Florida’s CDD Mess Gets Forbes’ Attention
A reader sent us a link to Forbes’ analysis of Florida’s Community Development District bond debacle.
It’s a must-read if you’re a bond investor. If you’re a real estate speculator, it’ll ping the salivary glands, but don’t get too excited. Getting at the actual dirt will be like trying to claw a home loan out of a CMBS.
Interesting that Forbes’ reporter Matthew Schifren should adapt structure, sources, and even phrases from a story we posted here in July, but with no attribution to that story.
For example, here’s a line we wrote in our July 11 post, “Ground Under Repair–Florida’s CDD Comeuppance:”
For more than a year, Tern Bay has been slogging through foreclosure proceedings, and the legal complexities are too numerous to go into. Now, multiply the Tern Bay case by say 120 or 130 times, with upwards of $2 billion in bond debt at risk, collateralizing land that may be worthless or at least far less than the face-value of the bonds outstanding.
Now, have a look at how the Forbes story moves from the Tern Bay example to its thesis on Florida’s CDD woes:
Multiply this scenario by 100 and you get a picture of recently issued community development bonds in Florida.
I guess Shifren liked what he read enough to borrow a fair amount of it.
Infill Home Building Goes to the Back Burner
D.R. Horton made sweeping changes in its strategy recently, ones we look at for insight into how other home builders behave at this juncture in housing’s boom and bust cycle.
On both coasts, Horton divisions that focused on multifamily for-sale residences got orders to sell or opt out of their land positions and wind down. The company was “going back to its roots in entry level, single family homes… They’re getting out of the condo business,” an executive who’s familiar with Horton’s recent action plan tells us.
It was just about this time of year in 2006 that Horton’s management leaders affirmed that urban infill , multilevel, podium- and midrise style homes were a big part–a double-digit share–of the company’s future. And Horton had company in its embrace of the “inner rings” of urban areas as a rapidly emerging market for the nation’s biggest builders–the leadership at Pulte, then-Centex, Lennar, KB Home, and Hovnanian each asserted that closer-in urban home building would represent between 10% and 20% of their operations by 2010 or 2012.
This is where the market was headed, they said. Younger buyers prefer to be nearer their downtown jobs, and empty-nest Baby Boomers would downsize in droves out of the exurbs into cultural hubs for their “next phase” of being Boomers.
That was theory circa 2005-06.
That’s history now. Housing’s 2002 to 2006 boom came and went without teaching most greenfield single family home builders skills they needed to know about differences in capital management, the land and city politics game, nor construction operations to succeed with an inner-ring push.
Put it this way, $35 per square foot in direct costs may be fact for some home builders today or it may be malarkey. But it’s the standard of the moment in terms of an operating efficiency that has had to match new homes with foreclosure sales, and is going to have to continue to do that.
That means the cost per square foot metrics for urban building are a dog that won’t hunt in today’s market.
Horton, like the other publics save Beazer and Hovnanian, has amassed a cash war chest. Dry powder to pounce on opportunity or to have on hand for more rainy days.
Here are a couple of factors that could burn through those war chests in no time:
- Another year of less-than-three-absorptions-per-community-per-month operations; this is entirely possible thanks to a predictably huge ongoing wave of foreclosures and a rough double-digit unemployment rate picture;
- The onset of new costs of capital–as lenders have to set aside more capital for their risky investments, they in turn are going to require home builders to secure their borrowed money with more liquidity as well… this may take a chunk out of some of those war chests.
- Home building’s equivalent of the cash-for-clunkers program is the taxation measure under consideration that would allow them to carry current losses back beyond 36 months to a new limit of 60 months. In effect, home builders could swap out land they paid too much for but is worth very little for a tax credit that would allow them to buy new, cheaper land. If this measure fails to clear Congress–and in this environment, with all the politicking going on around health care, energy, and financial regulation, who knows?–home builders won’t get that cash-for-clunkers bump they may need as a cushion for another tough year on the sales front.
All of this means Horton and the other home builders are now under the gun on several levels.
- All their land needs to be rationalized. It must be capable of being sold for either cash purposes, or for profit.
- Their operations need speed at every turn to drive toward better margins.
- The must do what they know, and in turn, they have to sacrifice doing what they know they’ll need to do to meet the next market.
It’s an awkward time where a balance sheet strategy gets more emphasis than an operating long-term strategy. Horton knows this only too well. They know the inner-ring plan was the right one for the future. They, and almost all the other home builders who tried it with the exception maybe of Toll Brothers, didn’t have the capital runway to learn that business.
