Digging Deeper

On 600 acres in a town auspiciously called Fate, David Weekley Homes struck pay dirt.

Fate is about 40 miles east of Dallas. There, Weekley Homes, a Houston-based builder, partnered with MHI, The Drees Co., and Highland Homes to buy 1,000 lots. Fate is located within a metropolitan utility district, so some infrastructure was already in place. Plus, it's near a transportation corridor. That purchase, though, was anything but risk-free, as only 575 people lived in the town at the time. “It made Mayberry look like a metropolis,” recalls David Hale, Weekley Homes' vice president of development. Yet the neighborhood that emerged, Woodcreek, where Weekley Homes offers houses ranging from 1,300 to 2,400 square feet and from $125,000 to $234,000, was so successful at luring new buyers to the area that the builder was on the prowl this summer with two other builders to find more land there for a second community.

“We never would have considered this five years ago,” says Hale. “But we're looking at land that's farther out, in the hinterlands.” David Weekley Homes and everyone else, it would seem. Land acquisition continues to be a game of hide and seek for builders across the country.

With few exceptions, builders say they must increase their land inventories as a hedge against an approval process that in most markets is taking longer and longer to complete and land prices that keep going up. Builders that in the past would have been content controlling enough land for two to three years' worth of closings now want to extend that to five to eight years. But finding affordable land that people will move to is a challenge that often requires compromises in terms of the size of the property purchased and its distance from city centers.

Acquiring smaller parcels is still in vogue, even among larger builders such as MDC Holdings, which typically buys in 150-lot quantities, says Gary Reese, MDC's CFO, in part to maintain its debt-to-capitalization balance. Maracay Homes Arizona recently purchased 15 acres with 39 lots for an infill community in Phoenix, says vice president of land acquisition Todd Weber. “How many builders can compete for 200 lots in Northern Virginia that sell for $200,000 to $300,000 per acre?” asks Ralph Grebow, CEO of The Atlantic Group, an Iselin, N.J.–based land acquisition and development firm. “The market is being pushed downward in terms of the size of most deals.”

It's also being pushed outward, as builders seek development opportunities on the fringes of population centers and turn to sources such as Dallas-based Provident Realty Advisors, which specializes in selling super pads with infrastructure ranging from 50 to 200 acres. “Big builders want to go ‘out there,' but they won't pioneer like we do,” says Jay Hawes, Provident's project manager. Finding bargains on these frontiers, though, is no cakewalk, as investors flood into the housing market waving capital, which giant developers and builders are using to gobble up huge tracts. Lennar Corp.'s acquisition of the much-sought-after, 3,724-acre El Toro naval base in Irvine, Calif., for $650 million plus $200 million in development fees, which it financed with capital from three real estate investment funds, showed how high some builders can raise the bar for land acquisition. “Even submarkets are grossly inflated by buyers who are paying maximum prices for stuff that's a target for bigger builders,” observes Tony Possidoni, vice president of land acquisition and government relations for Oak Brook, Ill.–based Montalbano Builders' Oakwest Development Co.

Land sources haven't changed much from past years: farms, nurseries, and dairies owned by families looking to cash out in markets that are rewarding sellers extravagantly. Those sellers are savvier about their land's value, more demanding about getting their money up front, and less forgiving about takedown schedules. This shift in leverage places some builders at a disadvantage, as Arbor Custom Homes found out in early September when Centex Corp. made an unsolicited bid for land Arbor had under contract in Salem, Ore., that was $38,000 per lot higher than Arbor's $147,000 option. To finally secure that property, Arbor ultimately wound up paying $250,000 per lot, says Arbor's co-owner Wally Remmers, who adds that his company is in similar price wars on other properties in a market where an urban growth boundary limits what gets built.

Only days before Centex made its bid, Dennis Sackett, Arbor's co-owner, told The Oregonian that this boundary “has really been our friend” by keeping out national builders that felt land there was too expensive and difficult to acquire. But even Arbor is counting on 1,500 lots it controls outside of the boundary to be brought into it eventually, says Remmers. It remains to be seen whether these buffers dissolve into Maginot lines in a rampaging housing market where growth-minded builders inevitably feed off other, larger builders and developers that regularly sell excess land assets (see “Cashing In,” page 350), or acquire competitors with strong land positions. When Yardley, Pa.–based DeLuca Homes acquired The Barness Organization in August, it increased the number of undeveloped lots it controls by 36 percent, to 3,000.

