New Home Sales are Dead

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IrvineRenter_IHB

IrvineRenter_IHB

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As many of you know, I work for a private land developer. We generally develop raw land and sell it to the builders. We watch the markets for raw land, tentative tract maps, bluetop lots (graded but no infrastructure), and finished lots very closely.





It is difficult to explain just how bad the market for lots is right now. During the bubble years, builders were buying tentative tract maps (also known as paper lots). The builders would then finish the lots in preparation for building houses. They wanted to buy the tentative tract maps because they wanted the developers to take on the entitlement risk, but then they wanted to obtain the appreciation thereafter. This meant the builders had a great many paper lots on their books that were on their way to becoming finished lots. As the sales figures started to decline, they stopped buying paper lots, but they still had a full pipeline they were finishing and many more that were ready to build on. When sales really started to drop, they were caught with all of this inventory on their books and no way to get rid of it (ordinarily they would just build it out and sell it.) Right now, the sales for new homes is the slowest ever recorded. <a href="http://forums.irvinehousingblog.com/discussion/576/9/most-important-post-ever/#Item_16">Lendingmaestro was right. </a>Tightening credit has been the death knell of the housing market.





The builders are really hurting for cash right now. There are simply no buyers. Each month I sit through an acquisitions meeting at my company. I see almost every major parcel for sale in Southern California and in some other markets. I have never seen deals like the ones we have been seeing lately. It is so bad that builders and overextended developers are selling properties with approved maps and sometimes graded lots for about 10% of peak value. These properties have no market -- there is no bid. None of the homebuilders are expecting a rebound in prices any time soon. They would be very happy for even a minor rebound in volume. Nobody thinks it is going to happen.





An investor buying one of these properties would be betting on the return of the housing market. If it gets cheap enough, these are excellent land banking opportunities. Anyone owning land right now is a bagholder. Anyone with debt on that land is headed to foreclosure. This is going to create some incredible opportunities for acquiring land assets at very low prices from those desperate for cash. You may have heard many of us on the board preaching that cash will be king. It certainly is in the land market already.
 
Have you driven through Orchard Hills? I would guess there are a couple hundred acres of graded, finished lots, with all the underground in, finished block walls, and landscaping being finished on the common. IR, what do you think that cost? And I see no evidence of any foundation starts. None.
 
It will be a large amount of money. In tract costs run about $40,000 per lot, the impact fees will be about $80,000 per lot, and there is probably another $40,000 per lot in off-site infrastructure. The Irvine Company will be able to recover a significant portion of these costs through a community facilities district (CFD), so they may only be out-of-pocket $50,000 per lot, but when you multiply that by the number of lots out there, and it becomes some serious money. Plus, they will be the only landowner, so they will be paying the debt service on the CFD through Mello Roos, and they may have some debt on the property. However, if anyone can absorb the carrying costs of land, it is the Irvine Company.
 
<em>>> The Irvine Company will be able to recover a significant portion of these costs through a community facilities district (CFD)</em>





Exactly what I was thinking. Aren't CFDs great?





I suppose I ought to trek over to the County. What are the odds that TIC had the bonds - excuse me, that the CFD district board had the bonds - pay only interest for two or so years, and that principal doesn't start to be repaid until 2009 or 2010. I don't know if that's what they did, but if I was still doing that kind of work, that's what I would have suggested.
 
Hmm... if you really know of graded or finished lots selling at 10% of peak, let me know. I am interested in acquiring land and have several investor friends who would be as well at those prices.
 
IrvineRenter, I appreciate your insight, and all the work you do on the blog. Although I don't think the time is quite right yet, I am interested in purchasing land. What is the best way for a small investor to take advantage of upcoming opportunities? Like you, I don't have debt, and I do have a substantial amount of cash and an above average income. I have about 25 years to go before I retire, and don't mind sitting on an investment for a while before I ring the cash register.





Any input you can offer would be appreciated.





Thanks again.
 
<p>After reading IR's post I checked the last quarter results for Khov because they are having "the sale of the century" and StanCrap who needs complete "mission impossible" by selling 200 homes by quarter end. If either one of these builders is in the category of trying to sell land at 10% of the peak price then neither one has properly written down the value of the land they hold. Since both have significant exposure to California I would suspect this is true. What is Enron like is since they haven't marked their land to market booking it as an asset so they can continue their credit facilities. If both were to mark to market their land they both would be in violation of the covenants of their credit agreements with a strong possibility that they would not be able to get an exception and these agreements would be revoked.</p>

<p>KHov would have bleed over a $100mil if they didn't have their credit line (that they tapped into for another $200mil) and deferred tax provisions. They not only have significant exposure to CA but Florida as well. Their gross profit margin in CA dropped 67% YOY from the same quarter. However the land and inventory they hold increased in value. If they were to mark to market they would be in even more serious trouble.</p>

<p>StanCrap was in a similar boat but at least they didn't tap into their credit lines. They used their tax provisions and hasn't marked to market their land. The difference here is they had $171mil of loans held for sale booked as an asset in June. At best they are worth 75% of that today with the secondary market lack of demand.</p>

