Open House (3288-JP): Part 1

The US$4bn market-crushing compounder that you've never heard of

Introduction

Open House (3288-JP) is a niche homebuilder in Japan that has a special expertise in building/selling cheap detached homes in urban areas. It participates in many segments of the residential property market, though earns the lions share (~60-65%) of its profits from the single-family homes business. Despite its relatively modest profile in the investment community, the company has a ~US$4bn capitalization. It trades at ~1.3x 2023e P/B and ~6.8x P/E.

In Yen, the market cap is 615bn. It has a trailing book value (Dec-22) of 400bn Yen, and I forecast that it will generate net profit of ~90bn yen this year. It will generate an ROE of ~22-25%. It has a rock-solid balance sheet with ~500bn in debt and 350bn in cash, against land of ~550bn. It will generate sales of ~1.1T yen this year, representing a ~2x turnover rate on it’s land.

So what! Another cheap Japanese stock that will never grow, re-rate or return capital? Well, maybe not. Since IPO in 2013, Open House has achieved the following:

• TSR of ~30% including dividends.

• Sales have grown 10-fold over 10-years.

• Consistently produced an ROE >25% with modest leverage.

• Has remained founder-led, and Mr. Arai still owns ~40% of the business.

• Has been shareholder-friendly (~3% dividend and periodic buybacks). Last year Open House returned ~7.5% of capital to shareholders whilst still growing double-digits.

• Developed a well-considered ESG policy.

Below is the company’s sales, profits and dividends development since IPO. Pretty impressive. The company’s EPS is higher today than its share price was at IPO in 2013 (and quite considerably so, too).

Why has this little homebuilder done so well if the Japanese housing market is in structural decline?

It’s true that Japan’s residential property market at an aggregate level is met with a general distaste by investors. And mostly for good reason. Demographic issues, post-bubble land deflation and multiple corruption scandals both in the real-estate and lending sector have rather tainted the sector. Housing starts and home prices have declined considerably since the late 1980s. As a result, the large Japanese developers have largely been lacklustre investments.

Open House, however, plays in a niche which bucks the aggregate trend by focussing on major cities and cheap single-family detached dwellings. And through a mixture of scale, process and culture, it does it really well. Whilst the population of Japan is declining at an aggregate level, net-migration to the cities from rural areas has created a geographic misbalance in household formations. Other factors, such as a growing double-income population (increasing female participation­), higher condo prices and more recently WFH trends have added further tailwinds to demand for detached dwellings in urban areas relative to condos. Open House is not your average homebuilder. This is a structural story and not one guided by a thesis on Japanese housing. I will address this in quite some detail below.

Here is my thesis in three key points

1. Open House has a proven model in a profitable niche that works and is hard to replicate.

2. The company still has a potentially quite significant runway for growth.

3. The stock is dirt-cheap and the CEO has shown to be shareholder friendly. Capital returns + cyclical rebound should lead to re-rating.

On valuation, i’ll add a quick little comment, and then I will address the financials/valuation in much more detail in Part 3.

In my view, the valuation today provides a significant margin of safety for macro shocks. At ~1.3x 2023e book, the investment will be almost entirely backed by tangible book by the end of 2024, and will return the entire equity of the investment even without any growth in ~5-6 years at a constant ROE of ~20-25%.

The balance sheet is solid and not over-levered, with a considerable cash holding against its debt meaning that the company is very liquid. Net debt is modest at only 25% of inventories. A considerable portion of this inventory is single-family homes, which turns at ~2-3x/year.

The stock is cheap for a reason and I’m not oblivious to that. In fact, it’s cheap for 5 main reasons, as I see it. First, it’s Japanese. Second, it’s a homebuilder. Third, it’s a Japanese homebuilder. Fourth, macro and tightening monetary policy. Fifth, concerns over certain “cultural” issues at the company.

For points 1-3, yes - it is a Japanese homebuilder and it will never trade at 15x P/E - I am not a total fool. That said, the stock’s valuation has gyrated in better-and-worse economic times, as most cyclicals do. It is currently trading at a trough P/B multiple of ~1.3x forward, having gotten as high as 3x in the past. I’m not holding my breathe for 3x P/B, but I don’t think it’s unreasonable for the stock to trade in the high 1’s or low 2’s for a company which has produced a >20-25% ROE over time and continues to grow both net profits and EPS.

Points 4 and 5 I will address in more detail in part 2. Point 4 is a fair one, though there are some fundamental differences between the Western and Japanese new residential construction market which makes it an inherently less volatile market. Whilst tighter monetary policy in Japan will surely slow activity down, I think that concerns for serious earnings deterioration (such that the current share price is suggesting) are overdone. I’ll go through this in much more detail in Part 2.

