Successful businesspeople always see the silver lining in economically troubled times, and the current downturn is no exception. One positive development for small and midsize builders during the slowdown is that the big builder stranglehold on land is coming to an end, as large builders walk away from land deals at an alarming clip.
Ivy Zelman, equity research analyst at Credit Suisse, says the 14 big builders she covers wrote off or abandoned options on $1.1 billion worth of land in the third quarter of 2006 alone. This compares with slightly less than $320 million in the second quarter.
“From the beginning of the slowdown to when the market stabilizes, we estimate that total net equity of our group will drop 20 percent in terms of write-offs and abandonments,” Zelman says.
These strategies can work well for big builders. For example, in its third-quarter 2006 statement, M.D.C. Holdings reported that the company's land investment declined by almost $100 million in that quarter alone, which contributed to M.D.C. generating more than $70 million in operations cash flow during that period. The company ended the three months with $1.36 billion in available cash and improved its borrowing capacity by 25 percent compared with September 2005.
Land brokers we interviewed cautioned builders that there will only be a small window of opportunity to capitalize on this situation.
“I think for aggressive and forward-thinking builders, the opportunities to buy lots are there if they go ask for them today,” says Mac Martin, owner of Martin Realty Florida in Arcadia, Fla. “After enough lots are sold at a bargain price, the landowners will cut it off and wait for the market to return.”
On the surface, freeing up land may seem like a golden opportunity for small builders. But the changed land situation may not affect very small builders—those putting up three to five homes a year—most of whom say they can always find a lot or two to build on. And builders in the 200- to 350-homes-a-year range say land is available, but that for the most part they aren't interested yet because prices are still high.
“The B- and C-quality land on the outskirts of the metro region is very available, but land prices aren't coming down [yet],” says Dave Servoss, president and CEO of Anderson Homes in Cary, N.C., a company that builds about 330 homes a year. “It's really not to the point where the smaller builder can pick and choose lots,” he says.
Steve Brooks, president of Homeland Communities in Norcross, Ga., says he has 50 land proposals in front of him at any given time these days, and while he agrees that builders can't yet be choosy about lots, the climate is changing.
“With the big builders selling off all this land, the situation may change very quickly so that there will be some choice lots available,” says Brooks, whose company builds 330 to 350 homes annually.
As many builders know, big builders write off land they own so that the land reflects current market conditions. The write-off presents an opportunity to operate under a new cost structure that's based on the current market cost of the land, which lets companies sell homes profitably while writing off the loss in land over several years.
Write-offs are an effective tool, but there isn't a big builder that hasn't done an abandonment. An abandonment is when a builder walks away from an option, which is essentially a down payment on a property. In 2004 and 2005, Zelman says her group held $2.5 billion and $4.1 billion, respectively, in non-refundable option deposits, with the average deposit running around 6 percent of the value of the land.
Learn more about markets featured in this article: Anderson, IN.