Did Home Builders Trade Off Better Land Deals to Juice Cash Generation?
Cliches do their work and get tired for good reasons. They’re often annoyingly obvious and aggravatingly true. “Be careful what you wish for,” for instance. Way back when–in December and January–as we were tallying up Net Operating Loss tax refunds home builders recouped after the extension from 24 months to 60 months backward, the clawback number quickly climbed well north of $2 billion without so much as breaking a sweat.
“That was the stupidest thing that ever happened,” said one of our highly placed public home building company executives.
Right about now, after a phalanx of home builders completed an 18-month tear to devour finished home lots everywhere at prices that swelled to double or triple distressed-deal pricetags, the sense of this comment, “the stupidest thing that ever happened,” becomes clear.
When you think about it, home building’s biggest beneficiary of an NOL refund–Pulte–already had enough land, so it didn’t need to participate in the ‘09-’10 run on finished lots. Too, the No. 2-ranking NOL refund recipient, Hovnanian, probably did use some of the windfall for land purchases, but most likely banked the lion’s share of the tax rebate for operations.
So, in fact, less actual NOL refund money made it into the land-buying market than meets the eye. But, that doesn’t mean the perception among land-sellers and banks has not been impacted by NOL refunds’ flow into builders’ acquisitions piggy-banks.
Says another home building company CEO:
It scares me, to be honest, when I look and see what happened in the Fall. There were three years of pain–builders beating land sellers and banks over the head, trying to convince them that market values weren’t there… and [the land sellers and banks] had to get to a psychological adjustment on what market values needed to be, because when you residual it back, their perspective on what the values were just didn’t work. And overnight we made that go away.
We just said, ‘poof!’ and it was gone. Because, now after the big Fall, everybody says, ‘those really are worth what I thought they were.’ But guess what, when it comes through the cycle, the house isn’t going to appraise there.
In other words, invoking the option to shift accounting timing on collecting tax refunds on business losses from later (the future) to sooner (the past) may well have won a policy battle, but it likely made the war longer and more difficult, with an even greater list of casualties as a result.
Says one of our trusted public home building company leaders:
“[NOL refunds] probably did contribute to a temporarily elevated demand for lots, and distorted the market for a while, but that’s over now.”
So thanks to an “extend and pretend” bank regulatory environment, an artificially inflated liquidity pool of cash put into the coffers of public builders who were bursting at the seams to open new communities to flex their competitive muscle and validate their footprints, an opportunity was lost.
A true-up of land market bids and asks that could have occurred widely by now got delayed. Near-term cash-generation interests trumped longer-term health and profitability.
Here’s a painful truth. Minus a jobs and consumer confidence recovery (which could still emerge, however anemically, out of the fog of broad regional economic trends), housing’s now stuck between a rock of no demand stimulus and a hard place of land sellers who won’t mark their lots to realistic end-home-buyer market rates.
Home builders’ focus on what they can control–which is not the economy and jobs growth–is more important than ever.
A key story of the balance of 2010 will be whether at least the public home builders displayed financial discipline (or not) in their lot acquisition activities dating back to Spring 2009. We have, or will see a fair number of communities come on line in 2010 and early 2011 based on those lot purchases, and the question of the moment is whether the underwriting was sound or not.
So even as end demand remains in the thrall of unclear employment and disastrous home finance trends, the supply side–namely land prices–is going to be where players seize a competitive and profitability edge coming out of 2010. But that won’t occur for anyone who hasn’t learned to pencil lot acquisitions with the discipline to exclude both appreciation and a faster pace of absorptions.
An anemic recovery is a recovery, period…
(Folks, this note will be our last until our return from a week on the Sonoma California Coast … a vacation we gratefully appreciate. Until August 9, then, best regards to you all!)
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