Point 5 I will leave for now and also address in Part 2.

And before you say “yeah okay the stock might grow but it will just de-rate forever”, the company has one of the better capital returns policies that I’ve seen in Japan. It pays a dividend and has a policy for ‘periodic acquisition of treasury shares.’ Last year, it returned ~45b Yen to shareholders via dividends and buybacks on a market-cap of ~600bn (7.5% yield). It still managed to grow at a double-digit rate. Homebuilders do not have FCF when they are growing (in-fact, quite the opposite), so it isn’t common for a growing builder to return capital. The fact that Open House both returns capital and grows is admirable. If growth were to temper or even stop, I’d expect that capital returns could increase quite considerably.

The company has incresed dividends every year since IPO. It has a payout ratio of ~20% and a “flexible treasury share acquisition” policy, which it has actually used.

This is going to be a three part write-up because it’s just too long. Part 1 will be about the business and it’s oppourtunities. Part 2 will address macro/rates, bear-case for the stock and corporate governance. Part 3 will be financial analysis of the company and forecasts with some scenarios and, of course, valuation.

So with the preamble out the way, let’s dig in.

Part 1 - Why Open House is a nice business and can still grow

History and Overview

A quick comment on the company’s history is in order.

Open House was founded by a man named Masaaki Arai. He still owns ~40% of the business. Mr. Arai is about as cut-throat as they come. In this interview after Open House won a Porter Prize, Masaaki Arai was described as “an extremely aggressive businessperson, somewhat resembling the Sengoku Daimyo” (feudel lords in the pre-Meiji era). Arai has created a culture of success and hardwork, but it is no secret that Open House has a reputation for being a tough place to work.

OH was founded in 1997 as a franchisee of Century 21 Japan. In 2001, the company acquired a growing single-family builder in Tokyo and started building its own detached homes. From 2000 to 2012, it was the single-best performing agent for Century 21 in Japan every single year, until it decided to end the relationship in 2012 and re-brand as Open House. Its heritage and legacy is in real estate sales first and foremost, homebuilding second. Arai developed an aggresive and ultimately succesful sales model before he ever built a home. This is important to keep in mind when considering Open House’s strengths as a fully-integrated developer.

Open House’s detached homes business comprises ~60-65% of the company’s profits. Traditionally, buying a detached home in Tokyo’s 23-wards near a train line was almost impossible for middle-income families. OH looks for old blocks, which were traditionally ~130sqm, and subdivides into 2-3 three-story homes, supplying similar floor space on smaller land. If you’ve never heard of a Japanese ‘pencil home,’ this is what they look like (pic is a current Open House home for sale). The business model is centred around a single idea: build cheap detached homes in urban areas, for which there is much demand.

Over the last half century or so, Japan’s economy has undergone significant deregulation. This has been particularly evident in housing, were zoning laws are perhaps looser than anywhere in the developed world (good article to understand it here and here). Post-bubble, housing underwent further deregulation allowing for a great deal of flexibility in both construction and sub-division of land. Zoning laws exist, to be sure, but NIMBY isn’t a thing in Japan like it is in the West. The early 00s deregulation created an oppourtunity to build cheap detached housing, and Open House jumped at it.

A word on the Japanese Housing Market - it’s quirky

I didn’t really want to write much about the Japanese housing market but I’m going to for two reasons. First, I know that I’m going to get a million “yeah but demographics” comments, and also Japan’s market functions much differently to what we are used to in the West in a couple of unique ways. I’m not going to write a total Japanese Housing Primer, and I will post more granular data in part 2 when I look more closely at the macro.

There are some puts and takes on housing in Japan generally. Firstly, most people will tell you that there is no demand because of demographic issues. Demographics at the aggregate level are obviously not great. However, there is a misbalance in household formations as the country has been undergoing “urbanisation” for some time. Below you can see that population growth and household formations in the major cities has been relatively robust and is forecast to continue growing.

Housing starts at an aggregate level in Japan have fallen considerably since the 1990s. This is partly unwind of the bubble-period, partly demographics and partly due to the plateuing number of people per household in the late 2000s (was a tailwind through the 80s and 90s, and ceased to be so in the 00s). However, over this time, built-for-sale detached housing (Open House’s market) has taken share and remained particularly resilient on a unit-basis level.

Custom-detached housing, whilst also on a slow downward trajectory at an aggregate level over time for reasons discussed, has also been pretty stable over the last decade. It was relatively resilient through the GFC, too. I’ll get to that in a second.

