On Jan. 31, Gilbert, Ariz.-based Trend Homes helped swell the ranks of home builders who have been unable to pull out of a financial tailspin and confirmed it is selling its operations to Phoenix-based private investment firm Najafi Cos. The $65 million deal for the assets of Trend and its affiliates is predicated on Trend owners' agreement to reorganize under the protection of Chapter 11 in U.S. bankruptcy court for the District of Arizona.
The news emerged in the wake of an earlier announcement that top 20 public company TOUSA had filed for bankruptcy in Florida (see "A Tale of Two CEOs" on page 24). More companies will follow suit by either closing, selling assets, or trying to navigate through bankruptcy reorganization. However, a number of industry observers say what may mitigate the cycle's impending distress phase could be a blitz of private equity capital onto the scene as a cash-flush white knight.
"The infusion of capital is simply necessary because, for many of us, our equity has all been wiped out by the downward correction," says Trend Homes CEO Reed Porter. "As the market has fallen 20, 30, 40 percent, ... it's taken our equity with it. So we need new capital because our equity is gone."
Trend established itself in Salt Lake City in 1966, originally under the name Trendsetter Homes. In 1989, founders of the company moved the business to the Phoenix area. Run by the second generation of family, the company enjoyed robust growth and expanded into a condo brand line called Classic Communities and a luxury single-family line called Regency, in addition to its bread-and-butter, value-oriented single-family offerings.
In 2005, the company shifted gears. Trend increased its focus to a move-up product line (from 25 percent to 60 percent of total offerings), as entry-level product took a backseat. The timing of the strategy proved to be flawed.
After peaking at 1,200 units per year in 2004, Trend's closings plummeted from 1,108 in 2005 to 926 in 2006, despite aggressive incentive offerings and slashed prices. Too little, too late, Trend then re-focused on the affordable entry-level market.
Going into 2007, after retooling floor plans and negotiating with subs and vendors, the company felt confident that it could offer entry-level product that would be attractive to buyers who had been priced out of the market during the Phoenix run-up over the previous three years. In fact, Porter was so confident that he predicted over 1,400 closings for 2007.
Trend reported gross revenues of $303 million in 2006, up 6 percent from 2005's $286 million. "At the beginning of '07, we were projecting that we would reach around $400 million in revenues," recalls Porter. "We were sitting on a record backlog. We had never made more sales in the history of the company than we did in the second half of '06. There were almost 1,000 homes in backlog, and those are the homes we started in first quarter ['07]."
Instead, sales in Phoenix stalled out, and inventory levels rose alarmingly. Early in the third quarter of '07, the company found itself in a position similar to many home builders across the country as a result of the mortgage industry implosion. Hundreds of homes that were under construction, ones that had been pre-sold and pre-approved to customers, wound up as cancellations as buyers were unable to close. Suddenly, Trend was sitting with a huge supply of unplanned spec homes.
"The market and pricing had already gone down, and we were selling spec homes for losses, losses on every single one," says Porter. "We kept thinking, 'Oh, this is the last one.' And then a new wave would hit us."
This eventually took its toll. "Our cash flow projections were devastated," says Porter. "And our financial covenants with lenders quickly fell to technical default as the homes sold with losses. Things like net worth went down, and interest coverage ratios and many of the typical traditional ratios that builders have borrowed on for 20 years."
The company ended 2007 with revenues of $303 million and closed 1,093 homes. But, Porter says, "If you close them all at a loss, ... that's a lot of losses." Though the builder had been working closely with its banks, by yearend lenders and principals were unable to find a solution.
"All our lenders were accommodating; they really did their best, but the bottom line is that they needed more capital," Porter notes. "Unfortunately, the current shareholders, who by this time felt like they had lost everything, weren't willing to put whatever they had left–if they had any–into the situation."
Porter says his team had been introduced to the Najafi Cos. back in June '07, and both firms had taken some time to get to know each other. Despite the fact that the firm is not experienced in home building, CEO Jahm Najafi has stated that he expects additional investment in the industry and, unlike some private capital, has a long-term threshold on his ROI.
"He communicated a strong desire to create a very large and successful home building entity, not just create a business to be flipped in two or three years," says Porter. "The stated desire is to keep the existing management team, since their philosopy is not to buy and run the companies. The goal is to work through these tough times restructuring the company, get on to better times and continue to build the company. So it's about growing, whether that's by taking advantage of those assets coming back through banks or taking advantage of other home building company opportunities, if those opportunities present themselves and make sense."
At press time, the companies planned to spend the month of March "focused on getting a consensual deal put together that creditors can live with, and the Najafis can live with, and the board of Trend Homes can support," according to Porter. The formal reorganization plan was scheduled for a court hearing on March 25.
Says Porter, "They are very flexible and just want to do deals that make sense to prudently grow Trend Homes. These are very smart businesspeople, and we feel like we can learn a lot from being associated with them."
–Lisa Marquis Jackson