Capital risk for homebuilders: why money leaves and evaporates

In 2008, I was a partner at a private equity firm investing in homebuilding and land. We weren’t perfect, and we made our share of mistakes. But we were fundamentally conservative, and when we didn’t like what we saw in the market, we significantly reduced deployment. As the downturn approached, we had $500 million in unfunded, discretionary commitments. We thought we were positioned for the moment that matters most in this business: when distress creates opportunity. Then in March of ’09 our lead investor came to us with a request. Please don’t spend the remaining commitments on new deals. They had problems of their own. We had been prudent, and we were in a bind anyway. It got worse. Over the years, other investors had approached us about coming into the fund. Each time, our lead said: “Don’t, we’ll put in more.” It’s hard to say no to your original backer. When that backer later pulled the plug, no one else was there. We started over at the worst possible moment. The lesson: no capital other than your own is 100% certain, especially when all correlations go to one. That’s why risk exists, no matter the source. Two kinds of capital risk Most builders think of capital risk as one ...