In Tokyo (more directly relevant for OH), a similar trend has been taking place. I don’t have data beyond 2020 because that’s when the Tokyo Statistics Yearbook ends. It’s worth pointing out that 2011, 2012 and 2013, Tokyo generally saw higher levels of housing construction in the Tsunami re-build. Also, increase in consumption tax in 2014 caused a pull-forward of activity in 2013 which is why the data spikes. It looks like there has been a big drop-off, but if you normalise for those factors, detached housing construction has been relatively stable.

You might also notice that detached housing starts have been particularly stable through time relative to the US. For those not familiar with what US detached housing starts looks like, here is the graph over the same period.

Yes, the GFC was centred in the US so it was more effected by the boom/bust behaviour. However, the general stability/resiliency in Japanese detached construction is also due to a particular quirk in Japanese culture - houses typically aren’t built to last much more than 20-30 years.

This is due to a number of reasons. I won’t repeat them but here is a really good article on the matter which will explain it better than I can. Basically, most Japanese don’t see their homes as investments and are hence generally hesitant to construct expensive and extravagent dwellings. There are also tax reasons (you pay consumption/inheritance tax on buildings, not land) for not wanting to have a high-valued house. Most homes, unless recently constructed, have little more value than the land that they sit upon. When Open House sells a block of land instead of a built-for-sale detached home, it is generally only ~10-20% cheaper. They actually gave a graphic to illustrate the typical land/building value split back in 2021 when people were worried about inflation in lumber. As you can see, the building itself does not hold a high value.

The signficance of this is that the 2nd-hand housing market in Japan is relatively underdeveloped. Japan has a population of 125m relative to the US at 330m, however the US starts ~1.4m homes/year compared to Japan at ~860k. That’s roughly 1.6x the amount of starts/capita, because they knock their homes down and rebuild them at such a high rate. This is an imperfect measure but it’s directionally illustrative of my point.

In-fact, as a little digression, whilst most think that Japanese home prices don’t go up just because of demographics, the deregulation in housing policies which have allowed for greater densification of major cities (of which Open House has been a large beneficiary) has kept house prices in Japan at relatively modest levels relative to incomes. This is true despite the fact that Tokyo’s population has grown in the last decade at a relatively healthy clip. Open House is playing a part in trying to keep urban housing affordable, which is trend that has gone against every major city in the world for decades. Unlike other major cities, Open House has a lot of freedom with zoning laws to actually achieve that.

The other point worth noting is that whilst a significant amount of investment has gone into the investment condo market, the fact that detached homes aren’t generally seen as investments in Japan has not allowed speculation/investment properties into the detached dwelling market such that it has in other places in the world.

So back on track - it is not as common in Japan to purchase a second-hand detached home. Let’s look at a real life example. Consider this snip from Suumo (one of Japan’s largest real-estate listing services - date, 14th April). The top image shows search results for used homes in the 23-wards of Tokyo (Open House’s largest market), and the latter shows a search for new homes.

Used Homes

New Homes

Whilst some areas have more used than new homes, in aggregate there were ~5.4k new homes listed versus 3.7k used homes, or ~45% more.

I tried the same excercise in Austin, TX on Zillow. It gave me ~3,700 results for homes in total, and only ~1,100 for newly constructed homes. It’s also worth mentioning US home listings are at historic lows right now due to the mortgage rate lock. Anyway, the point is - Japan has a culture of buying/building new homes which just isn’t the same here in the West.

This is further reflected in the statistics at an aggregate level. The below snip is outdated (US Housing starts are ~1.4m today, not 1m) but it is directionally correct. Japan’s 2nd hand sales market is signficantly smaller than it’s annual starts market.

What’s the so what of all this? The point is that Japan’s new construction market has historically been more stable than the US partly because a larger portion of new construction starts are “replacement” volumes, as opposed to new household formations. The has been seen over the course of the past decade, and also in the relative stability that housing starts showed through the financial crisis.

So to conclude this section, housing starts at an aggregate level will continue to slowly decline over-time due to demographic challenges, and they will slowly decline in the major cities over time aswell. However, I wanted to make this point to show that (1) populations are not forecast to decline in the major cities in the coming decade, and household formations should remain healthy, (2) the large portion of replacement has historically meant that Japan’s detached housing start market has shown relative stability, and (3) whilst household formations slow, a large number of construction starts are replacing existing dwellings, meaning that there is a greater resiliency to construction than one might expect if the same were to happen in the West.