It’s going to hurt them down the road.
Some Stocks Hammered, Some Nailed
This from CNBC’s stock market reporter Bob Pisani.
Home builders this week:
- Standard Pacific down 23% [SPF 3.25
-0.05 (-1.52%)
]
- Hovnanian down 16% [HOV 4.61
- Masco down 10% [MAS 12.76
- Lennar down 10% [LEN 14.06
- Ryland down 10% [RYL 21.11
On the surface, the decline may not seem logical. The housing market seems to be stabilizing, with sales improving and inventory levels declining.
If shareholders can protect any gains they achieved during the summer rallies of these stocks, it’ll be a surprise. The real rally in home building stocks that will pre-date housing’s volume and price recovery, is still ahead.
Monday Housing Crisis at a Glance
The the topline focus for the week will be macroeconomic trends–including producer and consumer price indices, housing starts and building permits, and home builder sentiment from the NAHB home builder market index due Thursday.
Here’s JP Morgan housing sector analyst on the “Street” expectations for the various housing economy benchmarks due this week.
This week features the July NAHB Survey (Street: 16; Prior: 15) on Thursday, June Housing Starts (Street: 530K Prior: 532K), and Building Permits (Street: 523K; Prior: 518K) on Friday.
Here’s the sum-up of last week in the housing sector from Citi housing analyst Josh Levin.
Although there were no housing market data releases, and despite the fact that mortgage rates continued to drop, the homebuilding stocks sold off ~6.5% w-o-w versus the broader market’s ~1.9% decline w-o-w. Our sense is that the underperformance of the homebuilding space was less homebuilding/housing market specific and more a result of overall risk reduction in the market. We also note that trading volumes were on the light side. Our coverage universe now trades at ~1.0x current TBV. According to Bankrate.com, 30-year mortgage rates now stand at 5.29% versus the prior week’s 5.34%.
Speaking of loans, young professionals–doctors, lawyers, dentists opening up new practices–are being shut out of the risk-averse market for mortgages, reports The New York Times this past weekend.
The denials are occurring for a wide array of reasons: the buyers’ incomes are adequate but irregular; they are self-employed and take many deductions, reducing the taxable income on which lenders focus; their credit scores are below the cut-off point, which has been raised drastically; their down payments are less than 20 percent.
Housing usually leads the country into a recession, which certainly happened this time, and also leads it out — which will not happen in 2010, the real estate industry contends, without stronger efforts to thaw the market.
The piece goes on to note that Congress is considering not one, not two, but three separate proposals to extend, expand, and increase the $8,000 tax credit available to first-time home buyers through Dec. 1, 2009. The existence of these proposals is the occasion for Housing Crisis’s sound bite of the week, spoken by one of the housing industry’s beloved analysts Ivy Zelman.
Some economists, noting that tax incentives helped stoke the boom, say these proposals should be shunned. “When do you decide enough is enough?” said the housing consultant Ivy Zelman. “I don’t want to feed the drug addict with more drugs.”
Zelman is not known as one who minces words, and she’s never eaten her own either. Lest she lose sleep over whether Capitol Hill policy should make the addict go Cold Turkey or try a Methadone plan, another observer, Yale economist Robert Shiller, offers a 40k-foot perspective that should calm agitated nerves a bit over what to do.
Housing markets are very inefficient – and that is why it takes several years for prices to fall to a market clearing price. Even if the rate of price declines has slowed, there will probably be a long tail of real price declines in many areas.
“My more probable scenario is languishing of the housing market for years.”
Robert Shiller
Beneath the glare of the macroeconomic and “Animal Spirits” surface–although not too far–the festering Chinese dry wall story is quickly oozing into public scrutiny in a big way. The Wall Street Journal reports this a.m.
Lennar Corp. has identified 400 homes in Florida that have confirmed problems with defective Chinese drywall, and it has set aside $39.8 million to repair the homes, the Miami-based home builder said in a securities filing Friday.
The figures are as of May 31, Lennar said.
Complaints about odors and corrosion linked to defective drywall have been increasing for months.
The U.S. Consumer Product Safety Commission said in a letter to four U.S. Senators last week that it has received more than 600 complaints related to the drywall issue from 21 states and the District of Columbia. Most of the reports are from Florida, Louisiana and Virginia.
