Lennar's sale of 11,000 lots in seven states to Morgan Stanley, which the two companies agreed to a week ago, will bolster the giant builder's cash flow, provide tax benefits, and possibly improve its stock price. But it's unlikely that the $525 million Lennar-Morgan pact will become a model for other companies' future deals, even as several builders, developers, and private equity firms amass their troops and credit lines to acquiring property.
For example, Charlotte, N.C.-based builder Crosland Communities announced this morning that it had formed an investment fund with Northwestern Mutual that has committed $225 million to land acquisition, with the partnership's potential investment in land and residential and commercial development projected to total $1.5 billion. And the Wall Street Journal reports that Newport Beach, Calif.-based John Laing Homes made its first-ever land purchase in Phoenix a few months ago, when it bought 136 lots from the developer SunCor.
But unlike such straight-up land transactions as D.R. Horton's recent sale of around 23,000 lots on 7,000 acres in Arizona to two real estate investment firms for $70 million, the Lennar-Morgan joint venture-which will acquire, develop, manage, and sell residential real estate-is seen as unique, in that Lennar will retain a 20 percent ownership stake and 50 percent voting rights. Lennar also will receive fees for its management services and retains right of first refusal on finished lots.
"I give Lennar a lot of credit," says industry consultant William Becker, "because they jumped the gun on the other [big builders]" in terms of controlling land assets while getting them off of its balance sheet. But Becker also believes that large builders pursuing similar joint ventures must accept the reality that "it's not going to be 50-50 anymore. The acquirer is the one that's going to be in command, and the builder is going to have to give something up to get off the hook."
Lennar may actually be sacrificing very little for a deal several analysts and industry watchers see as being advantageous on a number of fronts. For one thing, by selling land at about two-fifths of its estimated book value of $1.3 billion, Lennar can apply that loss to taxes paid two years back or 20 years forward. Its tax refund could be between $250 million and $300 million. (This deal reportedly was consummated between the two partners 2 1/2-hours before Lennar's fiscal year ended on Nov. 30.)
Wachovia's housing analyst Carl Reichardt thinks that it would be "foolish" for anyone to assume that the discounted price Morgan paid for Lennar's land will lower the bar for other housing-related real estate transactions. "Forty cents on the dollar is not a measure to use," he explains, because the ownership and fee structure of the deal could reward Lennar financially down the road. He and other analysts also note that Lennar's stock price could get a boost from this deal, because with less land on its books, an element of "uncertainty" that real estate introduces to any valuation of a company is lessened.
Reichardt and Jim Fielding, Standard & Poor's housing analyst, both see Lennar as being among a handful of big builders-Centex and KB Home are two others-that are moving away from a business model that relies heavily on margins from land assets and more towards a greater focus on just-in-time and build-to-order construction.
By selling land, Lennar also strengthens its cash-flow position, which leads some observers to speculate that the company is preparing to make a major acquisition of its own. That remains to be seen, of course, but builders in general that are winnowing their land holdings are likely to be in better cash positions. Zelman & Associates, a New York-based market research and consulting firm, estimates that the 14 public builders it tracks spent $160.9 billion on land in the years 1999 to 2006. The firm also believes that land acquisition-related expenditures among these builders fell by 52 percent in 2007 and will fall again by 50 percent in 2008. D.R. Horton alone has disclosed publicly that it would reduce is land acquisitions next year by between 60 percent and 80 percent.
"Builders have more land than they can use right now, land has high carrying costs, and they need cash," says Ivy Zelman, this firm's president. However, Zelman notes that the ability of any builder to shed land holdings could be encumbered by its debt structure with lenders and "tangible net worth covenants" that could be triggered if a company's assets drop below a certain level.
Nevertheless, Zelman says that she's hearing about "lots of deals in the works, only not as big as the Lennar deal." And with so many builders in precarious financial shape, land might not be the only thing that investors are looking to acquire. Last summer, Starwood Capital Group formed a Land Ventures division that Starwood's managing director Rich Kleeman says would have a "very large appetite," which could translate into several hundred million dollars in land acquisitions a year, and "conceivably" could include acquiring a builder down the road. John Peshkin, the former Taylor Woodrow CEO who runs Starwood's Land Ventures business, tells BUILDER Online that while the Lennar-Morgan deal may turn out to be "more of a headline grabber" than something that has a tectonic influence on the market, he nonetheless concurs "it's clearly a buyer's market." And while land prices have yet to find their bottom, "things have really changed dramatically" since October, says Peshkin, in terms of land sellers' willingness to work with investors like his company to reach an amenable price.
It's less clear, though, whether private equity has all that much interest in actually owning a home builder, even as the rumor mill has no shortage of builders that are said to be on the block. Becker says he knows of one top-10 builder that has had at least five presentations made to it from parties interested in buying the company. Yet, despite all of the turmoil within the housing industry over the past year, and despite so much private equity money that's supposedly circling the industry, there has been little merger or acquisition activity. Why? "Because no one wants to catch a falling knife," says Fielding, meaning that the valuation of any company in a down market that isn't expected to recover for another year is tough to calculate.
Short of being acquired or going out of business, the survival of many builders now rests with how well they manage their assets, which is likely to mean that more property is going to be on the market. On the day it finalized its deal with Morgan, Lennar sold 8,300 lots on 3,600 acres in Florida to the Tampa, Fla.-based Metro Development Group for an undisclosed amount. (Zelman estimates that Lennar controlled between one-third and half of this land via options, and the cash proceeds from the deal with Metro were $20 million or less.)
Rob Ahrens, a vice president with Metro (and a former division president with Lennar), says his company intends to bank this land for "one or two years, until builders are ready to purchase again." He expects Lennar, which has been Metro's biggest customer, eventually to be one of the buyers of finished lots.
Ahrens says his company is looking to buy more land in Florida, Texas, and the Carolinas. As for whether prices are lowering, "we're starting to see a few deals trickle in," he says.