And then I will finish with the section with this point: Open House is a very niche builder - it focuses on subdividing irregular blocks in urban areas to create affordable detached housing. It is rather unique in that it is creating a category of housing that didn’t really exist before. Its competition is typically people renting urban condos. The below graphic illustrates how small Open House is as a percentage of total starts. It also shows that the company has grown at a rapid rate, both within existing markets and by unlocking new markets, despite the market showing small declines.

So, yes, housing is cyclical and Open House isn’t immune to that. However, to make blanket statements about the Japanese economy/housing market and extrapolate to Open House would be misguided.

Let’s get into why Open House is such a nice business.

Why Open House is a good business - Scaled-Economies-Shared + Culture = A repeatable system

The company has a couple of characteristics that perhaps aren’t so important in solitude, but when integrated into a scaled system and overlayed with a competitive sales culture make for a competitive advantage which has lasted for decades.

Land-Acquisition

OH’s advantage starts with land-acquisition. The first nuance to the model is the type of land that they buy. The company focuses mostly on irregular properties, including odd-shaped lots (i.e. land in shapes other than a square or a rectangle), land without road access, land near cemetaries/railway stations and otherwise undesirable locations. In short, it buys undesirable land in desirble locations.

It’s hard to build a house on an irregular piece of land. It requires different considerations for zoning as well as design and construction techniques than a square block. So they are typically undesirable for traditional developers. Open House has a particular expertise in developing tough blocks and has automated a great deal of its zoning/design for these odd designs after doing it for 20+ years. By focussing on blocks that others dont’ want, OH is generally able to get land cheaper than the average square-footage price in that area. It’s also worth noting that due to lax zoning laws in Japan, there are lots of mis-shaped blocks in the major cities.

The second advantage is how it acquires land. Open House purchases pieces of land from local real estate agents, which is a fragmented industry in Japan. Each member of the procurement staff is required to visit at least 30 real estate agents per day, and several different staff will often visit the same agent in a single day.

The CFO explained it to me like this: there are ~300k registered agents in Japan and it is very fragmented. Many of the agencies are small family offices and only have maybe 1-2 employees. The small agents are typically quite local and have good relationships with sellers in their area. For this reason, they get lots of land to sell from locals (typically for deceased estates/inheritances, given Japan has a relatively high inheritance tax). Also remember that the second hand market for houses (particularly old houses that come by way of inheritance) is thin, so it isn’t uncommon for land to be sold to developers for redevelopment.

By visiting agents relentlessly, OH sees land as soon as it comes to market, before anyone else. Frequency of visits improves the possibility of finding land deals first so that Open House can put in an offer for without it having to go through a highly competitive process.

This doesn’t mean that Open House is neccesarily getting cheap land - they pay market prices. But it gets consistent access to land and lessens the risk of getting into bidding wars. Agents like dealing with Open House, too, for a few reasons. First, they are a constant and reliable customer and offer good prices for land. Second, they are able to turn-around offers fast – if a broker has a piece of property in the morning, Open House has streamlined the process in the back-end such that it can have a deal closed COB (this includes OH drawing up plans for redevelopment, considering zoning, considering sale-ability, etc.). Open House’s DX is very good for a Japanese real estate company, which has been confirmed when I did checks on the company. This speed saves brokers time and resources in trying to market houses, and in a people business, time is money. Lastly, Open House’s willingness to purchase small, irregular and undesirable blocks is favourable for agents; these blocks are typically harder to sell.

I posed the question to the CFO: why doesn’t everyone just do this?

He said, they can - but their sales staff need to visit 30 offices per day, and most just don’t. In fact, most days their procurement staff don’t find anything. To keep that level of motivation high is pretty tough, and it requires a certain culture. It is made even tougher for a smaller company which is not as well-resourced as Open House - how can a small company afford to visit the small agents every day? They can’t. Arai hires mid-20s kids in procurement and works them to the bone, motivating them with high salaries and promises of very high bonuses in success. The Zaibatsu are just not set up to operate in this manner.

So as I understand it, the smaller developers (the detached development industry in urban cities is rather fragmented) will build relationships with the large local agents and wait for their calls, or visit them periodically. Due to their smaller size, even beyond the cultural differences, they just don’t have the resources to continually visit all of the small agents, and have to focus on the large ones where land deals are more likely to be found.

Open House staff will visit the larger agents, too, but these deals will be more competitive, so they typically focus on the smaller ones, unless the blocks are particularly irregular.

Open House’s motivation-structure is also fascinating. It assigns 2-3 members of its procurement team to a territory, but purposefully doesn’t assign individual staff to particular agencies. The effect is such: no single procurement staff can rely on a relationship with a given agent, as they might lose out on a deal to a teamate. This creates an internal competition or ‘paranoia’ for deals in a particular region which causes Open House’s procurement staff to sworm the agents and not get complacent. It’s not a place to work for staff that don’t like competitive environments, but it is a motivation tool that works.

