Only 30 years ago flying someplace was considered somewhat exotic even if it was to Detroit. But with the Boomers flying everywhere for work during their careers and frequent flyer/credit card programs (FF programs turned 30 this year), people think nothing of hopping aboard a plane these days. Add to it that most extended families in the US today are spread across

the country, and people are flying to visit each other far more often than a generation ago (find stat about increase in number of flights compared to population increase).

Trends in Golf

The game of golf itself, and demographic and economic trends in the US, also do not paint a rosy picture for the gated golf course community.

According to the National Golf Foundation’s (NGF) report Golf Participation in America, 2010-2020, “…since the year 2000, the number of golfers plateaued and has been slowly declining, raising concerns about the future.” And let’s face it – despite recent in-roads made by such pro golfers as Tiger Woods and

Vijay Singh, golf is still overwhelmingly a middle-aged, upper-income white man’s game. Of all rounds played in the US, men play 80% and of those men, approximately 55% are between 30 and 59 years old, over 40% have a household income over $100,000, 52% are college graduates4 and they are 79% non-Hispanic whites.

Combine that with demographic trends in the US and the prospect for golf does not look too promising (despite the NGF’s forecasts; which honestly are not that upbeat to begin with). According to the US Census6, the percentage of non-Hispanic, white males in the US between 2010 and 2050 will fall from 31.9% to 22.9% of the population. Black and Native American populations will remain steady with a slight gain in the Asian male population from 2.2% to 3.5%. The big gain will be seen in the Hispanic population

where those men will grow from 8.2% of the population in 2010 to 15.1% in 2050.

Without participation growth by minorities and women, it is uncertain where golf will gain in play over the next few decades other than through an absolute growth in the number of middle-aged white men even as they become a smaller piece of the population pie.

Despite stating, “Golf participation is highly correlated to income, regardless of race” one of the key challenges to golf that the NGF studies do not address is the growing income gap and decline of the middle class in America. Unless this trend reverses, the segment of roughly 60% of all golfers who have household incomes under $100,000 is going to find it increasingly difficult to pay for expensive equipment and rounds. This is especially true with younger golfers (18-29) who are currently facing a much higher unemployment rate and a somewhat dim economic future – these are the very people golf needs to maintain its ranks as older players either stop playing or die.

Part of the trouble is the game of golf itself. We all have seemingly less and less time. Other than what the NGF calls “core golfers”, who has time to spend 6 hours playing a round of golf? Unless the game of golf adapts to serve younger and “non-traditional” players, its growth will remain relatively flat at 1%. While there are purists who want to defend the traditions of the game there is plenty of room for variation. One such way is to adapt by building courses with 3 sixes instead of 2 nines. It is still 18 holes but if you could play 6 holes in 90 min or so, more people would most likely play more often. There are now some courses designed this way, but the problem is - who needs more golf courses? Already the NGF is predicting that over the next ten years, the US will lose around 750 of them.

In Part 3 - What to do to survive?

Whither Goes the Gated Community? ...Part 1 - The Problem and Supply

The Real Estate Boom which gained steam after 9/11 was the high-water mark for gated, amenity-rich McMansion communities. Developers bulldozed acres of open space to create enclaves where, for the right price, you could live on a private golf course, eat at your private club, exercise at your private gym and relax at your private spa. Property values were skyrocketing; everyone was fat and happy. Then, a funny thing happened on the way to the bank…

It may seem like a fundamentally sound model, but there were some serious problems with the concept of these gated communities from both the supply and demand sides. While the current economic climate means the model is on the shelf for now, this article suggests that for the wise developer it should stay there – forever – even when real estate finally turns around.

In today’s world, a highly-amenitized community faces dual challenges. First, too many communities vying for too few members which requires they must offer ever better and better amenities and services at ever-lower price points. Second, the internet and commonplace jet travel are taking their toll on the traditional country  club model.

Supply

Even before the absolute and utter disaster of the real estate crash, the amenity-rich gated community was an unsustainable model. It was a cash generator for the developer in that it helped to sell lots of rooftops. The problem came once once the developer turned the community over to the homeowner’s association (HOA) 5-7 years later. The HOA received a rude awakening to how much the community really cost to operate. 

