Focus Fund Company Spotlight: NVR - Building A Better Home Construction Business

NVR is one of America’s leading home builders. With its uniquely “asset-light” balance sheet and focus on operational efficiency, the company has created a hard-to-replicate business model.

October 2020
  • David Rainey
    David Rainey, CFA
    Co-Portfolio Manager
  • Brian Macauley
    Brian Macauley, CFA
    Co-Portfolio Manager
  • Ira Rothberg
    Ira Rothberg, CFA
    Co-Portfolio Manager

Preeminent Home Builder

Founded in 1980, NVR has grown to become a top-10 home builder in the U.S. The company specializes in the construction and sale of single-family detached homes, with a substantial footprint in 32 cities in 14 states along the East Coast. 

The company has grown from its core Washington D.C. market, where it has an estimated  20% market share, into the adjacent markets of Baltimore and Richmond, where it now commands a similar or even higher market share. In newer locations, such as Pittsburgh and Charlotte, NVR has an estimated 5-10% market share, but they are steadily gaining as the company leverages its existing infrastructure and industry relationships.   

NVR’s strategy of establishing itself as the dominant builder in each geography allows the company to leverage its regional production facilities, leverage local management, foster strong relationships with subcontractors, and obtain access to quality land deals.    

Strengths of NVR’s Business Model

A core tenet of the company’s business model is its approach to lot acquisition and land development. Unlike other home builders, who typically purchase and develop land, NVR doesn’t own land, rather it negotiates with developers for the exclusive option on finished lots. By offering an upfront cash deposit and agreeing to purchase the finished lots at a premium price, the company is a preferred partner for developers who can use NVR’s credit rating to procure favorable financing from lenders. 

By avoiding the capital intensive and multi-year process of land development, NVR has been able to generate a return-on-equity (ROE) between 20-30%, compared to 12-14% ROE for most large home builders. Additionally, this strategy acts as a risk mitigation tool, allowing the company to reassess, renegotiate, or withdraw from commitments during housing market downturns. 

By focusing exclusively on home construction, NVR has achieved a remarkable level of efficiency. The company’s relatively standardized floor plans have helped reduce design complexity and achieve a best-in-class “cycle time,” - the time to construct a finished home – nearly one-third better than competitors. Additionally, by utilizing offsite manufacturing and assembly for its components, NVR can reduce waste and enhance construction quality. 

NVR’s unique business model also acts as a barrier to competitors looking to emulate its success. NVR’s size and experience outpace small and mid-sized builders who cannot match its land procurement, construction efficiencies, or marketing ability to compete on an equal footing. Meanwhile, large competitors are culturally and structurally wedded to land development due to their multi-decade experience in that arena, large development teams, and billions invested in land ownership.

Market Catalysts for Future Success

Low Interest Rates 

There is no shortage of demand for new housing as the “lower-for-longer” interest rate environment has reduced mortgage rates to historic lows in 2020. For first-time and lower-income homebuyers, historically low rates offer the opportunity to qualify for mortgages they could not have otherwise afforded. Existing and higher-income home buyers are also taking advantage of low rates to upgrade to larger, more expensive houses. With already-strong demand and steady price growth for homes in the Mid-Atlantic, NVR’s primary market, we believe the company can grow revenue by 7-12% annually and EPS in the mid-teens over a full housing cycle. 

Lack of Housing Supply

The housing sector’s slow recovery since 2008 suggests that new home construction will need to increase by more than 25% to return to normalized levels of the last 60 years, and the single-family housing construction segment that NVR specializes in needs to increase by 35%. In addition, because starts were so far below normal for so long, we estimate the country has under-produced by about 5 million housing units over the last 15 years, implying starts may need to exceed the long-term average for an extended period of time to get back to equilibrium.

Increasing Preference for Suburban and Rural Areas

The COVID-19 pandemic has halted population growth in urban areas. The rise of “urbanesque” developments, suburban developments centered around pre-planned town centers that include restaurants, bars, shops, and other amenities, offer previously suburban-skeptical millennials both a vibrant and active neighborhood as well as more affordable larger homes with bigger yards. Additionally, the increasing ability to work remotely because of the pandemic allows homebuyers to place less emphasis on proximity to their workplace, helping expand their search into underdeveloped suburban and rural areas. These trends all benefit NVR as a suburban homebuilder.

Our Independent Research and Key Insights

High Quality Business

•    NVR’s unique business model outsources capital intensive, low return activity of land ownership and development, enabling higher returns on equity.

•    The company’s focus on home construction has allowed it to eliminate inefficiencies and achieve a best-in-class “cycle time.”

•    NVR’s focus on building market share in each of its markets has allowed it to leverage its management expertise and marketing expense, secure attractive lending terms with landowners and developers, and access quality land.

Large Growth Opportunity

•    Years of below-average building rates suggest more than 25% industry unit growth is needed to return to normalized levels.

•    With only a 2% market share of the U.S home construction industry overall, we believe NVR can more than triple its current size by expanding geographically.

Excellent Management

•   Founder Dwight Schar and CEO Paul Saville have been with the company since the 1980s, fostering a culture and process supportive of the company’s strategy.

•   With both the Chairman and CEO each owning over $150 million in NVR stock, we believe management’s interests are well-aligned with the company’s shareholders.

Discount Valuation

•    NVR has demonstrated excellent capital allocation and has delivered shareholder value via opportunistic share repurchases.

•    We believe that the company’s earnings per share can achieve a mid-teens annualized growth rate over a full market cycle.

•    The company is trading at 17x our forward earnings estimate, below the market at 21x. However, the projected earnings growth indicates that NVR should trade higher, and thus, its stock price appears undervalued.