Since Toll Brothers alluded to possible joint venture-related "significant losses" in a recent SEC filing, conversation in the industry has snowballed with respect to the structure, risk, and ramifications for banks, asset values, and partnership obligations that are tied up in these off-balance-sheet deals.
Despite the recent news coverage on two mega Las Vegas joint ventures, Inspirada and Kyle Canyon Gateway, that are both in default, recent reports by several analysts indicate that the exposure to the public builders appears to be manageable.
Yet, this week, both Lennar and KB Home will be releasing earnings, and while the companies are now taking the "no comment" route, we would expect there to be some significant conversation during their investor calls regarding JV activity.
In addition, the unexpected replacement of longstanding Standard Pacific CEO Steve Scarborough--despite a significant debt load and overall atmosphere of financial distress--seems an unlikely coincidence. Standard Pacific is second only to Lennar among the public builders in terms of JV exposure.
Though joint venture seems to be the industry's dirty word du jour, let's not forget it was just three months ago that Lennar was lauded for financial brilliance in its year-end JV deal structured with Morgan Stanley Real Estate. Most analysts still consider the company to have higher land risk than peers, so stay tuned for the results on how this latest arrangement does or does not become a reflection of that.
And as always, e-mail me with your thoughts, any insight on JV activity and its implications in your market, or any other details on land transactions, at email@example.com.
It's hard to pinpoint exactly when and where these arrangements started to sour, but it ultimately stems from the fact that home building enterprises require finished land on which to build houses. And yet, they became entangled in arrangements that sometimes have three-, five-, or seven-year windows before a house is ever ready to sell. Therefore, not only have builders been caught having to carry these assets, but they bid the price so high during the frenzy that there was very little land profit left to realize at their original basis.
Smack in the middle of the conversation is the Las Vegas market, where skyrocketing land prices and government land auction sales gave birth to consortium arrangements during the run-up. Today's most notorious examples are Inspirada and Kyle Canyon. Each is comprised of an ownership base of eight builders with disparate percentages in the deal--and both are under stress.
In fact, on March 14, KB Home, Lennar, Toll Brothers, and possibly others were specifically named as missing interest payments on the two projects, which are in default.
According to home builder and land developer sources in the Vegas market, discussion swirling around Kyle Canyon is creating the "best soap opera in town." In fact, watching how events play out in today's most avidly discussed JV may give the investor community some insight into what to expect in other potentially troubled assets.
In the meantime, investors continue to demand more transparent information on the liability and risk of builders across the board. According to JMP Securities and Zelman Associates research, JVs as a percentage of a public home building companies' total assets stack up like so: Beazer, 3.2%; Centex, 2.5%; Horton, 0%; K Hovnanian, 3.7%; KB Home, 5.2%; Lennar, 10.4%; MDC, 0%; Meritage, 4%; NVR, 1%; Pulte, 1%; Ryland, 1%; Standard Pacific, 8.6%; Toll Brothers, 2.2%.
It's impossible to ignore the Stan Pac correlation. Throughout the past year, most notably in its second half, investors and analysts were vocal about their concerns related to the company's JV exposure (see below for a breakdown of the details Stan Pac has disclosed regarding its JV activity). In response, Stan Pac extricated itself from six JVs in the fourth quarter and reduced its JV debt by 39%, still carrying a burden of $771 million.
According to the company's latest 10-K, Stan Pac posted a loss of roughly $199 million from unconsolidated joint ventures. And as of Dec. 31, 2007, the company controlled 22 projects through "JVs and other arrangements." At the time, Scarborough pledged to continue to reduce the company's JV debt through 2008.
The company has collaborated with different entities--from other big builders such as Shea Homes and Centex to land holders like The Irvine Co. to less conventional land lords like energy company Unocal. Stan Pac is reputed to have done its boldest JV in 1997. Along with Catellus Residential Group and Starwood Capital, it formed a partnership called Talega Associates to acquire and develop a 3,470-acre master planned community near San Clemente, Calif.
The success of that 4,000-home community led to an opportunity in 2005, where Stan Pac partnered with St. Paul Insurance and IHP in San Diego's 1,240-acre Black Mountain Ranch project.
It was a particulary big development for Stan Pac, according to a local source who did some work with the project. The property was regarded as prime, but not surprisingly, the land was expensive. After a neo-traditional development plan was implemented, pricey homes came to market at the peak. The company continues to build through, albeit slowly. And today, with home prices in the area down roughly 30%--indicating land prices to be down 50% or more--it's not a stretch to assume that this JV could easily be one of Stan Pac's most troubled assets.
