Good News du Jour
Real estate is a local business. You’ll hear that from the wisest and best players in the industry.
So while things may be bad coast-to-coast, there are flickers of cheer here and there.
Like in Boise.
The good news is Boise is that Chinese drywall is, er, not there. On Idahostatesman.com the story is this. “Tainted Drywall from China Likely Not in Valley.”
The Idaho Department of Health and Welfare and the Central District Health said they have received no complaints of illness related to imported drywall from China.
The drywall is being blamed for letting off bad odors, corroding pipes and possibly making people sick in the Southeast.
Home Depot, which has several stores in the Treasure Valley, said it never bought the Chinese material.
“The company has not and does not sell drywall made in China or other overseas sources,” Home Depot said in a statement. “Simply, shipping drywall from such a distance is not cost-effective for us or our customers and is a practice we have not pursued.”
Which proves a journalistic rule: “A slow news day is a terrible thing to waste.”
We Won’t Get Fooled Again… Or Will We?
Conundrum on a gloomy, rainy afternoon.
Housing is more affordable. But for whom? Which makes the first statement questionable, if not untrue.
Whether the statement–Housing is more affordable–is valid or not is a big question. Many of housing’s economists say that the degree to which housing affordability reverts to longtime norms–such as house price-to-household income ratios and house price compared with market rate rents–will tell when the housing correction is complete. Once the house price correction is complete, and norms are restored, the assumption is the housing economy will have troughed out, and transactions, absorptions, and an efficient market will resume.
People will buy because it will be the time to buy. But is that asking too much of an economy whose consumer sector–the engine that could…once–is under such duress as it is?
We like Irvine, Calif.-based real estate consultant John Burns; he’s smart, and he can be a help to clients on both sides of the bid-ask chasm that has paralyzed the central nervous system of real estate in the United States.
We also like CNBC real estate correspondent Diana Olick for her standup job of reporting on the housing landscape from both Wall Street and Main Street.
What’s more, we like good news, just as much as the next guy.
These three stars aligned today, but we’re not comforted.
First, John Burns released data that backed up his lead assertion. “We have the best housing affordability in 38 years…” That’s 1971, folks.
Burns trots out chart porn to illustrate the drama of his assertion.
Source: John Burns Real Estate Consulting
Here’s Burns’ commentary on the data.
The monthly cost of homeownership has fallen 43% from the peak in this cycle, with more than half of that due to the decline in price, and the remainder due to the decline in mortgage rates and increase in incomes. The median-income household, which earns $52,800 per year, only needs 25% of their income to buy the median-priced single-family home of $164,600. In July 2006, that ratio was 44%.
Those of us who are in the housing business know that the monthly payment is far more important than the price for entry-level buyers. Entry-level buyers compare the cost of homeownership to the cost of renting and have no idea what a Case-Shiller index means. Once the word gets out that homeownership is less expensive than renting, which is now also true in 54 of the 88 markets where we track this information, we expect buying activity to increase substantially (even in a horrible economy).
CNBC’s Diana Olick caught wind of Burns’ data and smelled a good news headline, which all of us wish for desperately. See earlier Wishful Sinful post. Here’s her take today in her blog: “Yes, You Can Afford A House.” Her evidence of the validity of that claim? John Burns, of course.
I know we’ve been saying over and over that home affordability is soaring to record levels, but a report today from John Burns Real Estate Consulting really puts it into hard numbers, which I thought I’d share.
Let’s start with the big number: the cost of homeownership has fallen 43 percent from the peak in this cycle, with more than half of that due to the decline in home prices and the rest due to lower mortgage rates and increases in income.
Still, realty reality is what it is, not some spin that gets a fleeting instant of attention and then goes away like so much in this throwaway society.
Affordability, by definition, is a real-world term, not a theoretical one.
For instance, what happens when you add home price depreciation rates to your mortgage rates to figure out your real monthly interest rate?
This is the real world way that Chris Flanagan, Asset Backed Securities Research chief at JP Morgan, advises us to look at affordability. Flanagan notes that that by adding the FHFA index’s current 7% YOY decline to a 5% mortgage rate, “real” mortgage rates are closer to 12%, which results in affordability being near the lowest level in the last 30 years.
The other issue is your cost-to-household income ratio. Just as the “V” in loan-to-value has been destabilized by deflationary forces, so too have household income data points been corrupted by galloping job loss trends, which also corrupt consumer confidence.
Fact is, the single most important data point for housing and real estate people to watch is industrial absorptions. This is where the rubber hits the road in non-cyclical job formation that will need to happen to turn the tide on real estate across the board.