Ultimately, it is a mix of scale (resources), expertise (in developing irregular blocks) and culture (good old fashion hard work).

Homebuilding

Next comes the building itself. There are a couple of key ideas here. Firstly, as I touched on, Open House specialises in designing homes for irregular blocks, and it has achieved a great deal of sophistication in the process through decades of experience. Over time, the company has developed internal software tools which help automate and streamline the zoning/architecture process further. It does all its own design work, so it has accumulated much know-how over the years which feeds the system, and has quasi-templated designs to work with particular blocks. Custom design-work for irregular blocks can be rather expensive and time-consuming for the ill-experienced, as you could imagine. In order to put 3 houses on a block, for example, Open House really has to squeeze every last square-meter out of that block - it’s quite a considered process.

Next, the company also does its own development/construction. Doing so in-house, OH can earn the construction margin (which it passes back onto the consumer via lower house price). It also has other benefits beyond that. Controlling the whole process from land preparement including demolitions, zoning, clearing of land, ground improvement, etc. through to construction minimises “lost time” in construction. Having in-house functions to perform these tasks minimises communication errors between different trades, or between the land development team and the foundation contractor, for example. Open House puts strict KPIs on each stage of the process which is overseen by a specific team, where the handover of tasks is also strictly monitored. An example that they once gave is that the time it has taken them to prepare land for construction has shrunk from 90 days to 30 days over the past decade or so.

Doing everything in-house also allows the company to achieve scale in materials procurement and savings from in-house labour. It also allows the company to gather a specific expertise in dealing with irregular houses/blocks which external construction companies might not have. This is a mixture of scale, expertise and efficiency. It uses the savings that it gets from the construction process to re-invest in the final product and bring the price down. The combination of irregular block (cheaper land), redevelopment (smaller block) and scale/efficiency in construction is how the company is able to build homes so cheaply.

Direct Salesforce

The next and probably most important advantage is the company’s sales-culture. It employs a 100% direct sales force and has an aggresive sales-first culture. OH calls its strategy “selling at the source”, which entails targeting people in the direct vicinity of a new home.

The central premise of the strategy is such: In a major city, most people working in metropolitan areas who chose an apartment closer to the city over a single-family home in the suburbs put priority on a shorter and easier commute – otherwise, they’d be living in the suburbs in a more spacious and, frankly, cheaper home.

Open House finds that these would-be-home-owners generally hold an implicit assumption that single-family home-ownership in their desired urban area is beyond what they can afford, and they’d probably be right when looking at a typical 40tsubo double-story home. In many cases, however, the mortgage payments on an Open House property are in fact comparable to condo rents and within reach, given that Open House is able to build homes so cheaply.

Open House knows that 70-80% of people who buy a new house will choose a location that is very close to their previous residence. With this in mind, Open House focuses on approaching people “at the source”. That means old-school, feet-on-the-ground direct sales, handing out pamphlets at local shopping malls, busy stores and train stations. Truth is, they are a nuisance to a large percentage of the population (search Open House on Japanes reddit/twitter and you’ll see what I mean). But it works.

Open House’s homes will ultimately sell themselves given that they are generally the cheapest on the market and in good areas, but the direct-sales force is required to achieve the high levels of turnover that Open House gets. This is because, as I said earlier, many buyers perhaps hadn’t seriously considered homeownership before, or didn’t believe it to be possible. It is the job of the OH salesperson to arouse interest in homeownership, which can ultimately lead to a transaction. And it works - almost one third of the company’s sales contracts come from leads generated in shopping centres. This, combined with Open House’s efficient development operations, is what allows it to achieve such a high asset-turnover. That ultimately translates to a high ROE.

The other added benefit of direct sales is that Open House’s sales team can start selling homes before they are even built. In many ways, they are selling “homeownership”, and not a house itself. When making contact with a prospective buyer, they will take them on a tour of all their land, properties under construction and existing properties. Much of the time, they might sell a house that is only 1/2 way through construction. This further speeds up the asset sale as there isn’t a lag between completion of construction and home sale, and further complements the ROE.

To give some numbers: the average inventories for FY2022 (average of FY21 and FY22) was ~200bn yen. In 2022, the company generated 516bn Yen of sales, for a turnover of ~2.6x. Anyone familiar with homebuilding knows that is insanely fast. The segment generates margins of ~12-13%, which would represent an unlevered (pre-tax) return on inventories (which is effectively return on assets) of ~31-33%. That’s a pretty attractive return if you ask me.

