Broad Oak: your emotional support animal

Thursday, July 10, 2008

Why were construction companies caught in the credit crunch?

That's my question. Years ago I went to a Midlands construction company to prospect them for business, and learned that they had a long-term strategy of buying land when the market was depressed and developing it when the upturn came (well, duh, you're saying, doubtless). They'd done this for several business cycles, as (I assume) any well-established firm in their sector would have done.

It was obvious to me ages ago that house prices had gotten silly. How did major building companies get it so wrong this time, when watching the trend is so fundamental to their survival?

8 comments:

pej said...

Why wouldn't building company make such huge mistakes when banks (investment banks, building societies, retail banks) made also the same huge mistakes? 95% of the analysts and strategists were thinking that we were in a new era of house priced between 30 to 40 times the yearly rent...

They all got too greedy and got caught in the bubble...

I have many people around me who are analysts/traders/quants who were stupid enough to buy a property in London as late as June-July-August 2007 and even Sept and Oct 2007 !! Because the UK is not like the US they say!!! :-)

Ryan said...

The purpose of a company is to make money whilst it is possible to make money - not necessarily live forever. Whilst the demand for housing was there they had to take full advantage of it. Although a building company might fail in the current market, it doesn't mean the building company was in fact a failure when measured over the long term. Let the stockholders beware ,and take their profits while they can.

In my experience building companies rarely buy land anyway. They simply pay for an option on the land from the farmer so that if it gets planning permission then they will be first in line - only then do they pay for the land and at current market value. Thus they are never holding enormous quantities of over-priced land. Sure, they are making people redundant, but thats because they aren't actually doing much building.

John East said...

I know little about the building industry, but in those industries with which I am more familiar the shelf life of CEO's CFO's etc, is often 2-5 years. I assume similar trends have occured in the large cap building industry too, and if so it is surely kinder to their managements to assume that they are not stupid. Why plan for business cycles that can span a decade or more when the next few years bonuses, and the final severence package are all you have to work towards.

SACKERSON said...

I wondered whether it might be some combination of all the reasons you three have suggested. Does anyone have any proposals for restructuring top managers' rewards so that they don't knacker their companies for their own short-term gain?

pej said...

Well, to start with, Warren Buffet thinks stock options should never be part of a comp package, and I would agree with him.

Then I guess some sort of differed compensation scheme should be put in place, something like 3 to 5 years where you can't sell your stocks.

Finally, for the managers who are still at their jobs, some sort of negative bonus should be put in place.

I guess these are very unpopular ideas among CEOs :-)

dearieme said...

Yeah, and capital punishment of your firm goes bankrupt.

Ryan said...

"they don't knacker their companies for their own short-term gain?"

Given that stockholders often struggle to hold onto their shares in one company for a whole day, it seems a bit harsh to suggest the company itself should take a very long term view.

SACKERSON said...

Hi, Ryan. Maybe that's why people like Alan Sugar bought their companies' shares back, so they can make bold/long-term decisions. Which suggests that eventually, the best investments may be ones you can't get into!