In 2005, Big Builder reported on the unusual structure of the Black Mountain Ranch deal; the hitch was that St. Paul wanted to continue to be an investor after it sold the property and also required rather unorthodox payment terms that entailed letters of credit for six years. "Other builders thought those terms were unwieldy, but Standard Pacific saw an enormous opportunity," said Doug Neff of IHP Capital Partners.
Neff's company helped Standard Pacific obtain the bank credit to enter into the deal. As has often been the case with Standard Pacific, the Black Mountain deal came down to the rapport that this builder established with the insurer. "It was really an interpersonal thing; we hit it off," said Fred Maas, president of Black Mountain Ranch LLC. "Letting St. Paul stay in as an equal partner was highly unusual."
According to the company's latest 10-K, Stan Pac posted a loss of roughly $199 million from unconsolidated joint ventures. Throughout the last year, most notably in the second half, investors and analysts were vocal about their concerns related to the company's JV exposure. In response, Stan Pac extricated itself from six JVs in the fourth quarter and reduced its JV debt by 39%, still carrying a burden of $771 million. At the time, Scarborough pledged to continue to reduce the company's JV debt through 2008.
Meanwhile, back in Las Vegas, participants in Kyle Canyon include: Focus Property Group, 25% ownership; Lennar, 13% ownership; Toll Brothers, KB Home, and Pulte, which all have 10-15% ownership; Ryland, 3% ownership; and Meritage, Kimball Hill, and Woodside, which comprise various percentages of the balance.
Most analysts claimed the individual builders' positions to be defensible, and expectations that the projects would ultimately become recourse back to the builders were low.
"Ryland has guaranteed approximately $14.5 million in Kyle Canyon's debt, and we believe the liability for the project's remaining $420.8 million in debt is not joint and several," said FTN Midwest's James McCanless. "While we would prefer no joint venture exposure at all, we believe Ryland's $42 million in debt guarantees is an acceptable amount of risk for a company with no outstanding credit facility balances and $243 million in cash."
Still, with the value of finished lots worth less in today's market than the actual cost it would take to complete them, the viability of the JV seems uncertain at best. How it plays out is anyone's guess at this point, but here are some of the biggest issues that remain in question:
The apparently purposeful decision to not make interest payments is curious, as some of the fingered builders likely have the cash to do so. The major covenants in the deal lie in the take-down agreements, as that is the way the debt is repaid. And there is no denying that public builders have been going to extremes to prove they want to return to their merchant builder roots.
The still yet-to-be-heard-from contingent in all this is the banks. A real estate bank is more likely to understand these downturns and how builders get through. In contrast, a bigger commercial bank that got into these deals later in the game has less tolerance.
Clearly, they are all under pressure in recovering assets and recognize that there are complications of owning land, including managing HOAs, public facility debt, property taxes, and renewing developing agreements. But in the case of Kyle Canyon, raw land might be a bit easier to take on as it wouldn't require management at the same level as a large, active community.
Completion guarantees remain a major sticking point in the arrangement. In other words, the consortium guaranteed all the master plan improvements in the development, adding value to the property. And that obligation theoretically remains in effect regardless of a possible foreclosure. Of course, it's likely that would need to be enforced through the implementation of a tedious lawsuit.
At the same time, sources across the market all admit there is value in the properties. The Vegas market is expected to have substantial job growth over the next three years. And no one can deny the severe land constraints that exist in the Vegas market. "Outside of the master planned pieces, pretty much anything of any substance is gone. It's been bought and been zoned," stated Tom McCormick, CEO of privately-held Las Vegas builder Astoria Homes.
So it seems that the fine line in Kyle Canyon's future comes in understanding where the bluster ends. Could this be a game of chicken? A strategy to get the group of banks to come to the table and restructure a more favorable deal?
No matter which parties might end up holding the keys on the deal, they need to have a long threshold to carry. In addition, trying to value the deal against area comps--like the adjacent Focus Property Group project Providence, which has boasted fire-sale pricing--likely throws the infrastructure costs for Kyle Canyon's raw land completely out of line with its original projects.
