Land at 15 cents on the Dollar

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I saw this over at Calculated Risk, and I thought it was a good opportunity to remind everyone of how the raw land market works: <strong><a title="Permanent Link to Land Value 101" rel="bookmark" linkindex="6" set="yes" href="http://www.irvinehousingblog.com/2007/07/16/land-value-101/">Land Value 101</a> </strong>








<a href="http://calculatedrisk.blogspot.com/2008/03/land-at-15-cents-on-dollar.html" linkindex="339" set="yes">Land at 15 cents on the Dollar</a>

<p>Last night I spoke with a land developer. He just purchased improved land in SoCal (update: Inland Empire) for $0.15 on the dollar from a homebuilder (builder's total cost). The deal closed Friday. The purchase price was <strong>less than half</strong> the cost of just the improvements (grading, streets, etc)!





The deal has no leverage, and the buyers are hoping to sell in 3 to 5 years to another homebuilder. They can wait much longer if necessary. The other details (like buyer and seller) are confidential.





This is an important step. The homebuilders are finally starting to liquidate surplus land at prices that are attractive to "vulture funds", and this potential inventory is also being removed from the market.





I expect to see many similar deals this year as the homebuilders, and their lenders, struggle to survive.</p>




<p>From <strong><a title="Permanent Link to Land Value 101" rel="bookmark" linkindex="6" set="yes" href="http://www.irvinehousingblog.com/2007/07/16/land-value-101/">Land Value 101</a>:</strong></p>

<p>... we can estimate the total land value of the residential portion of the Woodbury Village:</p>

<p>$650,000 Sales Price</p>

<p><em>Fixed Costs</em>


2,000 Average Square Footage


X


$85.00 Average Cost Per SF


===================================


$170,000 Average “Box” Cost


+


$40,000 Average Per lot Infrastructure Cost


===================================


$210,000 Average Fixed Construction Costs</p>

<p><em>Variable Costs</em>


* 12% Profit


* 5% Marketing


* 3% Overhead


* 5% Finance


* 3% Other


===================================


28% Variable Costs Percentage</p>

<p>$182,000 Variable Costs Dollars


===================================


$392,000 Total Costs (Fixed Costs + Variable Costs)</p>

<p><strong>$258,000</strong> Land Residual (Finished Lot Value)


X


4,270 Number of Lots


===================================


<strong>$1,101,660,000 Finished Lot Land Value</strong></p>

<p>$1.1 Billion dollars worth of land — that is Billion with a “B.” If the Irvine Company can build out this village for an average home sales price of $650,000, that is how much they stand to make (their land cost is almost zero).</p>

<p>Now lets look at another scenario: the housing bubble crash scenario:</p>

<p>$325,000 Sales Price (50% decline)</p>

<p><em>Fixed Costs</em>


2,000 Average Square Footage


x


$85.00 Average Cost Per SF


===================================


$170,000 Average “Box” Cost


+


$40,000 Average Per lot Infrastructure Cost


===================================


$210,000 Average Fixed Construction Costs</p>

<p><em>Variable Costs</em>


* 12% Profit


* 5% Marketing


* 3% Overhead


* 5% Finance


* 3% Other


===================================


28% Variable Costs Percentage</p>

<p>$91,000 Variable Costs Dollars


===================================


$301,000 Total Costs (Fixed Costs + Variable Costs)</p>

<p><strong>$24,000</strong> Land Residual (Finished Lot Value)


X


4270 Number of Lots


===================================


<strong>$102,480,000 Finished Lot Land Value</strong></p>

<p>$102 Million dollars worth of land — That is million with an “M.”</p>

<p>Is that right? Does a 50% reduction in home prices really reduce the land value 90%?</p>

<p>Yes, it does.</p>

<p>Can you see why the Irvine Company is so protective of home prices?</p>

<p><strong>Why is land value so sensitive to home prices?</strong></p>

<p>As discussed previously, variable costs are only 28% of the home sales price. Remember, land value is a residual calculation, that means everything which isn’t a cost falls to land value.</p>

<p><em>Therefore, 72% of any increase or decrease in the price of a home flows directly to land value.</em></p>

<p>In essence, this makes land an extremely leveraged commodity. If the value of a house changes by $10,000, the value of the lot it sits on changes $7,200. Multiply that times the 6.67 units per acre, and you can see how each $10,000 change in the value of a house changes the value of an acre of land in Woodbury by $48,024. Since Woodbury sits on 640 acres, <em>the total value of Woodbury changes by $30,735,360 for each $10,000 change in the sales price of a home</em>. (If you want to see a really mind-blowing number compute this for all the land in the Irvine Company’s holdings.)</p>
 
I think the builder referenced by CR was Centex (see article http://www.bigbuilderonline.com/industry-news.asp?sectionID=363&articleID=683257)



IR, clarify what you mean by "protective", I'm assuming you mean that TIC is attempting to shut down elements that have a negative effect on land, specifically, media outlets, even more specific, IHB. I point out that TIC is not a home builder, most of their portfolio consists of commerical property.
 