Housing, clearly, has become a perilous occupation, not just on the job site, but in the office, the field, the bank, and the planning board.
That’s a mid-July Monday morning for you.
A Case for Dr. Shiller
Big Builder senior online editor Bill Gloede previews tomorrow’s monthly release of the S&P/Case-Shiller index. But Gloede does so in inimitable and unexpected fashion.
In a fit of apparently propitious timing, MacroMarkets, LLC, the developer and seller of structured financial products co-founded by Dr. Robert Shiller, on Tuesday will introduce its new MacroShares Major Metro Housing Shares to trading on the New York Stock Exchange.
Why propitious? Well, in California at least, it looks like prices are starting to firm up and even rise. The early second-quarter view from Lennar and KB Home earnings ;last week also seems to indicate better news, or at least market movement, ahead.
The new housing shares will trade under the symbols UMM, for housing market up, and DMM, for housing market down. The shares will track the S&P/Case Shiller Composite 10 home price index, a value-weighted average of the 10 original Case-Shiller metro area indices, which include Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington.
Dr. Shiller’s aim is to generate liquidity and stability around residential real estate, outcomes he says will occur if there’s a natural futures market for it.
Home Building’s 2Q: Heading to Fourth and Short
The bellwether boys–Lennar’s Stuart Miller and KB Home’s Jeff Mezger–have spoken.
The housing economy has diminished their respective companies’ businesses, their armies of associates, their empires of land holdings, etc. with the ferocity of the Judgment of Solomon. What’s not diminished a shred, though, is their will to win.
Each has spliced flickers of positives into an assessment of what’s been going on lately at their companies, and what the market looks like for the months ahead. Their measured statements echo what we hear far and wide, whether it’s from multi-regional publicly traded companies, or single-market privates. It kind of sounds like one of Mezger’s statements from his 2Q earnings call transcript:
On the brighter side, however, the existing home sales report released by the national association of realtors earlier this week confirms that the combination of historically low prices and low interest rates is having a positive impact and the new home sales data from the U.S. Census Bureau showed a sales pace that is stabilizing, albeit at low levels. Affordability is at an all-time high and inventory of available homes has trended much lower in many key markets despite the steady influx of foreclosures.
Clearly, when you talk about home builders’ will to win in this environment, it’s not head-in-the-clouds talk. They know what they’re competing with: Paralysis brought on by fear of buying before prices have bottomed on the one hand, and foreclosures on the other.
A monthly payment for a new home, and the total cost of homeownership that that monthly payment signifies, appeal to different values in a society that has in the past 24 months increased the likelihood that a home buyer will stay in his/her home for some years longer.
If we’re no longer looking at the four walls and rooftop of the owned home as an income-producing investment that will subsidize gain in ways beyond the household earners’ take-home pay, then a new home, with its warranties, its energy savings, etc. can start to measure up on a practicality scale. Not only against a foreclosure opportunity but vs. equivalent rentals.
In the weeks ahead, earnings and operational performance of a dozen other public companies will come to light. In each case, we expect to hear emphasis on:
- the balance sheet, and the ability to improve or sustain an impressive cash trove;
- a product push, with focus in most cases–save Toll Brothers–on affordability and speed of construction time;
- improved operational disciplines for margin opportunity;
- and, opportunistic land grabs that will yield quicker upsides vs. higher priced dirt in their current lot pipelines.
Knowing as little as they do about the specific quality of lot positions big home builders currently possess–it’s their secret sauce–Wall Street investors and partners can only react with an eye toward managing their fear of risk.
So performance will need to pan out as substantially better for confidence to build up around these stocks.
The united front–actually putting private enterprise home builders, the interests of invidual home buyers and prospects, and Capital Hill on the same team, for once–should be against the brute effect of foreclosures on communities, financially, emotionally, and physically.
No matter what anybody says about home builders having overbuilt–and they did in a finite number of markets in the seven or eight states (Arizona, California, D.C.-metro, Georgia, Florida, Nevada, and Texas)–new home builders are making themselves part of the economy’s way out of a hole.
You’re doing it every time you quicken the pulse of a prospective home buyer with one of your offerings that can actually get somebody out of the waiting game and into the market.
The bellwhether boys have spoken. Stay tuned in the weeks ahead as the rest of the crowd speaks up about where they are and where they’re headed.