QUICK-CHANGE ARTIST: The Corky McMillin Cos. has been adept at finding and developing raw land in a tight San Diego market. One such development is a 3,000-acre assemblage—which had been a former military facility called Sycamore Canyon—that the builder is transforming into a master planned community it calls Stonebridge Estates (above). To purchase a second property in Chula Vista, Calif., it calls Rolling Hills Ranch, McMillin Cos. outmaneuvered several other builders and a San Francisco–based broker by pitching its bid directly to Ford Motor Co., the land's owner. Development for both sites required the company to remove between 30 million and 40 million cubic yards of dirt.

What's clear, too, is that builders are adjusting their criteria for judging which deals are worth investing in. Unentitled land isn't scaring off builders as it once did, even though some companies remain allergic to it. MDC, insists Reese, buys only entitled lots “that [are] positioned so we have control over getting the building permit and the certificate of occupancy.” On the other hand, The Corky McMillin Cos., in National City, Calif., specializes in acquiring large parcels “that have some hair on them,” says Jim Hunter, vice president of planning and acquisitions, and enduring longer approval processes with the expectation that the profit margin could be as much as 10 percentage points higher than that which entitled property produces.

In one such deal, McMillin Cos. redeveloped San Diego's Naval Training Center, which Hunter says needed “quite a bit of toxic remediation,” into a mixed-use, 400-acre community with 350 homes, 1,000 hotel rooms, retail space, and 600,000 square feet of office space, plus parks and churches. At two other developments—Stonebridge Estates, a 3,000-acre assemblage in San Diego, and Rolling Hills Ranch, a 1,400-lot master planned community in Chula Vista, Calif.—McMillin Cos. removed between 30 million and 40 million cubic yards of dirt “and literally took the tops off mountains,” says Hunter, to get those properties ready for construction.

In their quest for land, builders are leaving no stone unturned and no source untapped. “The best move I've made in recent years has been to bring our GIS in house,” says Harold Campbell, land acquisition manager for The Fischer Group, referring to a geographic information system that provides myriad data on every available parcel in the seven counties around Cincinnati that make up Fischer's core market. Campbell says this land research is buttressed by a database of between 500 and 800 landowner prospects.

Campbell and other builders acknowledge that their ability to buy land hinges on the knowledge and perseverance of their field staff and their companies' standing with local landowners and planning officials. (The majority of builders contacted for this article say that most of what they buy still comes to them through cold-calling potential sellers.) “You never know where you're going to find the next deal,” observes Jeff Kaufman, land acquisition manager for The Bozzuto Group. “We might be building in a neighborhood where a buyer's cousin owns 60 acres somewhere, and he comes to us to see if we're interested. We get a lot of that, which is why we focus on customer service.”

But in a kingdom where land prices continue to escalate, the highest bidder usually rules. Kaufman admits that Greenbelt, Md.–based Bozzuto has been outbid for land, sometimes by double what it offered. “It boggles the mind what some builders and developers are willing to pay, which limits what we can look at,” says Mori Hosseini, CEO of ICI Homes in Daytona Beach, Fla. This summer, ICI became interested in a 10,000-acre property in its home state, on which 20,000 to 40,000 homes could be built, that would cost $100 million to buy. Hosseini expects most large public builders and developers to avoid this deal, as approvals could take at least five years.

Sitting tight is a gamble, because other builders are becoming more tolerant of delays and inconveniences as they gaze into a future that presages scarcer and more expensive land. A Brookings Institution report, “Toward a New Metropolis: The Opportunity to Rebuild America,” published in December 2004, calculates that between the years 2000 and 2030, builders and developers will need to find 35 million more acres to accommodate a 44 percent increase, to 427.3 billion square feet, in residential and commercial development needed to meet projected demand, based on population trends. Residential construction alone will need to add more than 108 billion square feet, or the equivalent of nearly 62 percent of what existed in 2000. Those projections also call for nearly 59 million additional residential units, or more than half the number that existed in 2000 (see “More Space Needed,” page 356).