Often, in the very amenity-rich communities, those attractions were loss-leaders for the developers who kept them afloat using profits from the sale of homes and memberships. While it was feasible for the HOA to continue to operate post-turnover, it was often only at diminished service levels from those provided when the developer ran it. Alternately, it required the HOA to jack up annual dues and fees.

Adding fuel to the fire was the problem that the developers’ pro forma models were based on a certain absorption rate of homebuyers opting to buy a club membership. However, the rampant level of speculation during the Boom threw that model out the window as speculators typically do not buy memberships. So, operations that run in the red by nature and only show in the black due to membership sales and dues are seriously behind the eight ball from the get-go.

Why do they run in the red? Because the quality and level of goods and services that members expect is expensive, especially when combined with the low membership levels you have to have (even with a full roster) to provide that personalized service. Moreover, in order to attract good staff members capable of high-end service you have to pay well and provide excellent benefits in order to make up the difference from what they can make at a commercial restaurant or public golf course with high volume. Finally, the volume at most clubs is simply not that high with respect to both the variable and (especially) fixed costs.

Compounding the problem is that many of the “hard amenities” – golf courses, clubhouses, fitness centers, restaurants, and spas – are too specialized in their construction and use to be easily adaptable should the winds of change blow in terms of what activities the members want. Offering a community based almost entirely on these hard amenities, instead of one focused more on “soft amenities” (travel clubs, programs, classes, etc) requires a tremendous amount of up-front capital investment that may or may not provide a suitable ROI. It is not unheard of for a developer to spend $20, $30 or even more than $40 million on a clubhouse…and maybe double that if you add a high-end golf course.

The gated golf course community so prevalent during the boom is essentially based on the country club model of a generation or two ago when there were only one or two clubs in town that anyone of means belonged to, and this was pretty much the extent of your social life and spending of discretionary income [You didn't live there - you joined and then played golf every weekend and ate dinner there a couple times a week]. During that era, there were not as many luxuries competing for your dollars or other places to spend your free time.

Financial models for recent gated communities were based on residents acting like those club members of 40 years ago. However, most people today are not willing to eat and spend that much time at their club given the choices they have outside the gates. Yet members still expect the same level of personalized service even if they only eat there once a fortnight instead of twice a week. Unfortunately, the club has a legal obligation to

provide that service because of what was marketed and sold. This is compounded by the fact that many members bought homes in the community based on the “lifestyle” and not just the house.

The other challenge is that with the old country club model, membership was somewhat fungible in that anyone could join. It was a simple decision to make – you paid your dues and joined. Alternately, you could decide not to renew your membership and leave. In today’s gated community, you first have to buy a house before you can even decide to become a member or not. That’s a really strong barrier-to-entry…in reverse. Or, God forbid you want to sell your house, you have to put your name at the bottom of an often long resignation list.

For some reason, it was thought the old country club model would be just dandy when mixed it with actual real estate sales. What they were marketing was a “lifestyle”, not just homes. This is not terribly different from how many companies pitch their products – they sell the benefit not the product – but an odd pairing when combined with someone’s home, especially the added cost associated with it. (The business model was not  merged into the marketing of a comprehensive lifestyle product. Home development plus country club management does not easily add up to twice the profit. Residential for-sale development is based on one-time, fast and high profits, while successful country clubs and other hospitality ventures are typically mid- to long-terms holds with steady returns based on superior customer service.)

Compare it, for example, with Coke™ whose marketing rarely pushes the actual product. Instead, you see advertising showing youth, action, and good times while drinking their product. Therefore, by extension, if you buy Coke™ you might somehow enjoy those things too (although it is never implicitly said you will). The Coca-Cola Company does not offer the option of adding an extra $0.50 to your purchase of a bottle of Coke™ to gain entry to this non-existent clubhouse of eternal youth and vitality. Pretty absurd when

you think about it – but this is exactly what real estate developers did when selling a lifestyle…except they spent real money building that good-times clubhouse. A lot of them in fact.

In Part 2....Demand