Meanwhile, this is our last blast to you before our Independence Day holidays. We wish you and yours a safe, joyful, celebratory official start to Summer 2009. Please keep in mind and heart those men and women in the armed services and other community initiatives who work to safeguard our sacred, one-of-a-kind independence. Here’s to your undying will to win.
Which is Better, More Sales or Less Cancellations?
If you’re a home builder, what’s going to feel like better news? (And, oh boy, what just a little good news could do going into a weekend!)
You get to choose one or the other of the two options below:
- Higher (Commerce Department) unit sales, accompanied by higher cancellation rates?
- Or fewer orders with less cancellations? (With apologies to the grammar police).
Analysts preoccupy themselves with monthly Census and Commerce Department data. Said analysts don’t run a business in the trenches that depends on turning inventory or dies.
The Census and Commerce Departments, and most of home building’s analysts, watch orders for new homes as if they were in a vacuum. They count them one time when there’s an earnest money deposit on a home, and irrespective of whether they actually flow through to the closing table and get a deal, they stay counted.
That’s not how reality works for the builders.
They report their orders as a sale, but they dont get to book the full price as a sale until they deliver the deed over to the new owner after settlement. So Commerce may already have counted a home as a sale, but a builder can’t until the Fat Lady Sings. A builder may have to sell the same house not once, not twice, but given today’s tricky credit and appraisal environment, as many as three times to get to the tail lights on the transaction.
Which makes cancellation rates significant. Higher cancellation rates mean more orders but less done deals. This rubs two ways when it comes to a fits-and-starts housing market stabilization.
A lower total on the earnest money deposits can handily be offset–on a balance sheet–by a greatly reduced number of failed or derailed deals.
Here’s a comment from Raymond James Associates housing analyst Buck Horne, on KB Home’s 2nd quarter earnings performance:
Notably, KB Home’s cancellation rate improved to 20% in the first (should say “second”) quarter from, 28% in F1Q09 and 27% in the same period a year ago.
So, KB’s total orders for 2nd quarter fell year-on-year by 31%, but the company’s cancellation rate for the reporting period improved from 27% in 2Q 2008 to 20% in 2009.
Whether or not this data is read as downbeat or green shoots by analysts or the broader economy virtually doesn’t matter to executives who live, eat, sleep, and breathe home building.
What matters to them is that they’re doing what they need to do to make a living.
Here’s Buck Horne’s hybrid lift from the transcript from KB Home CEO Jeff Mezger’s market conditions sum-up:
CEO Jeffrey Mezger highlighted that the company is “beginning to see signs that some negative housing market trends may be moderating at both the local and national levels.” Furthermore, from management’s perspective, while it is premature to declare housing has reached the end of its severe recession, the conflicting signals it has seen could suggest the industry is “approaching a point of relative stability.”
Likewise, while not trying to betray an overly optimistic outlook, Lennar CEO Stuart Miller sprinkled positive statements among his cautious ones in talking about Lennar 2Q’s performance.
“Abject pessimism (from consumers) has given way to a sense that opportunities are available to those who qualify,” he said. “While there continue to be significant headwinds … there are some significant positive influences out there that are beginning to shape a more positive future.”
These two bellwether company CEOs know better than not to recognize another leg down isn’t entirely impossible. But they’re talking about substantive if nuanced signs of improvement.
Higher (Commerce Department) orders mean prospective buyers might be being spurred off the sidelines, but some fair number of them might not have the means to complete a home purchase.
Lower can rates mean motivated buyers and gettable credit.
When home builders can sell both the already-counted orders that fell through, and push new orders through to closing at a higher rate, they’re coming out ahead.
This is why new home inventory is headed with conviction in the right direction. Have a look at Calculated Risk’s chart and interpretation.
Click to access Calculated Risk post
There were 10.2 months of supply in May – significantly below the all time record of 12.4 months of supply set in January.
The seasonally adjusted estimate of new houses for sale at the end of May was 292,000. This represents a supply of 10.2 months at the current sales rate.
The final graph shows new home inventory.
Note that new home inventory does not include many condos (especially high rise condos), and areas with significant condo construction will have much higher inventory levels.
It appears the months-of-supply for inventory has peaked, and there is some chance that sales of new homes has bottomed for this cycle – but we won’t know for many months.
Getting inventory sold, and getting the inventory level to where it is the least cumbersome and the most flexible is the business of the home builders right now. The chasm is something they can look across if they can do this.
So which is it, higher orders per the Commerce Department or lower can rates?
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.
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.