The question, though, is: Where?

“It's almost impossible to find 100 lots [in New Jersey], and those that are available take five to seven years to get approved,” says Grebow of The Atlantic Group. Hosseini sees the government buying more farmland to stem development. Even in markets where land is less constrained, “builders and developers are changing the parameters of what they will consider,” observes Maureen McAvey, senior fellow with the Washington-based Urban Land Institute. Nate Nathan, a prominent broker in Scottsdale, Ariz., recalls how most locals thought the developer DMB Associates was “nuts” when it purchased 8,800 acres in the west valley for a community it calls Verrado. Nathan says DMB asked 22 builders to participate in the first phase of that project, but only nine accepted. But after that phase's 1,100 units sold at a sizable profit, 44 builders wanted in for its second, 2,200-unit phase. (See “A Place in the Sun,” April 2005, page 141.)

ASSET ADJUSTMENT: LCOR, a Bethesda, Md.–based developer, made headlines a few years ago when it built one of the first elementary schools to be constructed in Washington in decades. That project's $11 million cost was financed by a 35-year, tax-exempt bond that will be repaid from revenue generated by a 211-unit apartment complex (left) that LCOR built on land adjacent to the school, which it had swapped with the city. Subsequent unique acquisition opportunities, though, have been “few and far between,” says LCOR's senior vice president, Tim Smith.

Perhaps out of necessity, more builders are also stepping into redevelopment projects. Columbus, Ohio–based Rockford Homes has a community called Delaware Place, built on the site of an old school, that combines condominiums with $300,000 detached houses. Donald Wick, Rockford's executive vice president, says his company has roughly half dozen of these projects in the works. A few years ago, Bethesda, Md.–based developer LCOR made headlines when it financed the $11 million construction of an elementary school in Washington through a 35-year, tax-exempt bond that will be repaid from revenue generated by an apartment complex that LCOR built on land adjacent to the school, which it swapped with the city. Tim Smith, LCOR's senior vice president, says his company's latest venture is the conversion of two shopping centers on 10 acres in Montgomery County, Md., into a mixed-use site with 100,000 square feet of retail space and 800 apartments and condos.

Jim Pugash, CEO of San Rafael, Calif.–based Hearthstone, the industry's largest investor in for-sale development, observes that the land acquisition strategies of most builders he works with lean heavily toward exurb or vertical infill development. Even Lennar, which acquires around 50,000 lots annually, pursues off-beat opportunities, such as a historic salami factory in downtown San Francisco that it transformed into 240 lofts. “We have to adjust to what the market will provide,” says Emile Haddad, who runs Lennar's California operations.

It sometimes seems like builders and developers will buy any land that's not nailed down. The growing popularity of land banks to acquire and hold land for later use would attest to this. (Hearthstone and The Atlantic Group recently started banking land for clients.) But most builders follow specific acquisition guidelines that gauge whether a given property fits their growth objectives and product mix. Vince DeLuca, president of DeLuca Homes, is reluctant to enter into any land deals “where the absorption rate would be four or five years.” Before Newland Communities, the industry's largest private developer, purchased 18,000 acres of the 20,000-acre Estrella Mountain Ranch, 17 miles west of Phoenix, last May, it first had to decide if it wanted to re-enter a market where Newland had sold its assets several years earlier. The San Diego–based developer retained Land Advisors Organization, a Scottsdale, Ariz.–based consultant, to get detailed information about that property and conducted 60 days worth of meetings with different local business groups.

Generally, Newland prefers buying entitled lots on at least 1,500 to 2,000 contiguous acres that front a roadway, are near a quality school district, and have “something special” in their surrounding environment, such as Estrella's two man-made lakes. “When you apply those criteria to land in the largest cities, you will have only around 20 prospects to choose from,” says Jim Jenkins, Newland's senior vice president of strategic acquisitions.