"clarify what you mean by "protective", I'm assuming you mean that TIC is attempting to shut down elements that have a negative effect on land, specifically, media outlets, even more specific, IHB."





They are doing that too, but that particular behavior wasn't what I was focusing on when I wrote the post. When I say they are being "protective" I mean they are trying to avoid doing anything which will facilitate a decline in prices. IMO, the logical move for the Irvine Company would have been to lower prices on new homes and meet the market. Instead, they basically shut down all construction on the Ranch when prices went south in 2006. I don't know how many sales they had in 2007, but it wasn't very many. They know that must-sell inventory drives prices lower, and they have decided not to contribute any must-sell inventory in the form of new houses. Of course, this isn't going to save the market because the other form of must-sell inventory -- foreclosures -- is going to bury the market. I believe they would have been better served by continuing to build while prices declined because they still would have captured revenue while prices were inflated. What is going to happen now is they will finally give up waiting, and they will start to build at much lower price points, and they will have missed the revenue they could have achieved when prices were higher. Prices are going to go where they are going to go. The Irvine Company was engaged in wishful thinking when they embarked on a policy of stopping construction in the hopes that prices would recover.
 
That's a very interesting thought, but would it be fair to say that their cessation of building was indirect in that it wasn't TIC that stopped construction, it was due to TIC unwilling to renegotiate land contracts, which also dictated sales prices, with merchant builders who directly stopped the building due to a lack of sales.



I agree if that's TIC line of thought, that they would come back into the market when prices rebound to 06 prices, they are guilty of being fools. However, an argument could be made that Bren is attempting to help the economy by keeping a supply of homes off the market, which would induce a speedier recovery in orange county.
 
<em>"However, an argument could be made that Bren is attempting to help the economy by keeping a supply of homes off the market, which would induce a speedier recovery in orange county."</em>





A shortage of housing will not drive prices back up to where they are not affordable. What the housing market needs, if these prices are to be supported, is higher incomes. In fact, I would argue that the best thing for the Orange County economy would be more affordable housing. If people could afford to live here, they could take jobs here at lower salaries, and businesses would be able to expand. It is very expensive for any OC business to expand right now due to the salaries demanded by people to move here.
 
JC - As I understand it, TIC releases the lots to the builders only a few at a time. In other words, <em>for the most part</em>, they will not sell the next phase of lots to the builder until the current phase is in contract. That way, the builder's holding costs are smaller and TIC can prevent a lot of vacant product from sitting. A builder can't build on land it doesn't have the right to build on. As you noted, some of the builders also sought renegotiation of the land price. I think at least some of them got it. (Paloma at PS seems to be building more of their project than other builders are around town.)





The thing I keep shaking my head at is Orchard Hills. I fully understand the branding and price supports for holding back on it. At the same time, they took productive land with paying leases, put in some of the infrastructure, and are now the only taxpayer on those bonds. I have not looked to see if those have been refunded (i.e., "refinanced"), but if not, it's gotta suck that they now have to pay money on that land when they were earning money on it before. Same thing with Stonegate and Laguna Crossing.
 
<em>"they now have to pay money on that land when they were earning money on it before. Same thing with Stonegate and Laguna Crossing."</em>





Fortunately for the Irvine Company, they have no other debt they are servicing and their land basis is essentially zero. Your point is well taken, though. They do have carrying costs.
 
Eva, i understand that contract, it's called a phased lot takedown, and it's primarily for the benefit of the builder who does not have to carry the cost of all the land at once. However, it's a contract and TIC is obligated to sell the land to the developer at the developer's request, but this does offer TIC control, in their psa's, control over pricing, hence they can stop development.



IR, what do you mean "affordable"? Market rate homes that are affordable to low middle class families or deed restricted homes?



Personally, I think incomes of white collar jobs need to rise. Irvine is what it is, a very desirable place to live and market forces will always keep home prices out of reach of low middle income families which is fine. Tough to predict how this will pan out in irvine though, with the spectacular collapse of the mortgage industry and the loss of those high paying jobs.
 
[quote author="EvaLSeraphim" date=1207363208]JC - As I understand it, TIC releases the lots to the builders only a few at a time. In other words, <em>for the most part</em>, they will not sell the next phase of lots to the builder until the current phase is in contract. That way, the builder's holding costs are smaller and TIC can prevent a lot of vacant product from sitting. A builder can't build on land it doesn't have the right to build on. As you noted, some of the builders also sought renegotiation of the land price. I think at least some of them got it. (Paloma at PS seems to be building more of their project than other builders are around town.)





