Housing: Hope on the Horizon

You would think the nation's biggest homebuilders would be writhing in pain right about now. Sales of new single-family homes sank in January to the lowest seasonally adjusted rate in nearly five decades of record keeping and are now off 78% from the housing market's frothy peak in 2005.

Yet in a housing industry as vast and varied as America's, the data often fail to keep up with reality. It turns out that big publicly traded builders, thanks to cost-cutting, asset sales, bond issues, and tax breaks, aren't in grim shape. Their shares have nearly doubled over the past year and they're back in the game of competing for land, reflecting confidence that after years of falling prices, rising foreclosures, and busted dreams, better days are ahead.

The number of lots owned or controlled by a dozen of the biggest builders rose slightly in the second half of 2009 after years of decline as renewed buying offset heavy tax-related selling of unwanted parcels, according to a Bloomberg analysis of company reports. In crash-prone markets such as Southern California and Florida, prices of some construction-ready lots are up 50% or more from their 2009 lows. "There is definitely a shortage of land, and you cannot turn the switch on overnight," says Douglas C. Yearley Jr., executive-vice president of luxury builder Toll Brothers (TOL). "That will cause builders to aggressively buy the land they can."

Land buying began to pick up last year after finished lots hit the market at below the cost of improvements, and housing prices stabilized. Builders could finally turn out homes with some assurance of making a profit, says Scott D. Clark, the CEO of Americap Development Partners, a residential land developer in San Ramon, Calif. Greater affordability and tax incentives should help in the short term. What's more, the big builders believe population growth will eventually require a burst of construction. Warren Buffett agrees. In his Feb. 27 letter to shareholders of Berkshire Hathaway (BRK/A), which owns manufactured-housing maker Clayton Homes, he predicted that "within a year or so residential housing problems should largely be behind us."

Bargain Buying

The builders are staying disciplined for now, selectively scooping up bargains while buying just what they need to meet expected demand for the next few years. "There isn't one public homebuilder that's stupid. They're all well-seasoned. They've shrunk down to the size they need to be, and now they're reacting accordingly" to opportunities for growth, says James T. "Nate" Nathan, the president of Scottsdale (Ariz.)-based land broker Nathan & Associates.

It's tough to say how much land prices have risen because each market is different. Last year, DMB Associates, a developer in Scottsdale, and its partners bought back about 400 lots in DMB's Verrado master-planned community in Buckeye, Ariz., that builders had acquired and then defaulted on. They spent about $15,000 per lot, then quickly resold 300 of the lots to other builders for an average $40,000 per lot. Nationally, though, increases have been considerably smaller than that.

The uptick in prices matters because land is the main factor in real estate's roller-coaster cycle. When housing prices boomed in the middle of the last decade, it wasn't the structures that were suddenly deemed more valuable but the land. Economist Morris A. Davis of the University of Wisconsin-Madison School of Business estimates that the price of U.S. land used for houses and apartments nearly tripled from the beginning of 2000 to the end of 2005. Prices more than tripled over the period in Washington, Miami, Tampa, San Diego, Los Angeles, and Phoenix, and better than quadrupled in two inland California markets, Sacramento and San Bernardino, Davis estimates. He figures that national land prices fell nearly two-thirds through early 2009 before bouncing back more than 20% in the rest of '09. (To calculate the implied value of land, he takes the fluctuating market value of residential properties and subtracts the relatively stable replacement cost of the structures on them.)

The sharp decline in land prices was especially hard on the small builders that account for about 70% of the market. The National Association of Home Builders says its membership has fallen by about 20%, or 45,000. Many that remain have slashed staff. Jerry Howard, CEO of the NAHB, says banks are refusing to extend credit to small builders and stiffening the terms on existing credit.

In contrast, most of the big builders whose shares are publicly traded are battle-hardened and ready to grow again. Writedowns and write-offs by 13 of the largest public builders exceeded $32 billion through December, according to Fitch Ratings. In contrast to small builders, which rely almost entirely on banks for financing, several big builders were able to raise funds by issuing bonds.

Tax-Refund Windfall

An additional boost came last year when Congress passed a law allowing companies to get refunds on past years' tax payments by applying their recent losses to earnings dating back five years. Many sold land at big losses to boost their refunds. The result was a windfall of $2.3 billion for the builders as a group, including $800 million for No. 1 Pulte Homes (PHM).

The result of those balance-sheet heroics? Builders have more than $12 billion in cash they can use to replenish their land inventory. Pulte and D.R. Horton (DHI) each had $1.9 billion in cash and near-term equivalents at the end of December, Toll Brothers had $1.6 billion at the end of January, Lennar (LEN) had $1.3 billion, and KB Home (KBH) had $1.2 billion at the end of November.

Some of that cash is going for parcels that weaker builders lost through default or short sales. On Feb. 25, Starwood Land Ventures of Bradenton, Fla., announced it received "interest from nearly every major homebuilder in Florida" for about 5,400 residential lots it bought in the bankruptcy auction of Hollywood (Fla.)-based TOUSA, one of the few big builders that bit the dust. Lennar was first in line, agreeing with Starwood to acquire or get purchase options on more than 2,700 of the TOUSA lots across Florida. The price wasn't disclosed, but Lennar said it expects to earn gross margins of 20% or better on the deal. In Loveland, Colo., land broker Craig Harrison of Harrison Resource Corp. says he's "in shock and awe" at the amount of interest he's getting from builders and investors for 5,000 acres of land across northern Colorado that recently went on the market for $177 million.

Builders are buying land in part because the parcels they have aren't in the places where they need them. Property on the outer fringes of metro areas is still out of favor, says Daniel Oppenheim, a Credit Suisse (CS) homebuilding analyst. Prices have risen the most for closer-in lots that already have sewer lines, water, electricity, and sidewalks, because builders can throw up houses on them quickly and sign deals by Apr. 30 to qualify for federal homebuyer tax credits. Builders that aren't focused on a quick sales pop are choosing to buy cheaper "paper lots" that lack infrastructure, says Jody Kahn, vice-president of regional markets for Irvine (Calif.)-based John Burns Real Estate Consulting.

Interest in unfinished land usually comes later in the housing cycle, says Thomas E. Lucas, senior vice-president of operations for DMB in Scottsdale. "We didn't think we'd sell raw land for three to four years," Lucas says. That's a striking vote of confidence considering the threats to housing from high unemployment, rising mortgage rates, and foreclosures.

Everything seems to happen faster these days—including the housing cycle, which is heading up before it has hit bottom.

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