Is private equity the answer to the lending squeeze?

With banks hoarding cash and other lending sources trying to remain afloat, some experts have suggested that private equity is the next likely source for development projects, as they've been tapped in the past. For now, however, much of that money remains on the sidelines as investors wait for a bottom that so far remains elusive. From a HousingZone.com story:

Reports have been surfacing that massive amounts of private equity funds are being pulled together to take advantage of the opportunity that the free fall of home and land values is providing. At the time this article was prepared, sources interviewed indicated that the majority of funds out there are sitting on the sidelines...

When these funds do come around, builders — as much as they want and need the cash to move forward with their developments — will want to be cautious. Private equity investors are not the same animal as the local community bank.

“There are different cultures. Builders are entrepreneurial. Financing people are bottom line. It's not like the good ol' days where things were done on trust...Finance people operate deal-by-deal. It's more black and white. Private equity firms are looking for a return, and there's a gap between what home builders have been used to and what these types of lenders are asking..."

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Finding the down payment in a time of scarcity

With mortgages requiring more skin in the game and down payment charities a thing of the past, how are home buyers coming up with enough of a down payment to qualify? According to a story at BuilderOnline.com, a mix of education and creativity certainly can't hurt:

With the elimination of seller-funded down-payment assistance and nearly all loans requiring at least a small down payment, home buyers--and the builders who sell to them--have to figure out how to come up with thousands of dollars at closing.

It’s a big challenge, but builders are making it work.Across the country, builders, lenders, and real estate agents are educating buyers on their options. For most buyers, the method is an aggressive savings program that starts when the contract is signed.

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Getting real about valuing land

With builders continuing to write down the value of loans (and banks then in calling loans when the collateral falls), attaching a number to the worth of undeveloped land has become increasingly difficult. Can you believe a land broker, who may want a high value for the commission? Can you believe a consultant who is under pressure to come in with a high value to get more work? I'd say believe whomever is willing to tell you the truth, because you can't address what you don't admit (i.e., the housing bust right before it happened). From a BuilderOnline.com story:

Home builders around the country have been swamped this year with news reports of public builders selling land for some fraction of its peak worth to get out from under the carrying costs on loans now worth more than the land's value.

Those large builders have teams of number crunchers and a roster of well-paid consultants and financial advisors to help them evaluate what their land might be worth, and what they might be able to get for it in a sale...

"We've been hearing all this stuff about how land is selling at 40 cents on the dollar, 60 cents on the dollar--that doesn't matter...It really needs to be selling at 15 cents on the dollar. And that's not even for raw land. That's for a combination of raw and finished lots."

While builders have been writing down the value of their own lots to be able to sell homes closer to market prices, the prices of lots for sale have not come down nearly as far, so very little land is being sold and even fewer new developments are breaking ground.

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Royce Homes now history

Houston, TX builder Royce Homes, once #44 on the Builder 100 list for 2007, has officially shut its door. From a BuilderOnline.com story:

Houston builder Royce Homes, which acknowledged this summer that it was liquidating, has closed its doors, according to its Web site.

"After 24 enjoyable years, Royce Builders is no longer in business," the Web page announces.

It proved to be a fast unwinding for the large Texas builder, which closed as many as 1,280 homes in 2007, placing it 44th on the most recent BUILDER 100 list.

Anatomy of a building boom & bust cycle

Builder magazine is celebrating its 30th year compiling the Builder 100 list, and as part of that there's a very interesting article by Ethan Butterfield on exactly what happened during this last cycle. Whereas the mindset over the last decade was 'big and diversified' would even out cyclical highs and lows, that turned out to be more wishful thinking than business fact. From the article:

After the record-setting highs and equally historic lows of the last 36 months, builders must take away one lesson: The housing market is still cyclical. Despite the quotable stylings of D.R. Horton CEO Don Tomnitz and others during the peak of the housing boom, averring that the nation’s large public builders were recession-proof, they proved not to be.

The large public companies, it was argued by the builders as well as by some industry experts and observers, had expanded their product lines to hit more corners of the ­market, and had broadened their reach through geographic expansion into new and different types of markets, making them impervious to fluctuations in local markets and in the greater economy.

But a quick look at this year’s Builder 100 numbers clearly demonstrates that builders both large and small, and public and private alike, remain subject to industry and economic cycles. Nobody is bigger than the cycle...

The Builder 100 struggled through what everyone is euphemistically calling a “difficult” year, with sales down 23.96 percent nationally. That sales were off was predictable, and that Builder 100 companies also saw a slowdown was no surprise. But Builder 100 companies saw a greater drop in closings (28.16 percent) than the overall market, with the Next 100 (down 32.60 percent) and the 10 largest builders (down 28.50 percent) feeling the biggest losses in closings year-over-year.

In the last housing downturn, which hit its nadir in 1991, Builder 100 companies saw their revenues shrink from $34.2 billion in 1989, to $30.7 billion in 1990, to a low of $24.2 billion in 1991. But the 21.17 percent decrease in total Builder 100 revenue from 1990 to 1991 pales in comparison to the 34.99 percent revenue ­decline the Builder 100 felt between 2006–2007. (Up to 1990, Builder calculated the Builder 100 based on housing starts, not ­closings. There is no way to tell how large of a closings decrease the Builder 100 saw at its last trough.)

Overall, the housing market saw new-home starts shrink 14.92 percent from 1.193 million in 1990 to 1.015 million units in 1991. In the ­current recession, total new-home starts shrank 24.74 percent from 1.80 million in 2006 to 1.35 million in 2007, according to the NAHB...