The thing I keep shaking my head at is Orchard Hills. I fully understand the branding and price supports for holding back on it. At the same time, they took productive land with paying leases, put in some of the infrastructure, and are now the only taxpayer on those bonds. I have not looked to see if those have been refunded (i.e., "refinanced"), but if not, it's gotta suck that they now have to pay money on that land when they were earning money on it before. Same thing with Stonegate and Laguna Crossing.</blockquote>


Yep, this is exactly what they do. Black Mountain Ranch does the same thing down south. It's designed to control the lot prices and to prevent a builder from going bankrupt and selling the land super cheap.
 
[quote author="IrvineRenter" date=1207350861]"clarify what you mean by "protective", I'm assuming you mean that TIC is attempting to shut down elements that have a negative effect on land, specifically, media outlets, even more specific, IHB."





They are doing that too, but that particular behavior wasn't what I was focusing on when I wrote the post. When I say they are being "protective" I mean they are trying to avoid doing anything which will facilitate a decline in prices. IMO, the logical move for the Irvine Company would have been to lower prices on new homes and meet the market. Instead, they basically shut down all construction on the Ranch when prices went south in 2006. I don't know how many sales they had in 2007, but it wasn't very many. They know that must-sell inventory drives prices lower, and they have decided not to contribute any must-sell inventory in the form of new houses. Of course, this isn't going to save the market because the other form of must-sell inventory -- foreclosures -- is going to bury the market. I believe they would have been better served by continuing to build while prices declined because they still would have captured revenue while prices were inflated. What is going to happen now is they will finally give up waiting, and they will start to build at much lower price points, and they will have missed the revenue they could have achieved when prices were higher. Prices are going to go where they are going to go. The Irvine Company was engaged in wishful thinking when they embarked on a policy of stopping construction in the hopes that prices would recover.</blockquote>


You're right. Irvine Ranch thought they could just cut off the new house spigot and the prices would stabilize. So far their plan has worked only mildly. Things aren't out of control in Woodbury or PS, but older neighborhoods are still under huge threat...hi Quail Hill....BUT things could have been way worse...see Lake Las Vegas for more info. Remember, this family has been at this game for decades. There's a Irvine Family rule book they are following...they have seen bubbles and busts come and go many a time over. I suspect once the foreclosure mess bottoms out they will lower the land prices a bit and start going for a more realistic upper middle class housing (100-150k a year family income) aka what they did for Woodbridge. But that might still be 2 years out.
 
[quote author="PadreBrian" date=1210821589][quote author="IrvineRenter" date=1207350861]"clarify what you mean by "protective", I'm assuming you mean that TIC is attempting to shut down elements that have a negative effect on land, specifically, media outlets, even more specific, IHB."





They are doing that too, but that particular behavior wasn't what I was focusing on when I wrote the post. When I say they are being "protective" I mean they are trying to avoid doing anything which will facilitate a decline in prices. IMO, the logical move for the Irvine Company would have been to lower prices on new homes and meet the market. Instead, they basically shut down all construction on the Ranch when prices went south in 2006. I don't know how many sales they had in 2007, but it wasn't very many. They know that must-sell inventory drives prices lower, and they have decided not to contribute any must-sell inventory in the form of new houses. Of course, this isn't going to save the market because the other form of must-sell inventory -- foreclosures -- is going to bury the market. I believe they would have been better served by continuing to build while prices declined because they still would have captured revenue while prices were inflated. What is going to happen now is they will finally give up waiting, and they will start to build at much lower price points, and they will have missed the revenue they could have achieved when prices were higher. Prices are going to go where they are going to go. The Irvine Company was engaged in wishful thinking when they embarked on a policy of stopping construction in the hopes that prices would recover.</blockquote>


You're right. Irvine Ranch thought they could just cut off the new house spigot and the prices would stabilize. So far their plan has worked only mildly. Things aren't out of control in Woodbury or PS, but older neighborhoods are still under huge threat...hi Quail Hill....BUT things could have been way worse...see Lake Las Vegas for more info. Remember, this family has been at this game for decades. There's a Irvine Family rule book they are following...they have seen bubbles and busts come and go many a time over. I suspect once the foreclosure mess bottoms out they will lower the land prices a bit and start going for a more realistic upper middle class housing (100-150k a year family income) aka what they did for Woodbridge. But that might still be 2 years out.</blockquote>


One thing I have found interesting in this decline is that the builders off the Ranch did not follow the early 90s playbook. They have been aggressively cutting prices and moving their inventory. Remember when Jim Cramer said we should bulldoze the Inland Empire? Right now, there is only 4 months inventory of new homes in Riverside County. They have almost completely worked off their inventory by reducing construction <em>and </em>aggresively lowering prices. The Irvine Company only did one of the two. They now have a huge inventory of finished lots and a nearly non-existent sales rate. Only recently have they begun lowering prices to find the market, and they are not there yet. I suspect they will chase the market all the way down.
 
