Tuesday, June 23, 2009

WSJ: Land Deals Help Home Builders Stay Alive (Not to Mention Tax Rule Changes, and Government Largess)

One of the few predictions I made in late 2007 about what was to come in the future [Dec 4, 2007: December 2007 Thoughts / Roadmap] that was an airball was the call that quite a few homebuilders would go bust. At the time home builders were so desperate to get rid of inventory, we had example such as Lennar (LEN) selling land at 60% of book value. [Dec 3, 2007: How Overpriced is Land in the US? 60%?] While this is a very fragmented business there are a number of national and regional public players .... many of us highlighted a few led by Standard Pacific (SPF) and Beazer Homes (BZH) set to bid goodbye. [Jan 29, 2008: Credit Default Swaps Paint Ugly Picture for Homebuilders] [Jan 11, 2008: Standard Pacific (SPF) - the First Major Homebuilder to Go?] Hovnanian (HOV) was incrementally better but just by a tad [Jan 24, 2009: Bloomberg - Hovnanian May Fail Absent Miracle]

Well apparently miracles do happen - all these companies remain alive... and with stocks trading in the $1.65-2.21 range at last check. Actually considering that aside from banks the home builders are the nexus of the greatest financial disaster in 80 years, it is quite remarkable. But I guess Schumpeter's "Creative Destruction" is now old school - I've seen more covenant extensions and adjustments in the past 12 months than the previous 12 years combined. I suppose if the banks can't take the hits to their balance sheet from larger companies they will just keep extending life, never calling in their chips. And then stomp on the small guys.

I mentioned yesterday that the homebuilders were showing relative strength in a quite ugly market - I did not mean the names above which were back to their old tricks, losing 5-10%ish, but some of the more stable fare. There was a prominent Wall Street Journal article that may have contributed to this or perhaps it is the new and existing home sales we'll see here in the next 48 hours. As we continue to cheer that May sales are better than April, and June is better than May (as they are each year due to house buying seasonality) I suppose we can clap with our head under the sand. Perhaps we can gyrate this whole market up a few % if the numbers "really surprise" us - considering the handouts from all sides of government and Fed, along with 30-40% price drops year over year, (and more if you get the right foreclosure) you'd assume home sales would be up 50% year over year.

What is funny is how one of the first bills passed by Congress to "help the homeowner" was ... wait for it... a backdoor handout to the homebuilders. And the banks. Cramerica - bought and paid for.
  1. [Jul 5, 2008: Washington Post - Vital Part of Housing Bill is Brainchild of Banks]
  2. [Apr 4, 2008: Congress is Rushing to Help Homeowners Out!! (Not)]
Older readers might remember that story from April - ... 2 months earlier this was the situation

The National Association of Home Builders, one of the top 10 corporate donors to politicians, has stopped contributing to congressional candidates after it failed to get what it wanted in recent anti-recession legislation.

The association had unsuccessfully pressed lawmakers to adopt a provision to reduce the tax liability of home builders by allowing them to offset their past profits with future losses.

Since 1990, the trade group has given nearly $20 million to federal candidates,

But who says nothing gets done in the halls of Congress? When they are motivated, and see their political contributions at risk... boy, they are like a steamroller! In under 60 days...

Homebuilders and the mortgage industry are emerging as big victors in a bipartisan agreement reached by Senate leaders on legislation designed to limit the housing crisis.

The bill contains a $6 billion emergency tax break that would let companies use losses from 2008 and 2009 to offset profits earned over the previous four years, instead of the usual two-year timeframe.

Other big beneficiaries would be Wall Street banks
such as Citigroup Inc., Merrill Lynch & Co. and Morgan Stanley.

While Democrats and Republicans called the bill a productive bipartisan compromise, Dean Baker, co-director of the liberal Center for Economic and Policy Research in Washington, questioned whether the trade off was worthwhile for Democrats. "This is first and foremost helping the big villains in the story," he said.

Want to know the name of the bill? Its warm, its fuzzy, its for "the people": Foreclosure Prevention Act of 2008 - I am not making this stuff up. Just more money borrowed from your grandkids which were direct transfers to banks and homebuilders and papered over with cute titles that somehow indicate its focus was to help us in the peasantry.
  • Homeowners facing bankruptcy, however, won't find relief in the proposal. The mortgage industry fought fiercely to spike a provision to let bankruptcy judges rewrite the terms of distressed mortgages.
Well on second thought perhaps I should not be surprised that the larger homebuilders did not go bust... I forgot how many handouts D.C. had been involved in - these seem like a pittance compared to what was to come next in summer and fall 2008. Ah we were so young and innocent in spring 2008... But I digress! For now let us see how the home builders will continue to tread water until the next round of handouts begins (the drumbeat gets ever louder for a $15,000 tax credit... now for everyone, not just 1st time buyers).

