CASE 2-1 BUILDING UP OUR ASSETS: DHR CONSTRUCTION

In August 2011, when the Dow Jones Industrial Average dipped under 8,000 from a high of almost 11,500, Richard Davis and Stephen Hodgetts, academics, friends, and coauthors, were lamenting their ever-shrinking retirement funds. As Hodgetts was fond of saying, “America believes in education: The average professor earns more money in a year than a professional athlete earns in a whole week.”

After a long discussion, they decided that they needed to take direct control of their investments and not be prisoners to the rise and fall of the stock market. Davis had done enough preliminary research on the real estate market in their area and convinced Hodgetts that there was money to be made in property ownership and renting starter homes (three bedrooms, two baths) to individuals with poor credit who could not afford a home but who had excellent rental track records. Davis and Hodgetts formed D&H Management and found six families in three months who were happy to rent and eventually purchase homes in the $175K price range. The deal was so attractive that D&H even had a waiting list of new tenants. The six homes, though, gobbled up their initial investment and required additional capital.

The New Firm: DHR Construction, LLC

Their construction company started off as just a smallcapital-raising venture. Hodgetts and Davis would finish off the basements of their rental homes, get the homes reappraised, and then remortgage the properties, pulling out an additional $10K to $20K per home. These funds could then be used as down payments for future rental homes.

In chatting about this matter with some of their renters, Davis and Hodgetts were approached by one of them to perform all of the nonlicensed work (excluding electrical, plumbing, HVAC, etc.). Davis explained to the renters (Alan and Wilma Bronson) that they would have to form their own company and act as any other subcontractor. After completing a few basements, Alan and Wilma enjoyed working on these basements so much that they approached Davis and Hodgetts about figuring out a way that Davis and Hodgetts could keep them occupied all year round. In essence, Alan would quit his job and work as a subcontractor for Davis and Hodgetts. This was not possible, though, since there was not enough work to keep Alan and Wilma busy. Yet a few days later the situation dramatically changed.

One of Davis’s students, David Russ, who was designing their basements, said that he thought that Davis and Hodgetts could cut out the middleman in terms of the rental business if they built their own homes. Davis thought that Russ was crazy at the time, but they talked after class and Russ said that he would be happy to act as the general contractor and that he knew all of the subcontractors who were needed in order to construct new homes. Alan and Wilma would do all of the interior work, and Alan could hire some part-time workers to help himself out. Davis and Hodgetts could then build the rest of their homes under a different company name, sell them to themselves for a small profit, and then make a profit renting the homes.

In around nine months, the preliminary profits derived from their construction operation led Davis and Hodgetts to build homes not only to be purchased by D&H Management but also for public consumption. In May DHR Construction broke ground on their first home to be sold to the public.

In November, Davis and Hodgetts bought out David Russ’s interests in DHR Construction due to differences in management and business philosophies. Davis was left to act as contractor while Hodgetts handled D&H Management. By January 2014, they had completed three homes at St. Andrews subdivision. Alan quickly took over the role of foreman/contractor when DHR shifted their building site to another location, the Florence Development, which had a much more upscale look. DHR was no longer building starter homes; they shifted into the midsize market (four bedrooms, $300K) where they could make a higher profit margin. By April, DHR had built three homes in Florence, had plans to build five more in that area, and were looking at other developments for future growth and expansion.

Branching Out: Patio Homes

In June, Davis located a brand-new development about 10 miles east of where they currently were building, in an area called Snowy Mountains. Snowy Mountains was a unique project for the area since the developers had built lakes, a golf course, and a clubhouse (including a three-star restaurant) and had very specific designs for community development. The housing currently in the development (Phase 1) ran the gamut of homes,from four-bedroom patio homes (that started around $450K) tomultimillion-dollar estates on the lake.

DHR Patio Homes was formed by Davis and Hodgetts (run under the corporate label of DHR Construction), who decided to build the lower-end patio homes; these homes would yield them their highest profit margins to date. Using the same management and work crew as DHR, Davis acted as the architect and head of operations for construction while Alan acted as foreman and continued his own subcontracting work. Hodgetts remained in charge of the rental operation but served as an adviser to Davis on an “as needed” basis.

Questions

1. What type of strategy did Davis and Hodgetts first use in their business? How did that strategy change with the change in their business?

2. Describe the structure of DHR Construction.