During this cycle, we have done work for some of the largest land investment companies and opportunity funds, as well as private equity companies. There are a lot of players who are all betting on land prices, trying to anticipate the next big land play.
To understand what’s going on with builders and land strategies today, it helps to look at what has changed in the past three years. In 2010, builders divided themselves into “land-light” versus “land-long.” These were the two strategies for the publics—one camp feeling that the last misadventure of having a lot of land on the books was a teachable moment and that Wall Street would reward them for keeping the balance sheet light; the other betting on tailwinds and a revival of home prices, buying land with abandon. It turns out the best strategy was to load up on land, but it took a leap of faith that the recovery would come soon. We advised some of the largest U.S. investment firms to go long in “supply-constrained” markets that we identified for them during that time, which did indeed pay off.
As lot and land prices caught fire, gas was thrown onto the blaze with more builders going public. Simultaneously, public builders started to buy private builders. We did the market due diligence for Standard Pacific when it bought Centerline Homes. I guess there’s a twist on the adage, “If you can’t beat them, buy ’em.” We expect more acquisitions to occur this year. Builders want to add to their community count, which they’ll do via organic growth and mergers and acquisitions.
In 2013, some publics felt they had fallen behind their competitors in lot stockpiles. They began playing “catch up”—buying land in late 2012 and early 2013, pushing lot prices up by 20 percent nationwide and up by 70 percent (or more) in the “A” submarkets. We saw lot prices go from $1,200 per front foot in the Chandler submarket of Phoenix to $1,600 per front foot, and as a result, the “B” submarkets started to inflate. In the Phoenix submarket of Peoria, where lot prices two years ago were $900 per front foot, we watched them climb to more than $1,600 per front foot. Around that time, some land investors began to migrate from Phoenix to markets like Atlanta, where lot prices went up by 30 percent last year.
Throughout this land-rush period, builders have denied using aggressive price escalators in their land pro-formas, but the reality is that some builders got into deals that down the road will turn out to have been overpriced.
Home price increases have moderated recently (an extreme example: we found list prices were reduced on 7 percent of new-home plans in Phoenix in the first quarter), so builders are now taking a careful approach to land acquisition. That said, the publics are still bidding against one another in prime locations. Certain submarkets and niches are getting overcrowded (i.e., the $400,000+ segment in Raleigh, N.C.), so care must be taken to guard future margins and internal rate of return.
We’re in a period of high land costs, but we expect a surge in new-home demand this year. The opportunities are there, but you will have to steer carefully to get to them.