  • In Indio, a small city east of Los Angeles, the supply of foreclosed houses for sale is plentiful. Even so, work crews are finishing a batch of new homes for Lennar Corp. While the recession wiped out many small builders, mortgage lenders and homeowners, the nation's biggest builders have hung on, in part through favorable land deals, loan agreements and tax strategies.
  • Now, the worst appears to be over for most of them. Nationwide, new-home sales are showing signs of bottoming out. The stocks of the big home builders have rebounded from their November lows, and some have bolstered their cash and borrowing ability. Lennar and Toll Brothers Inc. each sold $400 million of bonds in April, and Ryland Group Inc. sold $230 million worth, a sign that some investors think these companies will make it.
Most of the story focuses on how Lennar (LEN) - a former holding, navigated these treacherous times but of course many of these tactics applied to many of the larger players.
  • A look at how Lennar navigated the worst housing crisis in decades reveals that timely land deals have been critical to its survival. "Land can humble you," says Emile Haddad, Lennar's chief investment officer. "On the surface it looks like the simplest real-estate asset, but it's really the most complicated."
  • Lennar, based in Miami, was one of the largest home builders in states hit hardest by the housing collapse -- California and Florida. As the housing market was heading toward a cliff, it pulled off two complicated deals that got lots of risky land off its books before the market fell apart. The buyers: Morgan Stanley Real Estate Fund and the California Public Employees Retirement System, the giant pension fund known as Calpers. (the Morgan Stanley transaction was highlighted in the Dec 2007 piece I listed in paragraph 1)
  • In late 2007, Lennar cut a second big deal that raised cash. It sold about 11,000 home sites for $525 million to a partnership it formed with Morgan Stanley Real Estate Fund. Because Lennar was valuing the land on its books at $1.3 billion, the deal generated a large loss that allowed Lennar to collect a $320 million tax refund.
  • Lennar also entered into joint ventures to buy land, reducing its risk by not guaranteeing most of the $5 billion borrowed by the ventures. Some analysts say these agreements could come back to haunt Lennar, financially and legally, as lenders and partners seek to recover losses from soured projects. "The more joint ventures you have, the more partners you have that are likely to be struggling and angry,'' says Paul Puryear, a housing analyst at Raymond James & Associates. "It opens the door to a lot of disagreements."
  • Because Lennar typically owned 50% or less of each venture, or didn't hold voting control, Lennar says accounting rules required that it keep the debts off its balance sheet. (you have to love American accounting; instead of using logic like saying... well if you owe 35% of the joint venture you are responsible for 35% of the debt and it needs to go on your balance sheet, instead if you own 49.9% of the joint venture you don't have to put any of it on the balance sheet. Magic!)
  • Other publicly traded home builders also dumped land during the crunch. By selling land at huge discounts to what it was once valued, big builders generated large losses for tax purposes.
Here is the kicker....
  • By applying those losses against profits during prior years, they have collected about $2.55 billion in tax refunds this year, according to Zelman & Associates, a housing-research firm.
  • ... with land values now far below their peaks, Lennar and other big builders think the time is getting ripe to start investing in it again. Lennar hopes to eke out profits by building on low-cost land and by selling low-priced homes to first-time buyers.
The process...
  • When the housing market cratered, Lennar put together a team to buy distressed housing assets. Lennar is now about to reinvest in some of the same California land it unloaded in its deal with Calpers in 2007. Next month, a federal judge is expected to decide whether to approve the bankruptcy reorganization plan for LandSource, the company that owns the land. Under the plan, Lennar will invest new capital to retain a stake. Calpers has walked away from the venture.
  • Getting inexpensive land will be critical to builders' future profitability because new-home prices aren't expected to rise substantially for many months. (someone hasn't been watching CNBC) Lennar isn't the only big builder angling to take advantage of soft land prices. Ryland, a California builder, has teamed up with investment firm Oak Tree Capital Management to buy low-cost land. Toll Brothers has been speaking to lenders interested in unloading foreclosed real estate.
Too big to fail
  • Big builders are benefiting in other ways from the high mortality of small and midsize builders. The smaller players had loans cut off by lenders and are dying off in droves, surrendering market share to the big players. As many as half of the nation's privately held builders have shut down during the housing bust, and many others are struggling to survive, according to a Credit Suisse estimate.
The rest of the story details tales of duplicity and corporate fun among Lennar, Morgan Stanley, CALPERS, the city of Palm Springs... oh, so many ways to play the system and the accounting games. All legal of course...

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