All the jobs formed during the W Bush administration have been wiped out. Structural challenges with non-cyclicals that pre-dated the jobs and economic run up of the 2002-2007 period continue. We’re going to need to see non-cyclical industry sectors get well–and household incomes to normalize–before we’ll see the term “affordability” mean anything in the housing market.
We like Burns, Olick, and good news. But we don’t believe them here.
LandSource Reorg Plan Hits Deadlines
As two key deadlines approach–one April 15 [tomorrow], and one at the end of May–Lennar chief investment officer Emile Haddad is meeting today in Santa Clarita, Calif., with a steering committee of first lien holders of LandSource Communities to try to reach agreement on a deal structure that could take the vaunted land venture out of bankruptcy, according to an executive familiar with the meeting.
Click image for LandSource backgrounder.
The steering committee, which consists of representatives of five hedge funds–Och-Ziff, TPG, Marathon Capital Management, Anchorage Capital, and Third Avenue Management–together represent more than 50% of the first lien debt in LandSource. Lennar/Emile Haddad has had a letter of intent that offers $140 million for 15% of a new operating company accepted by the steering committee.
Now, Haddad and the steering committee must hash out a deal structure and business plan designed to generate cash so that the hedge funds can get their money out–probably in about three years. The $140 million Lennar has offered comes with conditions that would relieve Lennar of previous obligations–bonds, development costs, etc.–estimated to be worth about $55 million. See Big Builder senior editor Teresa Burney’s previous analysis of Lennar’s proposed purchase of LandSource assets out of bankruptcy.
Lennar’s accepted letter of intent sets tomorrow as the deadline for its offer of $55 million for an additional 10% of equity in LandSource.
This would indicate a value of $550 million for a land venture that was purchased for $1 billion in 2005, had a book value of $1.3 billion in 2006, and was valued at $2.6 billion in 2007, when Lennar sold 68% interest in the company to MW Partners, a partnership of Calpers, Calpers advisor MacFarlane Partners, and Weyerhaeuser Real Estate Company.
A $300 million valuation for the land in the venture would be a figure that executives familiar with current land trends estimate would be closer to market realities.
The other, more critical deadline, is May 31, which is when the LandSource Debtor-in-Possession (DIP) financing expires. Set up by Barclays, the DIP allows LandSource funds to keep operating while bankruptcy proceedings occur. The next scheduled LandSource reorganization hearing under Kevin J. Carey, Chief Judge, U.S. Bankruptcy Court–District of Delaware, is scheduled for Friday, April 17, at 10 a.m..
Here’s an additional topline from the Lennar offer letter from Burney’s earlier article.
The land Lennar would gain title to through its investment includes Mare Island, Kingwood/Royal Shores, Placer Vineyard, and interests in Lennar Bridges and HCC Investors.
The reorganization plan, which requires approval by creditors and the court, also calls for a non-public rights offering for shares in the newly reorganized LandSource to be sold to generate capital. Barclays would buy whatever isn’t farmed out to other investors.
The challenge with the Lennar proposal is that it takes care of the first lien holders, but it leaves second lien holders and unsecured creditors out in the cold, according to the executive familiar with the offer. The court has indicated it wants a plan that addresses not only the first lien holders, but second and unsecured as well.
“The judge can cram down the amounts owed to all the parties if it comes to that, but if any plan to come out of bankruptcy is going to move forward, there’ll probably have to be accommodations for the 2nd liens and unsecureds, because they can make things difficult if they’re wiped out,” said the executive familiar with the proceedings.
Wishful Sinful
What news-gathering organization is not under tremendous pressure to put an end to headline risk and add faint flickers of light into a brightening beam? With apologies to the Doors, we think it’s well too early to call the bottom, let alone mention a “spring selling season” just getting underway.
Here’s a report from CNBC’s Diana Olick, whose Realty Check may need a reality check if she gets any more carried away by recent glimmers of not-horrific news. Much as we’d like to be “right back where [we] came…” We’ve got some wicked ways to go before we can start the recovery story telling.
State Tax Credit Worthy?
The United States Congress passed a $787 billion stimulus bill that includes an $8,000 tax credit for earners who buy their first home in the 12 months, from January through December 2009.
States, which have seen California get some fast traction with an additional tax credit for any home buyer up to $10,000, are starting to ante up programs of their own, providing their tax coffers permit such an allocation.
Big Builder senior editor Lynn Norusis has compiled this map, indicating which states are working resolutions through their respective legislatures, and the status of each bill.