Newland didn't disclose Estrella's financial terms. But this property became available to Newland after one of the three builders under which the land had been contracted ran into balance sheet problems. As some land deals get larger and more complex, builders and developers have been reducing their financial exposure by hooking up with investment and development partners. They don't have to search too far, either, because private and public investors looking for that next pot of gold in real estate are plentiful. “Every major Wall Street firm has been in my office in the past 90 days,” Nathan said in September.

Hearthstone recently raised $300 million from various institutional investors that it is using to buy agricultural real estate. “We're burning through money quicker,” says Pugash. Las Vegas–based developer Focus Property Group spent five months raising $510 million for its last acquisition, the 1,710-acre Kyle Canyon Ranch in northwest Las Vegas, which involved eight builder-investors and was syndicated by Wachovia Securities. “Wall Street loves these deals because big, well-financed builders are involved and the risk is spread out equally,” explains Focus CEO John Ritter.

Some builders are ambivalent about investors' presence in the housing arena because, they claim, these investors are throwing too much money at land that, in the builders' estimations, isn't worth anywhere near what's being paid. Possidoni of Montalbano Builders notes that, in Joliet, Ill., sellers now ask $80,000 per acre in a market where most of what's under contract was optioned for $60,000.

WELCOME BACK: The Luminarium (top), a welcome center, and fountain-accented man-made lakes (right) greet residents and visitors at Estrella Mountain Ranch in Phoenix. Before Newland Communities acquired the 18,000 acres for this property, it had to convince itself to return to a market where it had sold off its assets several months earlier. Newland's decisions about market demand and what amenities it should offer were informed by two months' worth of discussions it had with local businesses.

Few builders complain, though, when the speculation wave lifts all boats. Hosseini notes that the value of an 800-acre property on Beach Boulevard in Jacksonville, Fla., which ICI and Beazer USA purchased for $90 million a year ago, has doubled.

ICI this summer closed another deal with Beazer for 2,400 acres in Jacksonville, as well as the purchase, with U.S. Home and KB Home, of 1,500 acres in Daytona Beach, Fla. Hosseini favors joint ventures with other builders because, he explains, if prices soften “we can squeeze down the profitability on the land and keep construction moving. You couldn't do that if your partners are only interested in land profits.” Campbell says The Fischer Group has five or six joint ventures with builders in the works, where that number was zero two years ago. Joint ventures take many forms, though, such as Trend Homes' partnership with the city of Phoenix, which helped Trend assemble a 100-acre parcel with 10 different owners, located in a targeted redevelopment zone. Reed Porter, Trend's president, says his company would build 752 homes on this property, in line with Trend's move toward higher-density projects. Lennar joined forces with the San Diego Padres baseball club on an urban redevelopment project that Haddad says will yield 1,300 homes.

Lennar is often the first choice in deals like these because of its reputation, even among competitors, as the industry's most creative land buyer. Other national builders and developers also have access to financial resources that provide them with considerable purchasing leeway. So to keep from being shoved to the sidelines, mid-sized and smaller builders must be nimbler and more flexible in their land acquisition maneuvers.

The importance of a builder's connections with sellers, lenders, and municipal planning and zoning officials cannot be overestimated. Ole South Properties recently received a call “out of the blue” from a seller with a 250-acre farm outside of Murfreesboro, Tenn. Mike Lilly, Ole South's vice president of development, knows this seller approached other builders, but believes his company won out because of its local reputation and because “we tend to pull the trigger pretty quick, and we don't present a contract to the owner that looks like the Encyclopedia Brittanica.” The lots David Weekley Homes purchased in Fate were presented by John Baker, a Dallas-based developer who assembled three different parcels to make them more attractive to buyers. Baker says he got wind of that land's availability before other developers through contacts he's cultivated during his 22 years in the business.

East Brunswick, N.J.–based Kara Homes is in phase two of a 285-unit active adult community in Old Bridge, N.J., called Horizons at Birch Hill, tucked away in a wooded area that once was a swimming club and nightclub. Before construction began, that 55-acre assemblage required a use variance. Kara's CEO Zudi Karagjozi says the seller chose his company because it felt that Kara had the best chance at securing that variance, with good reason. Before the Horizons project, Kara had built around 800 homes in Old Bridge and had donated 30 acres for parkland and $250,000 toward the construction of a new YMCA.

