Land as the New Currrency

A funny thing happened on the way to the housing rebound:  land – and the ability to buy and hold onto it – has returned as the primary currency in the home building industry.  At least for now, this access to capital will likely have a profound impact as stronger, public builders snap up private builders starved for cash and shut out of the public markets.  As a result, look for even more consolidation as this stage of the revival plays out.

Whereas in 2007 the top 10 public builders sold 24% of new homes built and sold, during the first quarter of 2013 that capture rate had risen by six percentage points to 30%, at least according to an analysis by Deutsche Bank.  That’s in large part due to the $1.5 billion some of these builders spent on eight large acquisitions over the last 18 months.  Argues Lennar’s CEO Stuart Miller in a recent article in the Wall Street Journal, “We have to ways to win now:  We participate in the natural recovery, but additionally, we’re picking up market share form a group of builders that isn’t able to get financing.”

Miller should really thank the bond market for this largesse, which allowed public builders to stay afloat through the Great Recession as long as they remained current on their debt or were able to refinance it.  Meanwhile, the small or regional banks which have been the life blood for private firms not only stopped making construction loans, but forced many builders into bankruptcy by calling in loans early or enforcing personal guarantees.  It also hasn’t helped that close to 500 banks have failed since the beginning of the downturn.

Even the remaining usual suspects who have historically made construction and development loans remain skittish, as the FDIC estimates the value of such outstanding loans fell by nearly 70% since early 2008.  At the same time, all of the nation’s top public builders have remained solvent since 2008, largely by writing down nearly $40 billion in their land portfolios – a trick their private brethren could rarely pull off.

As a special bonus, in 2008 industry lobbyists also convinced Congress to refund nearly $8 billion in taxes paid during the boom years to help them stay afloat when new home demand collapsed.  Without those refunds, we probably wouldn’t be seeing the type of consolidation we’re seeing today.  And, for those private builders not wanting to be snapped up by larger prey, the public market is also an option, with three companies already going public since January 2013 as well as others waiting in the wings for their debuts.

Still, there are already rumblings that an industry known for forgetting its lessons in over-building in cycle after cycle may already be pushing too fast on land purchases.  Throughout 2013, land prices nationally rose by about 13% -- the first annual gain since 2005.   In coastal areas of California such as San Diego, San Francisco and Orange County, land prices have reportedly jumped by 40% over the past year.  For private equity firms such as Paulson & Co., Starwood Capital and other groups which started gobbling up land in the land price trough of 2009, their timing has been prescient, with many lots going for as low as 20% of prices during the previous peak. Eventually, these higher land prices will certainly result in higher-priced homes, which is manageable as long as we remain in a relatively low interest rate environment.

Due both to rising demand and the growing scarcity of buildable lots today, look for new home prices to rise by 10% to 15% in 2013 – and certainly more in popular areas where builders are deliberately hiking prices aggressively between phases in order to slow down absorption and let their construction crews catch up on back orders.

Yet there is still opportunity for smaller builders who are nimble and creative enough to address challenges largely ignored by larger volume builders.  In Los Angeles, there is now a boomlet for new, single-family homes built on small lots.  The idea is that by providing outdoor spaces such as patios and rooftop decks but discarding the traditional backyard, sales prices can stay attainable.  Over the next 18 months, 250 such homes will be offered in existing communities such as Silverlake, Echo Park as well as the eastern San Fernando Valley.  Prices usually range from $500,000 to $800,000 for 1000 to 2000 square feet of living space in two or three stories – on lots as small as 600 square feet.