View Larger Map
Dan Ryan, Truth or Dare
In the wake of last week’s Pulte-Centex pyrotechnics, a classic debate intensifies. Will public home building companies–with their access to and use of the public equity and debt markets–weather the ravages of the next 12 months better and jump out farther ahead in market share when business shows its first signs of strength next year?
Or will private companies–comprised of a handful of Teflon wonders who survived, plus a few who played their non-compete clauses like violins during the industry swan dive, and, finally, the ones who financially reconstitute themselves like crabmeat you’d see in the frozen seafood section of the grocery store–come out of this with the secret sauce to dominate the recovery.
Dan Ryan, Photography by Chris Volpe
Here’s a story you couldn’t make up. The Pittsburgh Ryan family of home building royalty gives us this example of why you should never underestimate the power of the private home builders, even though lenders have most of them groveling on their knees, begging for time.
Yes, publics have millions of “other people’s money” to draw down and mark down as they figure out what their footprint should be, and what their cost-base can come down to while the going is tough. And public companies have unfair accounting advantages that basically allow them to deflate the land value of all competitors as they liquidate their own holdings and collect tax carrybacks, only to return as purchasers of some of the same land at cents on the dollar later in the cycle.
Private companies’ land impairments are literal pounds of flesh extracted from real people’s pocket books, frequently guaranteed with the company principal’s own personal wherewithal, i.e. their homes, etc. When they write down the value of land, they’re kissing money goodbye–whether it’s their own or it’s borrowed–and that’s bad.
So, here’s the Ryan story, and it’s about almost getting beaten, but not.
Chances are, Frederick, Md.-based Dan Ryan Builders will make it. If all goes as planned, even the current headwinds in the market will only haircut a little over 30% of his single family new-home volume from peak through this calendar year. He can thank being in some decent locations in the D.C. metro market for some of that fortune.
But that’s not all.
He knows adversity by heart. In the early 1990s, as another home building company we’ve all heard of–NVR–was hurdling into bankruptcy, the fact that the “R” in NVR stood for the company founder, Dan’s uncle Ed Ryan, couldn’t save young Dan his job.
When he tells the story, he says, “I left NVR, and started my own company in another tough moment for housing, during the downturn of the early 1990s.” Then he catches himself. “They fired me,” he confesses. “That was a difficult moment.”
So difficult for Dan that he went over to the home of his father and mentor Jim Ryan–Ryland Homes founder in 1967–for solace and direction. They sat out on the patio of Ryan elder’s home, and each of them looked out into the forest to the southwest. Dan tells his father what he’s been told in a very sensitively handled exit interview. He says, “Dad, they said they didn’t want to let me go because they really like me; they just didn’t think I was ready to run a profit center.”
“Dan, you know that in a downturn, a good company like NVR doesn’t let go of their ‘A’ players,” Jim Ryan tells his son. “They don’t think you’re an ‘A’ player, Dan.”
That’s what Dan Ryan got for comfort the day in 1990 he got fired from his $65,000 a year job. He didn’t talk to his father for a week or so from that moment, and his father got to thinking maybe he’d been a little too candid with his son. Jim recalls the moment in his own career in home building in the mid-1960s, when his own brother Ed gave him a pay cut of $5,000 a year–which prompted Jim to leave Ed’s company and go start his own.
So, fast forward to 2007, when Dan Ryan Builders nets a profit of $35 million, both father and son know in their heart of hearts that brutal honesty was what the moment called for.
In fact, after his father told him that NVR hadn’t regarded him an “A” player, Dan went for a public speaking course and a business leadership course a la Dale Carnegie, and started the job of turning his shyness into the warm magnetism you’ll see in him today.
“You’ve got to be strong to be good; it’s something you’ll hear my dad say often,” says Dan Ryan.
There are more of these stories, no doubt. Stories that blend your biography with the business. Stories of your determination; your perseverance; your tenacity. We’d welcome hearing them, and we feel that if you’ll share them with your industry colleagues here, it would give everyone a sense of the strength it takes to be as good as you are.
Those backyard patio moments make us who we are. Backyard patio moments may be where adversity hits the hardest, but also where character and resilience get their kick start. Why not share yours with your industry?
Pulte-Centex 101
Big Builder editor Sarah Yaussi and Hanley Wood Market Intelligence SVP for innovation and products Jonathan Smoke team up for a seven-minute seminar that will clarify “Pro-Forma” Pulte’s challenges as it tries to digest Centex in the months ahead.
Turn up the volume on your audio, and have a listen.