The sales process had been pruned over nearly 30 years and it is pretty sophisticated. It consists of three key roles. First is the demand generator. This is generally an entry level employee who is on the ground handing out pamphlets and trying to garner interest. Then, once interest has been registered, they are passed onto another employee who will conduct tours of the properties and try to fit the customer with a home in Open House’s inventory. Lastly, there is a sales person responsible for signing and closing the deal. All of these roles have been perfected - they know exactly what to say and how to say, down to an art-form.

It’s a pretty similar model to LGI Homes, for those familiar with that company. LGI’s CEO explained to me that they have a physical manual with details on how to sell the homes which has been pruned over years. It is as detailed as even saying things like “walk to the back corner of the yard 2metres from the fence, turn and face the house from an angle, and then ask the buyer to imagine their kids running around in the backyard.” I’m paraphrasing, but it’s something like that.

The company also sells blocks of land with options for custom construction either from Open House or otherwise (if the purchaser wishes to design their own house). In fact, the company prefers just to sell land, as it is more capital efficient. This is because Open House’s model is such that it aims to make a mark-up on the land, and charge out the construction-work at cost. The signficance of this is that smaller developers who wish to purchase re-developed lots and then build homes can’t possibly compete with Open House, because there is no margin in just doing the construction. In order to compete with OH on price, you must be fully-integrated. Such is the ‘scaled-economies shared’ phenomenon which makes Open House so succesful and hard to compete with.

Culture

Perhaps most unique to of all is Open House’s culture, which has also been a source of controversy for the company. Open House's procurement and sales processes requires highly motivated and hard working staff. In a move that would be atypical for a Japanese Zaibatsu, Open House employs an intense meritocracy, with high compensation for those willing and able to perform at a high-level. The company offers opportunities for promotion/pay increase every three months. High-performers are promoted quickly, which helps to keep motivation high. Lower performers are cut off. The average salary level is among the highest in the industry, and grad salaries are higher than investment banks. It’s a desirable job for hungry kids who didn’t perform well at school or University, but are determined to make a lot of money.

As a result, with this comes an intensely competitive environment, which as one can imagine requires close controls. In recent years, the company has improved its employee wellbeing with forced leave and office hours controls. For example, employees are no longer allowed to be in the office after 9pm, and annual paid leave acquisition rate has risen from 14.5% to 56% in just two years. Lots of training is given to younger employees, who generally start as lead generators for their manager and progress up the chain. As managers are assessed on performance of their team, incentives for training and mentorship are aligned – this is critical, as ~50% of the company’s annual recruitment is graduates. The company is a HR machine – it gets over 60,000 applications for the grad programme per year. It is generally viewed as a cuthroat place to work, but a place where you can make yourself very rich.

Mr. Arai is also very involved in recruitment and general human resource management – he has historically conducted over 1,000 interviews per year (according to the company… might not be true) and also has a meeting with each individual employee once per year to discuss performance and progression (this also might be outdated given that OH has grown). Open House’s success in people management is crucial to the company’s success or failure, given that large parts of its competitive advantage in procurement and sales rely upon successful motivation of staff.

Open House’s winning system is a result of Scale + Process + Culture. Below is an examination of how they’ve used the system over and over again to grow at an incredible rate.

Growth - OH is not done yet

Examining historic growth

The company’s growth in single-family housing has been largely organic. In 2013, upon listing, the company had just 9 sales offices, most of which were in the 23 wards of Tokyo. That has expanded to 69 offices today – 26 in Tokyo and 43 outside.

Open House grows first and foremost by expanding its sales offices. When entering a new region, the company will test a particular area’s population, housing starts, density of population, land availability and start building relationships with local landowners/brokers/construction companies. Once the company establishes a stable supply of land, it will open a sales office consisting of 12-15 sales agents and 3-5 purchasing staff, as well as a few in design. Construction generally comes later once it becomes clear that operations will be sustainable. The company is yet to enter an area where it hasn’t suceeded.

The sales office rollout has been replicated time and time again, both within Tokyo’s wards and outside. Within Tokyo, the company has expanded from 1 office in 1997 to 8 in 2012 and 26 today, reaching ~13% market share of single-family. This proves that it’s the Open House system and the national desire for detached housing in urban areas which works. It isn’t something unique just to Tokyo. In fact, today Tokyo represents less than half of the detached housing business.

