THE FIRST CASUALTIES OF THE HOUSING industry's downward slide have started to emerge. In August, a small Phoenix-area builder, Turner-Dunn Homes, filed for protection under Chapter 11 of the U.S. Bankruptcy Code, with 100 creditors and at least $22 million in liabilities. In September, another company in trouble came up when Toll Brothers officials told analysts and investors at a symposium in New York that their company had assembled a team to evaluate the possible acquisition of a distressed California-based builder. (Fred Cooper, Toll's senior vice president of finance, declined to identify the builder in question.)
But the biggest case so far is East Brunswick, N.J.–based Kara Homes, the industry's 127th largest builder in sales last year, which on Oct. 5 filed for bankruptcy protection from 1,000-plus creditors. Over the past several years, Kara—which was founded in 1999—had been recognized by various business publications, including Builder, as one of America's fastest-growing companies. However, it was forced into Chapter 11 because it “ran out of money,” its attorney, David Bruck, told the Star-Ledger of Newark, N.J. Builder couldn't reach Bruck, and Kara's CEO, Zudi Karagjozi, declined to be interviewed at press time.
In 2005, Karagjozi told this magazine of his goal to double his company's size—Kara Homes closed 590 homes and generated $288 million in revenue that year—within two years. But in early 2006, he told Builder that he had nixed those plans in response to slowing buyer demand. Like many builders, Kara tried to stimulate sales through generous incentives and mortgage buy-downs. But it now appears that, as market conditions worsened, Kara's financial situation became more dire: Its bankruptcy filing reports $296.8 million in liabilities, $238 million of which is bank debt. Kenneth Zener, Merrill Lynch's housing analyst, estimates that Kara's debt-to-capitalization is 82 percent. “Kara's filing underscores the risk regional builders take by using high leverage and short-term financing,” wrote Zener in an Oct. 9 report on the company.
Merrill Lynch's analyst noted that Kara's difficulties call attention to the importance of regional diversity for builders to succeed. Kara is active only in New Jersey, where its 29 communities feature homes ranging from 2,500-square-foot attached townhouses to 6,300-square-foot palaces. Its business model required the company to secure big land tracts for large, expensive homes in a state where land acquisition has become extremely difficult.
What industry watchers must be wondering is whether Kara's problems are simply those of a builder that flew too fast and too close to the sun and got burned, or if these are the first signs of potentially wider failures among financially shaky builders that could fall prey to larger, stronger companies. “Kara is already at the table. We expect more people to come to dinner; the question is, how many more?” Gerald Cassidy, managing director for Maine-based RBC Capital Markets, told Bloomberg News.
If anything, market conditions are likely to expose marginal builders that primarily stayed afloat on dual life rafts—the industry's robust unit sales and price appreciations—that are now leaking air. Prior to its Chapter 11 filing, Turner-Dunn Homes had walked away from the completion of about 200 homes in Arizona's Pinal County, stranding homeowners who had plunked down earnest money. Its bankruptcy was precipitated by a $23 million lawsuit filed by its secured creditor, Ohio Savings Bank, which initiated foreclosure proceedings on the 450 lots the builder used to collateralize its debt, according to the Arizona Republic.
Kara reportedly has reduced its headquarters staff significantly. But Bruck assured the Star-Ledger that the builder would complete the homes it has started and might sell some land assets “to return to its core business at a more manageable level.”
Learn more about markets featured in this article: Phoenix, AZ.