Pulte-Centex: Second Day Thread
On May 22, 1963, New York Yankee slugger Mickey Mantle hit The Home Run. The blast came from the left side of the plate against Kansas City [Athletics] pitcher Bill Fischer, and the ball struck Mantle’s bat and soared toward the ornate facing of the uppermost right-field reaches of the now mothballed old Yankee Stadium in New York. Fans and fellow players said the ball was still rising when it smacked the morter facade and caromed back into right field.
Tape measure home runs these days now all come with a cloud of uncertainty, given all the ways players seem to need or want to supplement their own strength.
The House That Ruth built had capacity to seat 57,545 fans, but it was almost like an unwritten law that gave any fellow the right to say that he was there at the stadium in the Bronx the day of The Mick’s legendary dinger. We were eight years old, but have enjoyed the license of any New Yorker and Yankee fan to white lie about being eye witness to our idol’s feat of wonder.
Which brings us to yesterday’s Pulte-Centex mega-deal, which at the very least, has energized a nearly comatose industry with talk of possibilities.
And just like that May evening in 1963 in the Bronx, it seems suddenly to be the case that everybody in the home building industry worked at one time for either one or the other of the companies. A fair number of people have put in time at both.
None of them are surprised that the deal–whether it makes strategic sense or not–ultimately happened; the timing is the only thing that dismays who we’ll call “The Ex-ers” to describe the host of former management and operational folks we’ve canvassed to try to make more sense of the $1.3 billion take-over.
The trouble most Wall Street investors and their representatives have on a fundamental level with the home builder sector is that, even when they’re allowed to put their head under the hood of the company they don’t know what they’re looking at. Home sites, neighborhoods, management talent, manufacturing capacity, distribution skills, sales and marketing … it simply doesn’t all add up.
So it’s when home building veterans themselves look at this deal–beyond the fact that Pulte bought $1.3 billion in cash, some actual number-to-be-named later in cost savings (i.e. nobody we spoke with believes there’s $250 million annually in overhead costs that can come out unless everyone at one of the companies is fired)–there’s some insight into what’s going on and what can be expected.
Here’s some topline notes from the “Ex-ers.” We’ve seeded out malice and speciousness, but left some of the spicier speculation in for audiences to decide on how credible the observation is.
* Centex CEO Tim Eller is said to have talked over the years with Bill Pulte and, more recently, with Richard Dugas about the cultural fit of the two companies on a regular basis. Most recently, in 2004, Mr. Eller was disappointed to learn that his company would never succeed in being the “acquirer” in a deal, and therefore, until now, he’s been unmotivated to pursue it.
* Both Pulte founder Bill Pulte and current CEO Richard Dugas have long coveted greater access to what they call Targeted Consumer Group 2 and 4, which is Pulte’s segmentation designations for entry-level buyers. Pulte himself retained ownership of a brand “American Homes,” which was one of the company’s acquisitions through the years, specifically to aim at entry-level consumers. More recently, Pulte was said to have been very close to doing a deal to acquire C.P. Morgan’s Carolinas operations to give it entree with the entry-level buyer. The Centex play is simply a more grandiose execution of a plan that’s been in place for years.
* The Centex acquisition gives them a possible brand line to make more successful inroads into more affordable single-family product. One issue there is that Pulte’s insistence on higher quality behind the wall could counteract unit profitability on more affordable Centex houses, and Pulte’s purchasing team won’t be able to go toe-to-toe with subs and manufacturers on unit prices and time cost studies, now that the more experienced talent has left the building, so to speak.
* The big question is the savings. The $250 million a year number is hard to fathom, given that you can take out division presidents, payroll, marketing and sales, and a lot of other corporate headquarters people who are redundant in the organizations. But with more than 950 active communities, Pulte will still need supers, sales people, and managers in the field dealing with issues like keeping bonds current, paying the insurance, dealing with special service area zoning and other issues that require constant updated vigilance.
* Pulte has recently restructured costs out of corporate around 200 of its communities in the last year, with some attention to KB Home’s lower cost production and management system. Dugas is said to feel he has an effective corporate-directed neighborhood restructuring model now, and it will probably use this template to go through rationalizing Centex’s 490-some communities.
* Centex–and Pulte too, for that matter–have many many unprofitable markets. In its heyday in 2005, a third of Pulte markets contributed more than 90% of the company’s profitablity. Now, between Pulte and Centex, fewer than double digit markets will be expected to be profitable over the next 12 months. This means the “return to profitability” mantra for Wall Street is sheer spin.
