By Lisa Marquis Jackson. Although the NAHB has officially offered its support of President Bush's tax plan, "analyzing the documentation coming out of Washington has been a fluid, moving situation," says Kent Conine, NAHB president and president of Conine Residential Group, in Frisco, Texas.

"There are pieces of this [proposal] that are no-brainers for us to support," says Conine. "Obviously, the overall health of the economy is so important to the home building industry in a macro-view ... we would support anything that would stimulate the economy [and] create capital investment, which then trickles down into job creation."

But the implications for builders and their businesses evoke mixed conclusions when it comes to dividends, capital costs, and interest rates.

Divided Over Dividends

To re-distribute or not? That is the question over which analysts and executives are strongly divided.

Some in the investment community view the continuance of double-digit growth as unlikely. As a result, investors may assume a greater return with the cash-in-hand of dividends than they could assume on performance. "A payment to the marketplace of a reasonable dividend would send a very good message about the confidence these companies have in their ability to generate cash in a consistent basis over the long run," says Carl Reichardt, equity research analyst with Banc of America Securities.

Some see the issue as more complicated. "You get a different answer depending on what kind of dividend adjustment is done in the tax code," says Toll Brothers CFO Joel Rassman.

The current proposal does not give corporations a deduction for dividends paid. "If I were to have to pay out a portion of my earnings instead of re-investing it in growth, then my rate of growth will reduce," says Rassman. "To keep leverage constant, not only do I not have the equity that I paid out, but I can't borrow the debt I would have borrowed. For every dollar I pay out, it's two dollars I can't invest in growth."

Public Builders Currently Offering Dividends
Public Builder (Ticker) Annual Dividend Dividend Yield
Lennar Corp. (LEN) .05 .09%
The Ryland Group (RYL) .08 .19%
M/I Schottenstein Homes (MHO) .10 .38%
Centex Corp. (CTX) .16 .29%
D.R. Horton (DHI) .28 1.51%
KB Home (KBH) .30 .63%
Standard Pacific Corp. (SPF) .32 1.24%
Pulte Corp. (PHM) .16 .31%
Source: Company information compiled as of March 2003
Sharing the Wealth: Public home building companies, many of which pay dividents, are more concerned about the Bush administration's tax plan on capital costs than on dividends.

"If the plan goes through, it makes sense for [builders] to increase or create dividends," says Michael Coyne, equity analyst with Columbia Management, in Portland, Ore. "Right now, stocks aren't creating a yield to investors in terms of price appreciation or dividend yield. If home builders play their cards right, and do what I think they probably should and can do with their capital, it could generate a lot of interest across all investment classes." But will that excitement pay off? According to a Lehman Brothers equity research report titled "D is For Dividend," issued earlier this year, the market shows a "pronounced tendency for companies to under perform following the payout of their first dividend."

"How is the market going to perceive people who pay dividends versus people who don't pay dividends?" asks Larry Hirsch, CEO of Centex. "Is the market going to all of a sudden say that companies who have a 3 percent dividend yield now trade at some fundamental multiple [increase]? We need to take the time to see how the market reacts to these proposals and how they are going to value the stocks in reaction to it."

Other Dividend Issues

Another nuance of the proposal "has created some difficulty for us in the affordable housing arena," says Conine. While tax credits are purchased as capital to invest in affordable housing, the current proposal eliminates the taxation on the dividends up to what the company had paid for those credits -- often purchased at a discount. "It's the difference between the discount and the face value of the tax credit that would slide through as taxable to the shareholder. We don't think that's a good idea."

Real Estate Investment Trusts could also be less advantaged by the new tax code and possibly less attractive to investors. This impact is most likely to be felt by large developers who participate in these partnerships.

The Cost of Capital

A dramatic turn in the budget deficit may also have an impact on the availability and cost of capital. While these issues are dictated by a number of factors, the market is exhibiting some historically inappropriate relationships today in terms of the cost of borrowing and inflation, according to some.

"There is a disproportionate amount of spread between government debt and the amount of interest I have to pay," says Rassman. "One of the reasons I use a lot of long-term debt in my structure is not because I'm smart, it's because I'm afraid. I know I can make money at today's interest rates by borrowing long and investing it in real estate assets, which I then develop and sell to the public. If I had to borrow it at 15 percent, I'm not as sure."

While it is not clear whether the tax plan alone would cause interest rates to rise or fall, there are some effects to ponder. Eliminating the tax distortion should reduce builders' cost of capital through lower rates, but pressure on the federal budget could increase rates, even if Congress gets its way and settles on a package with far more modest tax reductions than the president proposed.

The financial markets are now guessing that the Fed will start raising rates in September. Even if the tax plan is adopted, the legislative lags are so long that not much affect would occur by that time. And in the case that it did, it would be impossible to attribute the rising rates to the tax plan, the Fed, or other possible factors. Overall, any effect the tax plan might have on interest rates is going to be small, and is probably not going to be measurable.

"Whatever the law changes are, we would respond in a favorable fashion to be able to manage our business in the best light of the shareholder," says Pulte CFO Roger Cregg.