There are two ways to win a game of musical chairs. Move fast and be well positioned. Winners are often both, plus a little lucky. Losers are usually neither.
The home market was a lot like a game of musical chairs. But the music went on for so long that some forgot that it would stop, or figured, surely, there would be enough chairs for everyone.
And then the music did stop. Suddenly, a lot of chairs were pulled out of the game at once, leaving many builders without a safe seat. Some builders have war chests of reserves–once earmarked as "dry powder" for growth and acquisitions–that are now serving as an operational cushion. And some builders have the opposite. They've got a load of finished homes and costly debt that, in such a drastically slowed market, they will have trouble paying back.
This is the story of five builders–Comstock Homebuilding Cos., Dominion Homes, Orleans Homebuilders, Technical Olympic USA, and WCI Communities–that, at the end of this round of musical chairs, may have trouble getting a seat.
Perhaps ego made their leaders think they were immune to a slowdown because they had the secret formula, the special sauce, and the superior business acumen. Perhaps greed led them to overextend themselves, buying land at ever increasing prices and moving into new markets fast, with other people's money. For some, fear of being left out of the game may have even been the primary driver that pushed them to buy land at any cost.
Or maybe it was the thin air that everybody breathed as the housing market soared sky high and margins swelled that made them think the ride would last forever. Then, as signs of a fall became evident, the first stages of grief and denial kicked in, keeping some behaving as though nothing was happening for far too long.
Bad luck can't be ruled out as a factor either.
There are two common threads among all five–they are all land rich and cash poor. What's more, their financial straits are going to cause more financial straits. It's not going to get easier, not while cancellation rates trend upward, and cash is so hard to come by.
These five companies, which industry experts agree appear to be the hardest hit of the big builders, are all publicly held. Maybe that's because they were more willing to risk more because less of their own money was at stake. Or it may be just that these five stand out because they are public companies, with disclosure requirements. Perhaps there are large private companies that should be on this list but whose dire straights won't be evident until they show up at bankruptcy court.
At any rate, their struggles are clearly in the limelight, and their outlook as "going enterprises" in the independent sense is cloudy. It's going to be another year of living dangerously. Here's why.
- Comstock Homebuilding Cos. (CHCI, NASDAQ)
- Markets: Georgia, Maryland, North Carolina
- Who's in Charge? Christopher Clemente, chairman and CEO, founded Comstock in 1985. Gregory Benson is president, COO, director, and regional president of the Southeast, and Bruce Labovitz is CFO.
THE SITUATION: Over the past year, Comstock Homebuilding Cos. in Reston, Va., has been hit hard on a number of fronts. Its stock prices plummeted from over $30 a share in 2005 to under $3 at press time, trading at about .4 percent of its book value. Sales have slowed and the builder's debt-to-total capital ratio ballooned to about 70 percent. Last quarter, it had $17.7 million in cash, while holding slightly less than $500 million in assets. Its desire to preserve liquidity has led to showdowns with banks. In the first quarter, it received a letter of default from Regions Bank on a loan of approximately $10.5 million. In 2006, it received another notice of default under a $46 million loan from Bank of America. Its pivotal Eclipse at Center Park in Potomac Yards project in Arlington, Va., faced delays of about six months. In its core market of Washington, D.C., it sold 79 homes in the first quarter, but 58 were cancelled. In Atlanta and Raleigh, N.C., it reported losses in the quarter.
HOW IT HAPPENED: Comstock reaped the rewards of the Washington D.C., area's real estate boom and now it's suffering from the fallout. During the height of the boom, the company got aggressive. It held a public offering in 2004. Then it went on a buying spree, purchasing land and condo conversion projects in its core markets. It bought Parker Chandler Homes in Atlanta and Capitol Homes in Raleigh, N.C. Critics contend the company paid too much for both of these companies and shouldered an excessive amount of debt in the process. With Parker Chandler, CEO and chairman Christopher Clemente, acknowledges the company developed homes that may have been too pricey for the segment it was targeting in the Atlanta market (he says he's "thrilled" with Capitol). Like many builders, it pushed prices hard in the Washington market in 2004 and 2005, only to have to back off when sales slowed.
