Home builders around the country have been swamped this year with news reports of public builders selling land for some fraction of its peak worth to get out from under the carrying costs on loans now worth more than the land's value.
Those large builders have teams of number crunchers and a roster of well-paid consultants and financial advisors to help them evaluate what their land might be worth, and what they might be able to get for it in a sale.
A number of smaller builders got a similar dose of high-brow land valuation thinking in October as Lee Evans Group senior consultant Jim Weigel, a former banker and land advisor, offered tips on how to evaluate finished lots, lots under development, and raw dirt, and how to present information to banks during a Webinar run by consultant Chuck Shinn of Shinn Consulting in Littleton, Colo. Watch the webinar in its entirety here.
"We've been hearing all this stuff about how land is selling at 40 cents on the dollar, 60 cents on the dollar--that doesn't matter," Weigel told builders, bankers, and manufacturers. "It really needs to be selling at 15 cents on the dollar. And that's not even for raw land. That's for a combination of raw and finished lots."
While builders have been writing down the value of their own lots to be able to sell homes closer to market prices, the prices of lots for sale have not come down nearly as far, so very little land is being sold and even fewer new developments are breaking ground.
"That's where we are now, and it's probably going to continue through 2009," Weigel said.
What to do? Weigel contends that builders need to make the case to their lenders that everyone's financial interests would be best served if builders can finish their projects and get as much return as possible on the lenders' investment. If a lender takes all of a builders' assets now and tries to liquidate them in the current market environment (assuming they could find a buyer--a big assumption), they would take a substantial loss due to flagging land values and minimal demand.
The lender would also incur a slew of costs in taking on any project. Depending on the status of the project, those costs could range from hiring new crews, buying construction materials, and marketing and selling costs all the way to the possibility that some portion of the project would have to be torn down and rebuilt due to either vandalism or weather-related damage.
"Most of the time, when a bank owns something and sells it, they take about a 20-30% haircut in the market," Weigel said. "Then they're going to be exposed to additional costs for warranty and other obligations that continue after those houses are sold."
Weigel highlighted the case of a hypothetical builder whose numbers were based on what Shinn Consulting's clients are facing. That builder has seven closed homes, 10 more under construction, and six under contract that haven't been started yet. The builder also has seven spec homes and a second phase of development of 30 lots that are about 60% of the way toward entitlement.
Looking at the 10 homes under construction (each with an approximate price tag of $200,000): the builder owes its lender $925,000 of debt on them, and it will cost the builder another $675,000 to complete the homes, making the lenders' exposure $1.6 million. If the builder were allowed to complete the homes and sell them, they could generate $2 million to pay back the bank and have money left over. However, if the bank took the development, it could cost that bank as much as an additional $1 million, on top of its $1.6 million loan, with a maximum return of $2 million.
That is the case, Weigel said, that builders must make to their banks.
The builder's 30 lots under development have already lost 50% of their value from their peak and are now worth only $25,000 when entitled. But since they are only partially entitled, it will cost another $300,000 to finish developing those 30 lots. So that $300,000 has to be subtracted from their value, leaving their current value at $400,000 total, or $15,000 a lot.
If the lots were sold to a developer who would take on the project and have to build its own overhead and profit costs into the project, then the value decreases further. With Weigel's calculations, selling those partially developed lots in this market could yield maybe $190,000, or $3,700 per lot, just 15% of the potential value of the lots if they were sold as finished, and just 7.4% of their peak value of $50,000.
Raw land that has not been improved at all is now literally worthless, Weigel said. The cost to develop raw dirt in many places is either equal to or greater than the potential value of the land.
Weigel advised builders to try to tailor their business models to acquire land just in time, instead of buying, holding, and developing land, as has been the standard model in home building and a practice that has led to countless builder failures and massive debt loads.
Weigel also gave a last bit of advice, about how to tell when the market is coming back. He suggested that the builders track existing neighborhoods that tend to sell well in their areas and calculate the price per square foot on a monthly basis of similar homes that have sold.
"Once those per-square-foot values start increasing just a little bit, then you've probably turned around," Weigel said.
Ethan Butterfield is senior editor, business, for BUILDER magazine.