Big builders that had seen multiple housing cycles ebb and flow knew to be more cautious buying land during the recent boom. David Weekley, chairman of Houston-based David Weekley Homes, saw builders with large land positions go ­belly-up during the 1980s in Texas and pushed his company to go slower this time.

But not everyone took a judicious approach to land acquisition. Builders of all sizes were promoting their long land positions in 2005 and 2006 as major positives, thinking that land would only continue to increase in value, and that they were smart to lock in as much as they could at ­whatever price they could get before it got even more expensive. It turned out they were buying at the crest of the wave. The land they acquired was worth less than they paid for it almost instantly.

The fact that builders bought too much land for too much money is not the reason for the downturn. In most cases, though, land is the root cause of builders’ most pressing financial problems. The costs associated with buying, developing, and holding on to land are enormous, and the amount ­borrowed for it and still owed is preventing the builders from being able to borrow more money to keep their companies afloat...

Years’ supply of land among the 12 big builders has gone down over the last year as builders let go of options and sold off owned lots to try and cut costs. Despite all of the land that has changed hands, though, the calculated years’ supply of land at the current rate of sales has not dropped nearly as much as the total count of lots controlled because home sales have decreased considerably. The median years’ supply of land in 2005 among the 12 builders was 7.1 years; in 2008 it was 6.5.

Many builders and home building consultants are now talking up the benefit of optioning land and limiting the risk associated with buying it outright, because so many builders holding large positions of owned land are struggling to unload it and are giving much of it back to their creditors...

One builder holding that contrarian mindset is Pulte Homes, based in Bloomfield Hills, Mich. Pulte had 52 percent of its lots optioned in 2005, but began 2008 with just 14 percent optioned, according to ­Zelman’s research. Pulte has moved to offload its land to cut costs over the last two years, reducing options held from 188,800 lots to 19,950, but only cutting its owned land count from 173,800 lots to 120,888 over the same period.

“If you get rid of all your land, you don’t have the ability to earn on it,” says Pulte CEO Richard Dugas. “If you hold your land, and you have the financial strength to hold it, and you rightsize the value of it, like we have through the write-off process, you can still benefit from that land.”

Dugas says Pulte has too much land today and that the market slowdown is to blame. But Dugas believes Pulte has the financial strength to hold the land it chooses to and will benefit later.

“We are not looking to sell our valuable land at 10 or 20 cents on the dollar, which is the asking price from these vulture funds that want to take advantage of opportunities,” he says. “Any piece of land we walk away from through a preac-­quisition write-off of those option lots, are those we can never recapture any value from unless we buy them back in the future. The land we write down in value is still there. And we still have the ability to get value for that when the market improves.”...

A company has to have financial backing to be able to hold onto land and wait for the market to come back, but very few companies have that luxury. The real lesson to be learned on land is the lesson Weekley learned in Texas in the 1980s, not to overextend your land purchases, Ara Hovnanian, CEO of Hovnanian ­Enterprises, based in Red Bank, N.J, still contends.

“Whether it’s deposits or price or quantity of land, it’s a time to be cautious,” he says. “It was a difficult call to make at that time, because the housing industry seemed so immune to what would normally have caused a slowdown.”...

It seemed everyone believed the market had outgrown its cyclical nature and would only keep going up.

As the market took off, the combined revenues of the top 10 Builder 100 companies shot up from $21.6 billion in 1998, to $92.9 billion in 2005. As the overall market for homes increased, America’s largest builders grew to accommodate the demand. The same top 10 builders increased their share of the overall new-home market from 9.40 percent (of 941,000 units) in 1998 to 20.97 ­percent (of 1.38 million units) in 2005. Their market share increased again in 2006 to 25.70 percent...

In a scenario similar to what ­happened to technology companies, which were infused with huge amounts of investor cash during the dot-com boom of the 1990s, home builders had to show growth to appease Wall Street analysts, and buying other companies accomplished that in the quickest amount of time. Many of the acquired companies were in the ­hottest markets in the country. The builders thought it was a sure thing since land and home values in those areas kept going up.

And they were wrong.

Builder's brands not relevant in today's market?

According to an article posted at BuilderOnline.com, today's buyers not only don't care about a builder's brand, they don't even want to hear about it, which should tell you something about the uphill PR hill builders will need to climb in the next few years. What they DO want is a sales agent who appears to be a good listener:

Sales consultants advising home building CEOs about their salesforces have a buzzworthy catch phrase, “You were born with two ears and one mouth, and you should use them in that proportion.”

Harsh? Maybe. But to sell in today’s housing market, salespeople need to start conversations with clients, learn about them, build relationships, and by doing all of that, sell the right house to the right buyer, home building sales consultants say.

Customers don’t want to feel hustled, says Jon Fogg, former vice president of sales for Centex Corp. and now a partner at consulting firm The Berke Group in Atlanta.

“Customers have told us they are offended by this process and would like [salespeople] to spend time learning about them and their problems, not dump a bunch of features and benefits on them,” Fogg says.

Potential buyers also don’t want to hear about the builder’s brand, says Berke Group founder and CEO Martin Freedland.

“They don’t give a damn; it’s the nicest way I can say it,” Freedland says...

Selling homes with a system that worked wonders during the boom years, by greeting prospective clients, qualifying them, and constantly trying to close during initial conversations is now a doomed strategy, Freedland says...

Builder salespeople must get their heads around not trying to force transactions. Sales operations and strategies must be ­customer-based and geared toward selling to customers’ wants and needs, versus selling the builder to the customer. Salespeople have to earn the right to sell a customer a home, Freedland says...

Salespeople weren’t the only ones disinterested in improving sales skills during the boom. Builders did not feel the need to spend a lot of money or time on sales training. Now they must invest in training their salesforce to become better listeners...