Private equity firms continue their predatory circle around home building. Their strategy is straightforward: Buy land at distressed prices, hold these positions for a period of time, and then sell them at a handsome profit. Good examples would be Lennar's recent sale of 11,000 lots to a fund controlled by Morgan Stanley and the sale of 8,300 lots to MDG with financing from global investment firm D.E. Shaw.

Jamie M. Pirrello It makes perfectly logical sense, but the strategy is flawed. A catalyst that would move land prices high enough to validate such an investment doesn't exist.

Over-exuberant home buyers drove up prices during 2004 and 2005 as builders tried to catch up to demand levels they'd never before tried to meet. Home builders raised prices in an attempt to suppress demand, but–to their dismay–higher prices acted as an accelerant. Investors and flippers made matters worse as they pushed prices even higher, mostly dreading the possibility that they'd arrive too late to the game.

Home prices rose faster than income growth–good for margins, but bad for buyers. The gap between home prices and rents expanded. According to Fortune magazine, the historical ratio of sales prices to rents is 15 to 1. That ratio expanded by nearly 50 percent, reaching a peak of 24 to 1. Since incomes no longer adequately supported monthly payments, exotic mortgages gained quick currency. Home prices took a cue from this expanded access to easy money and soared even higher. An important assumption of exotic mortgages was: "If the borrower couldn't make the required payments, the property's [expanding] value would protect the lender's investment."

As the subprime and Alt-A mortgage liquidity began to implode, people's paychecks could not keep pace with higher home prices. Prices had one place to go; they had to revert to the norm, and the norm was much lower than the price levels achieved by 2006. In markets where prices rose the fastest and by the largest dollar amounts, they had farthest to fall.

Exotic mortgages, which relied on appreciating home values, began to collapse. Distress settled in, and prices spiraled downward. Where will it end? It will stop when the difference between incomes and rents justifies home prices given rational and prudent lending practices.

Now what can home builders and land speculators expect?

More of Less

Single-family starts peaked at nearly 1.8 million and have fallen to a seasonally adjusted 794,000 as of December. Most likely, starts will continue to fall. During the recession of the early '90s, single-family starts bottomed out just below 500,000 before reversing. Barring a significant increase in demand, housing starts can only move marginally higher through 2009.

Consequently, prices will continue to fall until they come back inline with incomes and rents. Without appreciation or a significant increase in demand, land prices cannot move higher. Land values are the residual result of market prices, less cost to construct, selling costs, carrying costs, and a fair risk adjusted profit.

If land prices don't appreciate, private equity firms speculating on a "buy and hold" play at the risk of disappointment.

Try to identify markets whose home price trend lines return quickest to their historical spreads with incomes and rents; these markets will stabilize first. In markets where large inventories of vacant homes exist, rents will be pushed lower as the oversupply of rental stock impacts the supply and demand curve. As rents move lower, home prices will trend downward to sync up with historical spreads. Until such time as incomes and rents begin to move higher, land prices will remain under significant pressure.

–Jamie M. Pirrello is the CEO of Vision Homes USA, a Fort Myers, Fla.-based home builder. He may be reached via e-mail at