Reportedly, private equity investors are swarming in an attempt to assess a potential opportunity. But with a boatload of lenders likely involved and some agreements as to what the valuation might be, as well as a consensus on how to handle--or release--the completion guarantees, a distressed asset buyout scenario seems unlikely at this stage.
"There is a lot to work through, and these builders might be banking on the fact that, no matter what happens, its going to take a long time to get to the end of this road," observed McCormick. "Maybe by that time, the market's better and [the builders] want the property anyway."
So what is the viability of these JV deals in home building's future? "People will get back into this business," said McCormick. "But I have to imagine in JVs of the future, land prices are not going to be end-user pricing. That's what made these deals hard.
"As much as you can make a ton of money, it can take a lot of years to get to it. Home builders are paid to turn capital--get through assets as quickly as we can. I just have a hard time believing that in the future any of them, or their subsidiaries, really get into doing big huge half-billion-dollar land deals. The finished price is probably going to go up, but they can pay a premium and not carry it on the balance sheet."
STANDARD PACIFIC'S DISCLOSED JOINT VENTURE ACTIVITY "Master Planned Communities
"1997 -- Orange County division entered into a joint venture to acquire land and develop a 3,470-acre master planned community located in San Clemente, Calif. Lots for 3,300 attached and detached homes were developed, as were a championship golf course, community amenities, and commercial and industrial sites. As of Dec. 31, 2007, the company had purchased 1,630 lots from the joint venture for construction and sale of homes by Standard Pacific, and the joint venture had no lots left to sell. In addition, the venture has two home building projects consisting of approximately 150 lots, which are being constructed within the venture. As of Dec. 31, 2007, Standard Pacific had a net investment of approximately $9.6 million in this joint venture, which represented Standard Pacific's share of undistributed earnings.
"2003 -- San Diego division entered into a joint venture that is developing the Black Mountain Ranch master-planned community of Del Sur in San Diego, Calif. This joint venture plans to develop approximately 3,000 finished lots, certain community amenities, and commercial and industrial sites. Development is underway and deliveries of finished lots commenced in May 2005. Standard Pacific also has the right to purchase up to approximately 1,100 finished lots from the joint venture at fair market value. As of Dec. 31, 2007, Standard Pacific had purchased 297 lots from the joint venture for construction and sale of homes by, and the joint venture had approximately 2,200 lots remaining to sell. As of Dec. 31, 2007, the company's net investment in this joint venture was approximately $9.0 million, which represented the company's share of undistributed earnings.
"November 2005 -- The Las Vegas division entered into a joint venture with two other home builders and one developer to acquire and develop a 2,675-acre master planned community located in North Las Vegas, Nev. This joint venture plans to develop approximately 15,750 lots, along with parks, schools, and other amenities. As of Dec. 31, 2007, the joint venture had approximately 9,300 lots remaining to sell. To date, Stan Pac has purchased 690 lots and has an obligation to purchase an additional 290 lots from the joint venture. In addition, the company has the right to purchase up to an additional 2,000 lots. As of Dec. 31, 2007, Standard Pacifric's net investment in this joint venture was approximately $53.0 million.
Lot Development Joint Ventures
"March 2003 -- The Southern California Inland Empire division entered into a joint venture with a large regional home builder to develop approximately 2,600 finished lots in Menifee Valley Ranch, Calif. This joint venture will deliver finished lots to Standard Pacific and its partner for the construction and sale of homes and may also sell finished lots to third-party home builders. Development is underway, and deliveries of finished lots commenced in April 2005. As of Dec. 31, 2007, Standard Pacific had purchased 580 lots from the joint venture for construction and sale of homes, and the joint venture had approximately 1,430 lots remaining to sell. As of Dec. 31, 2007, the net investment in this joint venture was approximately $27.6 million.
Homebuilding Joint Ventures
"November 2002 -- The Northern California division entered into a joint venture with a local land developer to develop and deliver up to approximately 560 homes and 200 lots in American Canyon, Calif. Through the year ended Dec. 31, 2007, the joint venture had delivered 319 homes and sold 200 finished lots. As of Dec. 31, 2007, Stan Pac's net investment in this joint venture was approximately $13.1 million, of which $11.9 million represented undistributed earnings.
"June 2007 -- Orange County division entered into a joint venture with an investor to develop 550 acres of land and deliver 268 homes in Walnut Hills, Calif. Through the year ended Dec. 31, 2007, the joint venture had delivered six homes. As of Dec. 31, 2007, net investment in this joint venture was approximately $4.4 million."