While many builders have been quoted in newspapers saying the media has overblown the severity of the housing downturn, some home building consultants are saying the picture is far bleaker than even the media is portraying.
“We’re at complete and utter despair,” says Noelle Tarabulski, CEO of Builder Consulting Group in Lakewood, Colo.
Tarabulski means to sound alarmist. Many builders are filing or preparing to file for bankruptcy, and she’s even talked to a number of builders who are leaving the home building business to try and find work elsewhere.
“People have to earn a living, so they’re thinking maybe they need to go into oil and gas, or maybe they need to build things for the military,” Tarabulski says. “Understand, we’re at a catastrophic state as an industry. We’re not in a downturn anymore; we’re way beyond that.”
Rhona Sacks, founder and president of Legal Life Settlements, a mergers and acquisitions advisory company, and an attorney and business coach who has written a paper on entrepreneurs facing bankruptcy that has appeared in several publications, has seen the downturn spread far beyond housing.
“Restaurants have been deeply impacted by this,” says Sacks. “I’ve seen restaurants offering gasoline vouchers so that people will leave their homes and drive to the restaurants to eat dinner. The collapse of all the home builder construction–related industries is really just the tip.”
Why are things so bad? Declining land values combined with banks worrying about their real estate–related loans has caused a number of banks to call on countless builders and land developers to either pay lump sum amounts to get their loan-to-value ratios back in order, to sell the land, or even to give it up to the bank.
Evan Smiley, a partner specializing in bankruptcy law at the firm Weiland, Golden, Smiley, Wang Ekvall & Strok in Costa Mesa, Calif., and coauthor of Bankruptcy for Businesses, pegs the problems that banks and builders are having on declining land values.
A bank’s reaction, mainly out of fear for its own financial health, is to declare default or send the builder notice that the bank doesn’t intend to renew the loan. Or the bank may tell the builder it needs to pay down the loan, often through personal guarantees, to somehow re-leverage the transaction and decrease the bank’s risk, Smiley says.
How a bank or banker will handle any given situation will vary from bank to bank and person to person within each bank, but Smiley offers three strategies for a builder facing tough times.
A builder must maintain good communication with its lenders, he says. Lenders are unlikely to want a builders’ land, especially if they are dealing with many builders and facing the proposition of owning huge amounts of land, and will therefore try to be cooperative. Smiley says banks are doing a better job of working with builders than they did in the 1990s housing bust in California.
“I’m finding that [some builders have] conflicts with that, obviously,” says John Burns, president of John Burns Real Estate Consulting in Irvine, Calif., as builders think they are better off keeping the worst news from their creditors. “But as soon as the bank loses trust in the builder, negotiations break down and they can even get personal.”
A builder can also pay down the value of the loan, sometimes on their own, sometimes by bringing in new money, Smiley adds.
Some builders are being coached to impair their land so that it will be cheaper to build on later. But in doing so, they may be shrinking the value of the land below the value of the loan, triggering the banks to ask for payments or guarantees and creating a larger problem, says Burns.
And some banks, fearing for the health of their loan portfolios, are pulling out of real estate entirely, Tarabulski notes.
“They’re giving three months’ notice, and basically they’re saying, ‘Hey, go find another bank.’ That’s basically like saying you’re on a deserted island and there are 10 women and one guy, and the one guy saying, ‘Hey, go find another guy,’” she says.
Not a Free Pass
On the positive side, Smiley notes, there is a lot of money floating around.
“There’s a lot of money out there shopping for good deals,” he says. “It’s not, in my opinion, a lack of liquidity in the marketplace right now, but everyone’s looking for a deal.”
But selling homes becomes far more difficult once you’ve entered bankruptcy, because consumers will find out, Burns says.
“They’ll stay away from you all together,” he warns. “They’ll be worried that, ‘They might keep my deposit.’ Or ‘They might cut corners on the house.’ We’re seeing, when we go out in the market, if somebody’s in bankruptcy or on the verge of bankruptcy, the other sales agents are saying, ‘Well, don’t go buy over there. That guy is rumored to be in bankruptcy. ... Don’t buy from them.’”
Market conditions for new-home builders are deteriorating day by day, say the building consultants Builder spoke with.
Builders must seek expert advice; their human resources departments do not have the experience to adequately guide them through this crisis. Solving the complex problems that builders are facing requires specialists, say the consultants Builder interviewed.
“Our rule is, if you have six months of cash and you have non-recourse loans, most of the time we can restructure your company and save your company. You can come out as an entity,” says Tarabulski. “If you don’t have those, then you have to fight for every aspect of your assets to get as high a value as you can, and you can’t roll over.”
Builders need their own advocates, because their creditors will have a team of lawyers at their disposal and the issues that need dealing with are not simple—tax issues, life insurance policies, land, debt, possible cash infusions from private equity, and so on.
But before builders get to the stage of hiring experts, they must admit they have a problem, says Tarabulski.
“One of the problems is that builders are can-do guys. They’re the heroes by nature,” she says. “This is very psychologically hard for anybody, and they are having a really hard time saying, ‘I can’t fix this,’ admitting they can’t. And by delaying this, their chance of surviving this catastrophe and coming out the other side diminishes day by day. By day.”
Learn more about markets featured in this article: Los Angeles, CA.