VERDANT DEVELOPMENT: In the west-southwest corner of Orlando, Fla., DeLuca Homes is developing two properties: Woodland Lakes II, which it started in 2002 and is completed, has 239 50-foot lots; and the adjacent Woodland Lakes Preserve, which when completed will have 546 50-foot lots. DeLuca is shooting for developing 15 lots per month.

Three years ago, Hunter of Corky McMillin Cos. discovered through local contacts that Ford Motor Co. was liquidating $1 billion in noncore assets, including Rolling Hills Estates—a master planned community already under development—that Ford owned through a local builder, Pacific Bay Homes. Pacific Bay's president offered to buy that property with other builders as investors. Corky McMillin Cos. coveted Rolling Hills, too, but Pacific wouldn't surrender any financial information. So Hunter conducted his own analysis and approached Ford's treasurer, John Mc-Donald, with a counteroffer that Hunter believes was at least $20 million higher than Pacific's. To mitigate that cost, McMillin brought in Continental Homes as a partner, which would get 350 lots for $55 million. Corky McMillin Cos. also offered to assume Rolling Hills' warranty obligations and to pay Ford “a few million in nonrefundable money” upfront. Realizing how much cash he'd be leaving on the table by accepting the insider bid, McDonald agreed to McMillin's terms. Hunter says McDonald faxed a signed contract to the builder's headquarters at 2 a.m.

It's clear that smart land acquisition is about networking and taking some risks. And while money talks, growth-minded builders need to have their antennae up at all times to know who's listening.

SOURCE: BROOKINGS INSTITUTION

Land may be in short supply, but builders with excess real estate are turning ground into gold by selling off some of it.

In September, Technical Olympic USA (TOUSA) raised its earnings projections for 2005 by $20 million and stated that land sales would increase TOUSA's net income by 10 percent.

The Florida-based builder's good fortune reflects a larger dynamic within the housing industry of builders and developers wielding land assets more purposefully to expedite their growth. New Jersey–based Kara Homes, which expects to quadruple its revenue to $2 billion by 2007, leverages the 2,500 lots it owns, which are valued at $175 million, to negotiate expansion capital, says Kara CEO Zudi Karagjozi. Phoenix-based Maracay Homes Arizona controls 8,000 lots but closes only 700 homes per year, so “that allows us to generate income from what we control,” says vice president of land acquisition Todd Weber. This summer, Maracay was talking with a large builder about trading a 130-lot parcel for a position in that builder's master plan. What Maracay wanted to swap was part of a 240-acre, 800-lot parcel that it's been selling bits of in recent years.

TRUE PARTNERS: The developer Focus Property Group raised $510 million for Kyle Canyon (above), which will be a 1,710-acre master planned community in northwest Las Vegas. Focus favors involving builders as investors, including eight companies that will participate in Kyle Canyon's construction, as well as Meritage Homes and Beazer USA, which have product in, respectively, the Yellowstone (right) and Collina neighborhoods of Focus's 3,500-acre Mountain's Edge master planned community.

Lennar Corp. recently sold its 1,942-acre Bick-ford Ranch project to the developer SunCal for an estimated $210 million. When asked why Lennar didn't hold onto this project and complete the development itself, Emile Haddad, president of Lennar's California region, explains that the decision was simply a matter of dollars and cents. “We invested X dollars and could sell for Y and still build 50 percent of the home sites.” (Lennar optioned back 920 lots.) “One of the big changes in the industry has been that builders who once looked at land opportunistically now view it as a commodity to fuel growth.”

David Keller, TOUSA's CFO, says that it's not unusual for his company to acquire a “strategic property” and then decide it doesn't fit into the company's immediate business plan. TOUSA held a parcel in Southern Florida under contract for a while but never closed on it. Late last year, it flipped the parcel for a pretax gain of $16 million. “The land had appreciated rapidly, and it was just more profitable to sell it,” he says.

TOUSA sometimes purchases a parcel of land that is too large to retain itself. It owned a 2,000-acre tract in Phoenix that it originally wanted to purchase through a joint venture that never materialized. Keller says it closed out the land for cash on its books and didn't want to carry it any longer. So it sold half of the property in 2005.