Latest article for Builder & Developer magazine now online

My latest article for Builder & Developer magazine on the state of the land market is now posted online:

Moving into 2009, some brokers think that values have fallen almost low enough to capture the interest of not just the usual suspects, but vulture funds armed with nine-figure war chests set up especially by land development veterans to pounce at the right time. But for inexperienced hedge funds and private equity companies located far from where the land is located, they often must outsource their due diligence, purchase decisions and the development of their land portfolios to others. For them, the term ‘caveat emptor’ has rarely been more true...

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A housing recovery must first start with land values

For many people working in the business of developing and selling residential land, they’re hoping that 2009 is the year that buyers and sellers will finally be able to agree on a price and thus plan ahead for an eventual rebound. To be sure, the year 2008 was a terrible year to be in the land business: according to Real Capital Analytics in New York, the dollar volume of land sales in 2008 was just a fraction of the $37.07 billion reported in 2007.

One major reason for the sharp drop-off in activity – estimated at 75% through August of 2008 versus the same period of 2007 – was that buyers and sellers were not able agree on prices and terms. At the same time, potential buyers such as land developers, builders and hedge funds remained in ‘wait-and-see’ mode as they devoted most of their energy to simply holding onto what they already had.

Moreover, since many land sellers in 2008 were home builders looking to book losses before the end of the year in order to carry back tax losses for 2007 and 2006, objective price discovery became impossible when companies such as Lennar and D.R. Horton were getting rid of land holdings for as low as 25 cents on the dollar. Finally, with private capital hibernating, the few buyers out there with the capital to invest are looking to invest for long-term gains and are thus unusually patient to find the best deals.

That patience may be about to pay off.

According to Erik Christianson at The Hoffman Company in Irvine, California, land values for a standard 7,200-square-foot finished lot in the high desert of Los Angeles County, the low desert of Riverside County and various submarkets of the Inland Empire have fallen from 55% to 70% since the market last peaked in the fourth quarter of 2005. Similar declines have been reported in other sun belt markets such as Phoenix and Las Vegas. With raw land selling for close to its value for agricultural uses, the best potential deals today are for finished lots, entitled lots that are not yet improved and even standing inventory of home builders cut off by their lenders.

Moving into 2009, some brokers think that values have fallen almost low enough to capture the interest of not just the usual suspects, but vulture funds armed with nine-figure war chests set up especially by land development veterans to pounce at the right time. But for inexperienced hedge funds and private equity companies located far from where the land is located, they often must outsource their due diligence, purchase decisions and the development of their land portfolios to others. For them, the term ‘caveat emptor’ has rarely been more true.

For example, argues Les Whittlesea of Whittlesea-Doyle, which specializes in Southern California’s Inland Empire, a fund which insists it is only interested in larger parcels including 500 or more lots could easily miss better opportunities with fewer lots that are located closer to existing jobs and city infrastructure. Consequently, when the market rebound does happen, it will likely favor certain submarkets over others, but only a thorough analysis will separate the winners from the laggards.

Instead of finding the deals first and then conducting the analysis, it might be smarter for buyers to first rank a region’s submarkets before falling in love with a specific parcel and then having to justify it with economic smoke and mirrors. After all, sometimes the best opportunities come in smaller packages, but you wouldn’t know it unless you have your own – and objective -- guides to show you the way.

Determining the value of land

So how can builders compete 'when the land is free?' Well, according to the Calculated Risk blog, they can't -- at least not against REOs.

And it's not like land values haven't already corrected. Since the peak of the market in 4Q 2005 through 1Q 2009, finished lots in L.A. County have fallen by well over 60%. In Riverside County they're down by 60% to 75%. In San Bernardino County, down by 55% to 70%. And in the Coachella Valley, they're down by 60% to 75%.

Even with these price drops, there's still a disconnect between what buyers are willing to pay and what sellers -- mostly banks and some builders -- are willing to accept.

Into this mix are venturing hedge funds and private equity groups. My concern is that since most of them don't know much about land development, they're tapping the same executives who bought so much of the over-priced land that has decimated the industry in the first place. Falling in love with resumes, some seem to be glossing over basic performance benchmarks (i.e., "How many of your prior land deals went BK or to foreclosure?"). Given that it's now the taxpayers picking up the bill for these mistakes, it's a fair question. While the declining market certainly has played a role, in many cases it was a simple lack of proper due diligence that was the problem.

I'll be writing about the importance of the price of land -- and buyers and sellers agreeing on terms -- for my next column in Builder & Developer magazine.

The ongoing battle to discover land values

There's a great post over at HousingCrisis.com about the current stand-off in residential land values. After all, if homes don't sell, how can you hope to value undeveloped land?

From the post:

What we’re certain of is that most of the scant deal flow in the residential land game over the past 15 months or so has been tax motivated. Occasional and minor exceptions to that rule have occurred, and will continue to occur. Big Builder senior editor Sarah Yaussi has set herself the task of getting to the bottom of the impasses and inertial forces at work that have croyogenically frozen the great land reset in time.

As it looks, a Democrat-weighted Congress has favorably disposed itself to extending the provision that allows money-losing companies to recover taxes paid on prior-year profits. This would allow home builders to tap into their IRS payments as far back as the latter half of 2003.

So, we’ll see several companies bone up and leverage their expertise in tax accounting to get access to those cash dollars, which might serve to help a builder from tripping a convenant that could make its debt more expensive or could actually keep some builders from flirting with negative cash flow during a new-order-lean 2009...

The other question around land has to do with a broader question of when capital will flow into any asset class, be it land or paper. The answer may be that for as long as there’s no floor beneath any asset’s value, capital remains in holding. Most institutions that would release it don’t have a clue as to what either their asset portfolios are worth or what their exposure to toxic assets totals to. So, no capital flow.

Hence few big land deals.