* As for whether this deal will precipitate others, a look at companies balance sheets rules out a number of possiblities–at least as acquirers. “Ex-er” speculation is that Lennar CEO Stuart Miller would probably be the most likely of the bunch to leverage Lennar’s balance sheet strength to do something. Word is Miller came this close to a done deal with Bob Toll in 2005/06, but Mr. Toll woke up the next day and said he’d changed his mind. A Lennar/KB Home combo is also a possiblity in the minds of many.
No doubt, we’ll keep talking to people, and a lot of those people will have been “there,” which is to say Pulte and/or Centex in the the recent past. What would you like to know from them?
Home Building’s Deal Gets Wall Street Talking
Pulte-Centex deal rocks stocks.
The New York Times reports:
Homebuilding stocks tacked on significant gains early Wednesday after Pulte Homes said it would buy Centex for about $1.3 billion in stock. Investors seemed encouraged to see that, despite a severe housing slump and wildly lurching markets, two major players in the home construction business could agree to a stock-based merger.
Shares of Lennar, which builds and sells mostly single-family homes, were up 9 percent in the first hour of trading.
Here’s CNBC home building and real estate analyst Diana Olick’s take on the deal.
Pulte’s Competitor Elimination Play
So much for the truism “you can’t cost cut your way to profitability.” One major “Nash Equilibrium” move later, and you’ve proved that truism untrue in the home building landscape. Maybe the phrase should be, “you can’t cost cut your way to profitability … unless you get to cut the costs of two companies rather than just one.”
Pulte’s $1.3 billion stock-for-stock purchase of Centex is probably more important right now for the cost cut-ability being bought versus the today’s revenue from Centex. Two companies’ tripping over one another for customers in so many markets for so scarce a number of buyers made getting to the finish line–past the threat of liquidity crunches, missed debt payments, and financial dislocation–a pretty scary challenge.
For when you mash two large home building companies together, subtract $250 million in overheads, and re-rationalize geographies, product lines, subcontractors, and manufacturers, you’re suddenly looking at pro formas for a grail-ish sounding below-$40-per-square-foot in direct costs. This may just be the only ticket to the finish line (a ka survival) for companies, however much they boast about their cash “dry powder.” Value re-engineering and retooling will be critical to capture the savings, but bloodletting in mass layoffs inevitably will be the biggest part of what’s going on here.
This is really two companies awakening to a recognition of reality. The epiphany? “The world needs one less of us.”
That may not be a normal mergers and acquisitions strategy, but normal mergers and aquisition strategies really don’t exist in home building. As home building industry financial consultant Ivy Zelman says, why buy legacy assets when you can buy land cheap or soft-take-down your way through the doldrums.
What companies are waking up to a third of the way through the year they hope is the worst year ever in home building is that if they want to be around on the other side, it’s going to take more than a treasure chest of cash to ensure that. Cash, after all, burns.
So we’ve got a strategic acquisition where the impetus of the strategy is “we’ve got to build houses cheaper so we can move them through the teeth of the maelstrom.” Even though the combined companies build in 59 markets today, the likelihood of that being the case in six or 12 months is almost unimaginable. Pulte’s footprint a year from now is probably far more concentrated.
Their opportunity is to scale in enough markets–entry level and first time move up–to get with the earliest waves of absorption recovery, at low enough price points to avail of tax credits, and mortgage buy downs, and FHA and agency lending, etc.
This assures Pulte of being able to concentrate more, get margins up, and avoid at all costs having to reach into its trove of cash to run everyday operations.
The other part that makes sense not only for Pulte but for other players is the potential ability to separate home building operations and merchandising from its real estate development business. We understand that D.R. Horton and Lennar have had a similar exploration–where Horton would stick to its home building operational expertise, and draw on Lennar for its real estate strategy and development skills. We’ve seen Ryland in a strategic alliance with Oak Tree. We’ll see more asset-light home builders strategically tied to land strategy and finance companies.
We know that consolidation of this ilk will occur, although, probably after a rather protracted dance of the tail feathers since there are still some big egos in the way of what makes sense strategically.
There’s pressure on every public builder to explore a public-to-public merger because this deal makes it abundantly clear that there’s lots of cost and lots of capacity that needs clearing before this thing can turn around.
An overall reduction in capacity is the only way to reintroduce scarcity into the home building supply and demand equation. We believe we will see other top 12 home building companies try follow suit, because $250 million in cost savings is going to sound pretty attractive to boards and note holders in the near term.
It’s basically saying that the 40% to 60% downsizing in people and operations that has taken place since 2006 gets home building organizations a little past half-way there. That’s quite some pain to go.