THE PLAN: Comstock is liquidating assets, raising cash, and negotiating to push loan deadlines into 2008. It sold about $20 million in the 1Q2007 and sold the Bellemeade condo conversion project in Leesburg, Va., to rental operators for $47.5 million (which paid off a Bank of America loan). It's so aggressive about selling condo communities that it's buying back units from its customers (which explains some of the 58 cancellations in the first quarter). Then it's holding the properties as apartments (in the strong Washington rental market) until it can find buyers. It also departed the Charlotte N.C., and Myrtle Beach, S.C., markets. It retooled its Atlanta division and parted ways with James Parker and Andrew Chandler of Parker Chandler.
THE PROGNOSIS: Labovitz contends that you can't totally grasp Comstock'sfinancial health by looking at its balance sheet. In some ways, he has a point. A third of the company's debt is nonrecourse and tied up in its Eclipse project. In June, it received the certificates of occupancy for the second tower floors, one through seven. If it can settle units in that project on schedule, Labovitz expects to have the project's loans paid off and cash flowing to the company by the end of the year. Clemente says that sales are steady in the project, without having to cut prices in over a year. If that project generates cash and Comstock continues to liquidate assets in Washington, D.C., Atlanta, and Raleigh, N.C., the company could go into 2008 in better shape than it's been in a little while. If it doesn't, Comstock could be in trouble since it pushed back the maturity on many of its loans to 2008.
Why Oh Why, Ohio?
- Dominion Homes (DHOM, NASDAQ)
- Markets: Ohio and Kentucky
- Who's in Charge? Chairman and CEO, Douglas G. Borror, along with family, owns nearly half of Dominion's stock. His retooled team includes new hires William Cornely, CFO/senior vice president of finance, and Jeffrey Croft, president/COO.
THE SITUATION: Ultra-heavy on undesirable land holdings in a plodding Ohio market, Dominion Homes is smothering under a tenuous debt load, much of which is owned by hedge funds. Liquidating land assets is proving tough since long-term economic and demographic drivers aren't favorable in Columbus, Ohio.
HOW IT HAPPENED: After going public in 1994, the company focused on first-time buyers, with a geographical footprint in Columbus, and two Kentucky markets. But with pressure to grow, the company diversified its Columbus product mix in 2002, gambling on an affordable, high-density strategy, designed to coax renters in as first-time buyers. To support the product, the company searched for "transitional" areas and leveraged themselves heavily by investing in land. By 2004, when the Columbus economy stalled, Dominion had nearly all of its business tied to this buyer segment and more than 40 percent in this new niche. Demand dried up, sales plummeted, and the company scrambled to sell units to any buyer they could. By 2005, the industry's best-ever year, Dominion revenues fell 23 percent and customers of the company's mortgage arm had a foreclosure rate that more than doubled the state average. A possible investigation by the state's attorney general and numerous class-action lawsuits over alleged mismanaged mortgages, soured the company's reputation.
THE PLAN: In its most recent quarterly filing, the company states: "We expect to continue to reduce our total investment in land inventories during 2007 by selling raw land and developed lots that are not required in the near term, delaying significant land acquisitions, and continuing to limit land development activities."
Management says it will continue to "aggressively manage and control all overhead expenses." Sources in the market report say that even senior level employees have been recently asked to move to sales positions where restructuring includes commission-only compensation.
THE PROGNOSIS: Despite a valiant effort in the past 18 months, it's unlikely that the company can pull out of its tailspin. At half of the revenue in 1Q2007 versus 1Q2006, the viability of Dominion's business model becomes even more questionable. At the current gross revenue level disclosed in its latest 10-K, it's clear that the company can't pay its debt and can't pay its SG&A. Despite substantially downsizing operations from a year ago, the restructuring of debt drove interest levels to almost double those of 1Q2006.
Only by using its $35 million revolver to float the company, can Dominion buy more time as they try to liquidate land assets in order to pay off debt. And the sooner the better, as going this route continues to escalate interest levels. Assuming that current market conditions prevail, and that costs, debt, pricing, and profitability aren't likely to increase, the company will find itself out of money in two and a half to three years. The company's stock will likely be de-listed long before that.
That being said, land speculators or smaller local builders in Columbus may have an interest in small bits and pieces of land or lots at fire sale pricing. But with a shrinking or stagnant economic base, 17,000 existing homes on the market (historically, 10,000) and recent confirmation of Centex Corp.'s plan to exit the market after 20 years, it may be unlikely that even bottom feeders can detect an upside in Dominion's position in the marketplace.
Learn more about markets featured in this article: Washington, DC.