Let’s take a closer look. The first foray out of Tokyo was Kawasaki in the Kanagawa Prefecture. The first office was opened in 2007, and by 2014 the company had achieved 4% market share in Kawasaki, prompting the expansion of a second sales office shortly after going public. The second office was a success for the company, bringing its market share to 8%, leading to another four offices between early 2017 and 2019. As of FY2022, the company’s market share in Kawasaki reached ~20% of single-family houses, and the company has coverage of almost the entire city.

After its original success in Kawasaki, the company moved further south, opening its first branch in Yokohama in 2011. Similarly, through a number of expansions, the company moved its market share from 1% in 2013 to ~8.5% in 2020, where it achieved 6 sales centres. Yokohama has grown market share every year since 2011 and can potentially still grow some more to reach market share penetration levels more akin to Kawasaki and Tokyo’s 23 wards. Market share in Yokohoma as of FY2021 was 10.5% and has increased every year since 2013.

In late 2016, the company opened up its two sales offices in Nagoya City – its first foray significantly out of Tokyo and its neighbouring regions. The company started to see immediate success in Nagoya and expanded to 5 sales centres in just 24 months, also expanding its condo business to be almost as big as it is in Tokyo. In 2019, the company grew revenue by 60%, going from 0% to 5% market share in just three years. Whilst the company never disclosed 2020 numbers, it had planned to grow SF homes and revenues by a further 50% pre-covid. On that forecast, Nagoya would have contributed 15% of the company’s SF and Condo sales – a very impressive growth rate over 4 years. Nagoya is still relatively nascent, with market share only at ~10% and 9 sales centres.

In late 2017, OH made its first foray North into Saitama, expanding to 4 sales centres by 2014 and gaining a market share of ~7% in just 3 years. Today it sits at ~10% with 5 sales centres. Similarly, the company has just expanded into Fukuoka and Chiba, which the company believes exhibit similar characteristics, and expanded to 3 sales offices within 2 years in both. Whilst I don’t have market share data for both, they’ve continued to grow offices - Chiba has 4 offices today and Fukuoka has 5. Both markets are relatively small but unpenetrated, and could represent further growth going forward.

The below table provides a summary of the company’s expansion, and its market share in key areas. The company has grown market shares relatively consistently over time in pretty much every region.

In addition, the company has also recently made its first foray into the Kinki prefecture, which holds Osaka and Hyogo. I’ll touch on this in a bit.

A few succesful acquisitions have also helped

The company has also bolstered its single-family homes through two acquisitions. The first was a single-family homes construction company called Asakawa homes in 2015, already a major supplier of the company, which gave it in-house design/construction capability. It is now the architecture arm of OH (OHA). This was a very successful acquisition – since completion in 2015, Asakawa (now Open House Architect (OHA)) has grown sales from 29.1bn to a planned 80bn in FY2023. A large portion of that growth has been the in-sourcing of design via OHA, so it isn’t apples-for-apples per se, but it’s impressive. The company also showed tremendous price discipline, paying just 8x earnings and 6x EBIT for the company back in 2015.

The second acquisition was Hawk One in 2018. Hawk is a single-family homebuilder, not dissimilar to Open House, though it is focussed on quasi-urban areas as opposed to Open House which traditionally focussed on urban areas. It is understood that Hawk had a similar model to Open House, though was generally quite complimentary both regionally and by product line-up. The below image shows a clear distinction between where the two companies compete.

By the end of 2019, 13 of Open House’s sales offices out of 42 were brokering at least 10 contracts for a Hawk One house, and at the end of 2020, that number increased to 30 out of 49 - the goal has been to cross-polinate the two companies’ sales teams. Hawk One also brings capabilities in building for quasi-urban areas, which are higher in the Western Tokyo, Nagoya and Saitama regions.

Financially, Hawk One grew its sales from 63.9bn Yen in 2017 to 125bn in 2022, and plans for 134bn in 2023. The price paid for the acquisition was a ~28bn Yen, representing ~10x 2017 earnings and ~6x operating profits. Given that the company has increased margins and >doubled sales in just over 5 years, I’d say that 10x P/E is a pretty good price.

Both of these acquisitions have helped w.r.t. increasing the OH’s EPS over time. Together, they will represent ~20% of the company’s sales in FY2023.

There’s still plenty more room in the SF business

Within its current markets, the company is confident that there is more growth to come. Below is the company’s office growth through time. According to the company’s site, it has added an additional 2 offices in Osaka since the last company presentation (Feb 2023).