<p>Both warned that they may violate their credit agreement covenants if they have further land write downs or impairments. Which clearly they are violating by not marking their land to market.</p>

<p>As many of you know I follow the foreclosures. I rarely check the I.E. especially now since the foreclosures have soared but I did recently. I found two that had a NTS over $4mil and after looking into them they were land deals that builders backed out on leaving the current owner as the bagholder.</p>

<p>Marty - I am sure IR and anyone who hasn't been laid off already has in the back of their head that they may lose their job. The difference is people like IR and a SVP I know who started warning people before the you know what hit the fan are the ones who are now in the best position. The people who kept drinking the kool-aid are the ones that are having trouble. I know where you want to go with this and say that IHB and the other doomsayers were an influence who caused this but the reality is it boils down to econ 101. If IR and the like I know start to lose their jobs it will only excerbate the problem and prices will crash even further. If you know who is hiring people who drank the kool-aid for too long let me know. I know several very talented people who are off the sauce now that could use a high paying job like they had.</p>

<p> </p>
 
<p>Oh and I will need to contact IR about some land deals. I have a Korean connection that would love to buy some deals with cash. See NIR is right the asians are willing to buy. Of course it needs to be cheap.</p>
 
<em>"IR -- are you worried about your job? Just curious. "</em>





There were some times I have been, but I work with a company that sold most of its holdings during the bubble and is sitting on a mountain of cash. We will be buyers when the market ripens further. Development is counter-cyclical. If you are working for a well-capitalized developer, your job is relatively secure.
 
<em>"Hmm... if you really know of graded or finished lots selling at 10% of peak, let me know. I am interested in acquiring land and have several investor friends who would be as well at those prices."</em>





Obviously, I could not tell you, but if you look, you can find them. You have to be a big player though. Builder tracts are generally 100 lots or more, so even at $10,000 a lot, these tracts are over a $1,000,000. Most of these deals are north of $5,000,000 even at fire-sale prices. It will need to be cash because no lender will touch these properties. Plus, you really need to understand what you are buying as most of these tracts are at some stage in the development process. The builders are not dumping their finished lots at that kind of a discount yet.





There will be excellent opportunities in the small-tract and infill property markets. These are where I would focus if I were a smaller investor or consortium. These are buy-and-hold deals, so you need to keep any overhead to a minimum. We have no idea when the market will come back, but it won't be any time soon.
 
I'm sure many have already saw this but the Dataquick numbers for the O.C. are staggering.





August home sales are down 33.9% from Aug. 2006 and 48.9% versus the average.





The number of homes sold between May and Aug (prime selling season) was approximately 665 less than that for Jan to April. (9,992 v. 10,661)





Defaults are up 26.5% vs. July 2007 and 196.4% from last August. <strong>Foreclosures are up 27.8% from July 2007 and 694.9% from last August</strong>. Overall, the year-to-date average for foreclosures are up <strong>800% from last year.</strong>





Worse to come?
 
I'm waiting for the month when only 5 homes sold at $1.5 million each. The headline can then read "Median price reaches all time high at $1.5 million!!!"





Then the NAR can come out and say that its a seller market and that everyone needs to buy before the median price hits $2.0 million. Lawrence Yun will say something like "the laws of supply and demand does not apply to Orange County. It is oblivious to economics."
 
10% of peak prices is still far too small of a drop. Especially if we consider the pricing from the 1997 sales brochures + inflation adjustments in cost of labor and materials. 3% of peak prices is probably closer to where this will end up.





IR I would be saving aggressively in preparation for being laid off. I am very doubtful any developer will spend money on mapping unless they are crazy right now.





Actually I do know a lender willing to write 70% LTV on raw land in SoCal at below 8%. So if you need financing you can get it.
 
<em>" IR I would be saving aggressively in preparation for being laid off. "</em>





I have been. I have no debts, and I have supplemental income, so I am not too worried. I have been preparing for this since 2004. Not drinking the kool-aid has had some advantages.


<em>


"I am very doubtful any developer will spend money on mapping unless they are crazy right now."</em>





We aren't. Even if you aren't actively buying, you still need an acquisitions department to prepare for when you are ready. We are tracking these properties to evaluate where the proper entry point would be. We anticipate buying many of these from the banks after foreclosure. Plus, there is a price point where it is so cheap, you can hold it for 10 years and still make your required rate of return. Your 3% number is probably not far off.


<em>


" Actually I do know a lender willing to write 70% LTV on raw land in SoCal at below 8%."</em>





IMO, those bankers are crazy. Of course, I suppose it comes down to how you evaluate "value" for the LTV calculation. Appraisals are all over the map right now. It is very difficult to estimate value on properties when the market suddenly and violently deteriorates. I suspect the banks may talk a good game, but the process of actually obtaining that loan will be cumbersome. I imagine these banks will start wanting personal guarantees and other pledged collateral which no borrower will want to do.
 
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