Yep, you're right, seems to me as well they are chasing the market down down down...BUT I think the ranch has a few more years to play with. The land was basically free, so the only things they are holding loans/bonds on are the lot improvements...



Which are a TON. These bonds are just ticking away. I count seven different areas sitting with some phase improvement but housing that wont appear for a decade! All the phases of The Orchard. 4 Stages of Portola Springs, 2 Districts in Woodbury, all the phases in Woodbury East, the two ancillary developments bordering Woodbury, all the phases of Laguna Crossing....I'm sure I'm missing a few.



They will have to do something about their sitting developed land with the bare minimum being finishing the 2 ready stages of Portola Springs, the 2 in Woodbury, and the all of Woodbury East in the next 2 years. I count 2500 Homes.



What, they must have sold 100 lots last year?
 
[quote author="PadreBrian" date=1210825808]Yep, you're right, seems to me as well they are chasing the market down down down...BUT I think the ranch has a few more years to play with. The land was basically free, so the only things they are holding loans/bonds on are the lot improvements...



Which are a TON. These bonds are just ticking away. I count seven different areas sitting with some phase improvement but housing that wont appear for a decade! All the phases of The Orchard. 4 Stages of Portola Springs, 2 Districts in Woodbury, all the phases in Woodbury East, the two ancillary developments bordering Woodbury, all the phases of Laguna Crossing....I'm sure I'm missing a few.



They will have to do something about their sitting developed land with the bare minimum being finishing the 2 ready stages of Portola Springs, the 2 in Woodbury, and the all of Woodbury East in the next 2 years. I count 2500 Homes.



What, they must have sold 100 lots last year?</blockquote>


I found it very surprising that they developed all those lots at a time when they are not selling any homes. If it sits there as raw land, their carry is basically zero. Once they develop it, they have carrying cost on all the debt. Granted, they get a good deal on the CFD bonds, but it is still a cashflow drain that they would not have if they had simply waited on the new developments.
 
Yep. With them shutting down their entry house developments, I'm not sure what their next move is. Sitting on 2000 fully developed lots is not fun at any price.



OH! And what's up with them throwing up those 2 new apartment complexes across from Woodbury? Do they know something we don't? Are they getting ready for the next wave of foreclosures?
 
[quote author="IrvineRenter" date=1210824046]

One thing I have found interesting in this decline is that the builders off the Ranch did not follow the early 90s playbook. They have been aggressively cutting prices and moving their inventory. Remember when Jim Cramer said we should bulldoze the Inland Empire? Right now, there is only 4 months inventory of new homes in Riverside County. They have almost completely worked off their inventory by reducing construction <em>and </em>aggresively lowering prices. </blockquote>




Have you been reading the housing-kaboom blog by golferX?



He profiled west riverside today. Both there, and in Corona there are still a lot of new houses sitting, some for as long as 3 years. The problem is what is left was the formerly high priced stuff (4k sqft, 1/2 ac lots). No one is buying it, even as it drops down from $900k to $500k. It is all going to be "New-Old houses" soon.
 
[quote author="freedomCM" date=1210840899][quote author="IrvineRenter" date=1210824046]

One thing I have found interesting in this decline is that the builders off the Ranch did not follow the early 90s playbook. They have been aggressively cutting prices and moving their inventory. Remember when Jim Cramer said we should bulldoze the Inland Empire? Right now, there is only 4 months inventory of new homes in Riverside County. They have almost completely worked off their inventory by reducing construction <em>and </em>aggresively lowering prices. </blockquote>




Have you been reading the housing-kaboom blog by golferX?



He profiled west riverside today. Both there, and in Corona there are still a lot of new houses sitting, some for as long as 3 years. The problem is what is left was the formerly high priced stuff (4k sqft, 1/2 ac lots). No one is buying it, even as it drops down from $900k to $500k. It is all going to be "New-Old houses" soon.</blockquote>


At work, I have access to a proprietary market report on the happenings in Riverside County. There are certainly places where they are having difficulty moving inventory, but they are moving it by lowering prices -- a lot. This is very different than their behavior in the early 90s. They kept building and kept prices high while the inventory piled up.



I like his blog, BTW.
 
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