Big builders need a constant diet of land to keep their mighty pipelines filled. And they need a steady stream of land to benefit from even-flow production and grow their market share. In today's world, it takes years to gain all necessary entitlements and approvals. So, years of land to feed production are a must. Thus, the decision to chase deals and build land positions has long been a no-brainer. After all, the float that builders derived from appreciating land fattened margins and lifted earnings. Now, though, some worry that the price appreciation tide may be turning.

BANKING ON LOWER RISK Banking land equates to financial risk, and taking down land means bulking up on the balance sheet. So, big builders are turning to old and new methods to manage risk. From joint ventures to diversifying land holdings across a growing number of divisions to creatively crafting options, builders are tying down land without as much carried on the books. A recent survey of large builders by the Joint Center for Housing Studies of Harvard University found that the use of joint ventures is up sharply over recent years, followed closely by expanded use of options and off–balance-sheet financing mechanisms.

But, because land is still essentially a relationship business, many local land owners and brokers prefer to deal with regional and smaller local developer-builders with whom they have a track record. What's more, regional and local players usually have the authority to commit to land deals, while the divisions of the national companies may not. Harvard's survey found that the share of corporate offices with employees on the payroll for land acquisition and development decisions shot up from about 50 percent to 67 percent from 1999 to 2004. The share of head offices with land entitlement staff surged from 42 percent to 53 percent.

INQUIRING EYES Like it or not, many local land owners and brokers view national builders as potentially fickle. They fear corporate offices will reject deals that take considerable effort and expense to craft. No one likes rejection. Whether it's because the corporate office just doesn't like the deal or has decided to redeploy capital to a division earning better returns, backing out hurts in future negotiations. Also, walking away from options leaves a bitter taste in the mouths of local land owners and intermediaries. But sometimes large builders must just walk away. Managing their balance sheets may demand that they unwind from land positions sooner than regional and local builders.

REAPING BENEFITS OF SCALE So what can the large builder do to reap the benefits of land banking while minimizing both financial and relationship risks?

  • Give divisions breathing room and direction to speak with absolute authority for the company as often as possible.
  • Avoid shifting around allocations for land purchases among divisions without fair warning.
  • Consider pulling the trigger on some undesirable options and taking some land. Then either wait the time it takes to get your capital back out or sell off the land to a third party.
  • Diversify across markets. Down markets at the local level are more likely to make local builders tank and leave regional builders teetering than to knock national builders off their perch.
  • Defer sunk costs in land as long as possible and as close as possible to when a sale is certain. It's less painful to walk away from an option or pull the trigger on entitled land under option than to walk away from or take in developed land in a weak market.

    • On balance, big builders are in a strong position. While they may fray some relationships because of the corporate overlay, it's that same overlay that brings them beneficial cash, discipline, and risk diversification. In up markets and down, this should serve the large builders well if they play their cards carefully.

    Corporate Agenda Sixty-three percent of respondents highlighted land acquisition as the item that, from a corporate perspective, most increased in importance between 1999 and 2004.

    SOURCE: JOINT CENTER FOR HOUSING STUDIES