Joint ventures, debt offerings broaden builders' finance options.

By Lesley Brown Garland

Times have changed, and so have the industry's need for capital and its approach to getting it. For instance, builders in search of financing for large projects don't always go it alone; instead, they often team with a friendly partner, typically through a joint venture, to split the liability and cost.

And as builders get larger and more diversified, so do their lending sources. A broad array of giant national and international banks has replaced the narrow circle of hometown banks that builders once relied on for funding. Toll Brothers, for instance, has more than $400 million in credit with nearly 20 different banks on three continents--a move designed to insulate them from most financial crises. (See Rolling Credit sidebar.)

Meritage Homes CFO Larry Seay works with a group of banks including Wells Fargo, Guaranty Bank, and California Bank and Trust. These lenders provide project financing for Meritage and more than $250 million in credit. Seay says this approach works especially well because Meritage keeps only a little more than a three-year supply of land and uses rolling options on more than 60 percent of its land inventory.

But Toll Brothers CFO Joel Rassman insists that despite good builder-bank relationships, banks are not always the best answer to financing new projects.

"The banking world has changed a lot over the past 10 years with consolidation," says Rassman, whose company is working on extending its credit lines. When two banks merge, he says, the number of commitments is reduced. "You lose availability to the industry," Rassman says.

Indeed, fewer public builders will rely on banks for project financing this year, going instead to Wall Street's deep pockets for capital. And with more builders counting revenues in the billions rather than millions, they have more available to them than just run-of-the-mill loans.

Balking banks?

For some banks, the honeymoon-is-over feeling is mutual, especially with regard to privately held building companies. Given the economic slowdown, analyst Scott Campbell predicts that banks will only get more cautious.

"Clearly, the economy has slowed, and the housing industry, both in the new and existing homes, has been

impacted as the consumer confidence starts to roll over and unemployment starts to pick up," says Campbell, who works for Raymond James & Associates in St. Petersburg, Fla. "Financing for private guys is much harder. They are relying on the banks, but the banks are really putting the pinch on. In an economic slowdown, real estate lending gets much different."

But that doesn't seems to hold true everywhere. Guaranty Bank's Paul Pirok, who works with more than 30 private home builders through the Sun Belt, says his bank has not exercised "significant" tightening on private builders' access to capital. In Pirok's view, it may be the largest public builders who will have a more difficult time dealing with bank consolidation, while private builders have numerous small- and medium-sized banks willing to finance projects.

Pirok's financing strategies vary depending on the region, with most private builders in Texas and Colorado using base borrowing--a method in which bankers use the houses as collateral and receive "work-in-progress" reports on the units.

But because Pirok's California clients are often forced to pay large sums up front for land, they use a variety of techniques to soften the financial impact on the company's checkbook.

"I have enough gray hair to remember the last downturn," says Dallas-based Pirok, Guaranty's managing director of residential real estate. "I think there's a big difference going into this.... There's very little spec building or land inventory. In the late '80s and early '90s, there was a lot of inventory. You just don't have that this time."

And because there is no inventory, builders are not as susceptible to being hit hard by a recession, says Patt Schiewitz, senior vice president for Bank One's home building division.

"If in fact there is a slowdown of big developments nationwide, all they have to do is stop buying land," he says. "The only thing to do at that point is think of what to do with the cash flow."

Nevertheless, Toll's Rassman says the building industry has gotten a bad rap from bankers.

"Since there have been a few visibly bad credits, the entire industry has gotten a black eye from a few companies that have not performed well," Rassman says. "It's unfair. If you're looking at it, more banks have gone bankrupt than builders."

New options

Though banks will continue to be key players in builders' borrowing portfolios, other possibilities serve the financing needs of builders' increasingly complex operations:

Term loans. Recently, more of Banc of America's clients entered the term loan B market--investments targeting institutional investors that mature in the three- to seven-year range. Most important, investors in this market are also more interested in builders after years of heavy technology investment, says Michelle Johnson, managing director of Banc of America Securities' national home builder group in Irvine, Calif.

"This is a market that did not do a lot in real estate," Johnson says. "It's got an investor base looking for diversity out of the technology and telecommunications industries."

High-yield bond market. In the first half of 2001, home builders accounted for four new issues totaling $1.5 billion in the high-yield bond market, equal to 4 percent of the total $28.7 billion high-yield new issuance volume. (See Bond Issues sidebar.)

UBS Warburg analyst Robert Manowitz calls that share "impressive" considering the size of the home building industry. He also predicts that larger builders in both the private and public sectors will continue to enter the high-yield market, especially if interest rates continue to be favorable. "The low interest rates not only have an impact on affordability, but [they] instill some confidence in the market," says Manowitz. "The interest rates also help the equity markets, which then make the consumers feel better about the prospects for tomorrow."

Builders are also poised to move more quickly for bond deals than in times past by preparing shelf offerings. It's a trend that Arnold and S. Bleichroeder analyst Barbara Allen attributes to builders' seeing the market's volatility and preparing to act immediately when a situation turns favorable.

"With the increasing use of the shelf offerings--partly fueled by marketplace fluctuation--you just put the paperwork on file, then pow--you go," Allen says. "They have become an innovative and helpful way to get access to the market very quickly. ... And from my point of view, they can move when the market is right. You've got to put that document together whether it's two weeks from now or two months."

Bonds aren't a suitable mechanism for all builders. Because by nature bonds require a substantial amount of pre-existing debt, they typically work best for big-cap builders. Issuing bonds wouldn't make sense for Meritage, for instance, which has less than $250 million of debt outstanding.

Indirect funding. Meritage is using sale/lease back arrangements on model homes as an indirect method of helping to fund projects. By selling a model home then leasing it back from its owner, the model is off the builder's balance sheet while providing the buyer with a home that has all the top amenities. The technique has been so effective that Meritage's Seay says his company and others will use it to a greater degree in the future.

"We do that quite extensively in Arizona and California," Seay says. "Some companies even do it as a line of business by selling a group of models and then leasing them back."

Joint ventures. Reducing risk by teaming with other companies has enabled builders to make investments in sizeable properties. Centex Homes' CFO Larry Angelilli, whose company recently entered into a joint venture, says while it involves going to a bank for financing, joint ventures spread the risk and cost around for pieces of land "beyond the reach of one single builder."

"When these mega-properties come onto the market, joint ventures are a way to invest," Angelilli says. "When you see large parcels of land for $100 million or more, the industry is becoming better and better at going with joint ventures. ... No one would want to take that on themselves."

Rising Cost of Banking

Working with banks is likely to become more costly for builders, and in short order. Because of the Basel Accords--a set of international standards requiring banks to maintain certain amounts of capital in reserves--banks will likely need to make more money from their loans by 2004, according to Bank One's Patt Schiewitz. Many of the largest banks have already planned to put in place plans for the new capital requirements long before 2004, says Schiewitz, senior vice president for the bank's national home building division in Chicago.

But here's the hitch for home builders: Banks traditionally have not charged as much for unused capital as used capital, a rule that may change if banks need to keep more in reserve.

"The biggest builders, for public ones at least, over the past two years wanted significant dry powder in case they wanted to buy somebody," Schiewitz says. "Now, we're saying, 'You either need to pay me for the dry powder or don't take it. ...' It's a reasonably inexpensive insurance policy for them, but as pricing policies change, some will say they think it's worth [paying extra money]."


[BIG BUILDER Magazine, August 2001]