As we examined before, the OH’s market share continues to grow in basically all of its target regions, and it has just 10% market share in the areas which it operates in (which is just 13% of the country). When I spoke to Open House’s CFO, he told me that they are targeting 20% share in Tokyo, and believe that shares can similarly converge to that level in other regions too. Whilst growth is sure to be at a slower rate going forward, even 1-2 sales offices per year will add ~MSD-HSD growth to Tokyo alone, whilst other regions should be able to grow faster albeit off a lower base.

Beyond market share gains within single-family, work-from-home may prove to be a further growth tailwind for the company. Whilst it may have an impact on net migration into urban areas, the model that has been most common across the globe thus far (hybrid-working) will limit the ability to move significantly far away from the city centre, whilst also increasing the need for space at home. Whilst housing starts in Japan have declined at an aggregate level by ~45% since 1994, starts for built-for-sale detached dwellings are ~roughly flat.

In May 2020, the company acquired a 32% stake in Pressance Corporation, before taking it up to 65% via a tender offer in early 2021. Pressance is the second largest condominium manufacturer in the country, but dominates the Kansai and Chukyo/Tokai regions, with 20% market share and dominant number one positions in both areas. These positions that have been held for 7 and 9 years respectively. In both markets, it is ~2x the second player and ~4x the #3 player.

Pressance has a lot of similarities to Open House as a company. Firstly, it was founded in the late 1990s and was until recently a predominately founder-owned and run company with an aggressive growth mindset. The company engages a similarly intense focus on its sales force, citing it as its number one strength, and has a very competitive internal sales culture. Open House’s CFO believes that Pressance’s key competency is its “aggresive salesforce.” For example, with studio condos, the company does not segment properties by salesperson, but instead assigns the whole sales organization to a single condo building to create competition for sales, offering big stock commissions for those that excel. Its size in key markets also gives it a brand and cost advantage over competitors.

The synergies between Pressance and Open House are clear. Open House had, until the acquisition, no presence in the Kansai region, though Osaka and Hyogo alone represent more single-family housing starts than the entirety of Tokyo area – a large opportunity to expand for the SF home business. Pressance’s established salesforce, brand recognition, local market knowledge and broker/landowner relationships are valuable for Open House expanding in the region. Through the general course of business, Pressance would approach many detached land deals that it would pass on as it is focussed on condominiums, which could be used by Open House. Similarly, Open House sees deals in the general course of business in Tokyo which it passes on, which could be used by Pressance.

The Kansai expansion is a big growth oppourtunity and early signs are positive

Open House opened its first sales office in the Kansai region in April 2021, and has since grown to 6 offices, which is the fastest that it has ever grown in one region. Kansai represents a huge opportunity if the co. can get it right. There have been question marks around the strategy as historically Osaka has not been a market for three-story homes, but Open House believes that the competitive landscape is perfect as the detached home development industry in Osaka/Hyogo is very fragmented, which tends well to their ability to use scale as an advantage. The early signs are promising, and the below graphic gives a sense for the size of the opportunity relative to Tokyo. Arai is targeting ~5% market share in Osaka in the near-term.

Given Open House’s early success in the region, and continued repeatable success in other regions, I am optimistic that these markets present a signficant growth oppourtunity for the company. I think that the company’s success lays in its culture, scale and process. It’s figured out multiple markets before and done them well. It seems to be doing so in Osaka, and I have no reason to doubt Arai.

With the combination of growth in Kansai (Osaka + Hyogo) and continued penetration of its existing markets, Open House appears well positioned to continue to grow for some time. I could show some numbers of TAM (it remains very big within existing markets), but I think it is mostly a waste of time in the context of the above. The point is that the company has room to continue to grow, and a LDD rate going forward seems totally plausible in the context of past-growth rates + future white-space.

Summary

Let’s take a step back.

Open House earns a high-return on capital with clear competitive advantages which get stronger with size/time (scale advantages). It also has a considerable growth runway ahead of it. Homebuilding is not a glamarous business, but Open House is really quite good at it, and its super efficient asset-turns, combined with the fact that it holds land mostly in desirable urban areas, means that its book value is, in my view, rock-solid. It is, in my view, a rather nice business.

I view the recent pullback in the stock as a particularly enticing entry point for a longer-term structural winner. Clearly, there are concerns around macro - and for good reason. I think those are absolutely real and there is a lot of uncertainty. But I think that they are overdone at the current price, and I will address it in the next part.

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Part 2 - Addressing the macro risks, the bear case and corporate governance.

Coming soon….

Appendix

The focus of my case is on the single-family homes business. I am aware that it only makes up ~60-65% of profits. I will address the other businesses in Part 3 when discussing the valuation. I believe that the stock is so cheap today than you can write the rest of the business to zero and still have considerable value from just the detached homes business.