During 2022, high mortgage rates, home price appreciation, and inflation began to negatively impact overall consumer confidence and demand in the housing market. Cooling demand was reflected in Zonda’s December New Home Market Update, which indicated the count of new homes sold in November represented a 10.6% decline from the previous month and a 35.9% decrease from the same period in 2021.
Due to current market conditions, many builders have shifted away from a full-steam-ahead approach to land acquisition, instead taking a more cautious path with a focus on developing land within the existing pipeline rather than acquiring land at a rapid pace.
During Zonda’s National Housing Update webinar in November, senior managing principal Tim Sullivan said nearly 60% of builders were “cautiously moving forward” with their land acquisition strategy, with a quarter of builders pausing completely on land deals. Only 2% of builders said they were continuing to move “full steam ahead” in regard to land acquisition. Sullivan said many builders are “pausing deals in the outskirts” while focusing on land acquisition within core operating markets.
“Tri Pointe Homes is being conservatively opportunistic,” says Tom Mitchell, president and chief operating officer of Tri Pointe Homes. “Our strong land pipeline gives us future supply and affords us the ability to be opportunistic on new land acquisition, all while staying focused on ‘A’ locations and growing our premium entry-level segment of homes.”
Many builders, including Taylor Morrison and Tri Pointe Homes, have moderated the pace of starts to reflect current demand conditions while employing a cautious, selective approach toward new land acquisition. Erik Heuser, executive vice president and chief corporate operations officer for Taylor Morrison, says the builder has adjusted its capital allocation by “pulling back” on land investment, prioritizing the health of the company balance sheet, and remaining “highly selective” in new land spend.
“There are very few deals that need to be acted on right now,” notes Mark Wolf, founder and CEO of AHV Communities, a developer, builder, and operator of build-to-rent single-family communities. “Voices within the market want to force a fear of missing out; however, the reality is that there is time, and there will be plenty of opportunities when conditions improve. One approach of ours is that our target sites are extremely well-located, unique, and, oftentimes, holes in the doughnut. Because those deals are always rare to source, we would dig into them even in a market like this.”
During Taylor Morrison’s fiscal third quarter, the builder invested $377 million in home building land acquisition and development, a 21% decrease on a year-over-year basis. Taylor Morrison spent $102 million on land acquisition during the quarter, a 70% reduction compared with 2021 and the builder’s lowest spending level since 2016. Similarly, D.R. Horton reported its investments toward lots, land, and development decreased 19% on a year-over-year basis during the fiscal fourth quarter, with $150 million allocated to acquire land.
“We have been cautious for some time as we’ve seen the market pivot over the last couple of years, having moved to an opportunistic stance,” says Heuser. “With a healthy land supply and favorable vintage, the ability to focus much of our attention and spend on land development, and negotiating most of our active land pipeline deals, we will maintain a disciplined approach to land investment.”
For many builders, including Lennar, Taylor Morrison, Tri Pointe Homes, D.R. Horton, Hovnanian Enterprises, and Landsea Homes, cautious land strategies include re-underwriting, stress-testing, and reevaluating land deals. Stuart Miller, executive chairman of Lennar, says the builder reconsidered every land deal in its pipeline during the fourth quarter and, in some cases, walked from deposits or renegotiated terms in price. As a result of PulteGroup’s reassessment of pending transactions, the builder elected to terminate several pending deals and wrote off $24 million of deposits and pre-acquisition expenses associated with deals in its fiscal third quarter.
“Regardless of market conditions, we are always disciplined in underwriting new land transactions. But in today’s more challenging sales environment, there is an increased vigilance to our underwriting process,” said Larry Sorsby, executive vice president and chief financial officer of Hovnanian Enterprises, during the builder’s fourth quarter earnings call. “As of late, we’ve not been approving many new land transactions. Given the slowdown in sales pace and increase in incentives, it’s difficult to find land sellers willing to lower their expected sales price to a level that will meet our underwriting standards.”
Heuser says Taylor Morrison began to stress test every land deal in 2021, and the firm recently has reassessed every deal while also re-reviewing each land transaction prior to final closing.
“[We] have remained disciplined to our long-held mantra and are investing in prime locations in core submarkets with proximity to job centers, schools, hospitals, and other desirable amenities, all of which are attributes that have historically contributed to more stable land values over time,” Heuser says. “This opportunistic approach became even more conservative over the last several quarters to ensure that each dollar invested meets our stress-tested, risk-adjusted return thresholds.”
In addition to stress testing and re-underwriting all land deals under contract to current market conditions, Mitchell says Tri Pointe Homes also is focused on increasing the number of controlled lots relative to owned lots. At the end of the company’s fiscal third quarter, of Tri Pointe Homes’ 37,000 lots in its land pipeline, 56% were owned and 44% were controlled under land option contracts or purchase contracts. Taylor Morrison controlled 42% of its 80,000 home building lots via options and other off-balance sheet structures, an all-time high percentage for the company.
Scott Snodgrass, founding partner of Houston-based developer Meristem Communities, says since the company is a new developer and does not have a pipeline that is already built, it is in a unique position in the current market. While caution is still present, Snodgrass says Meristem is actively looking and “kicking the tires” on deals. He adds Meristem is interested in more difficult-to-entitle scenarios, which in the present market may be more available at a discount.
“[2023] is a great planning year. If you could have a project that could come to market in mid- to late-2024 or 2025, I think from our perspective, it’s a fantastic chance to partner with somebody or do something where you may not change the risk calculation on acquisition,” says Clayton Garrett, founding partner of Meristem Communities. “[2023] is a great year to get a lot of the planning and entitlement work done, even if you’re not coming to market.”
Sticky Land Prices
During the National Housing Update webinar, Sullivan also shared how many builders surveyed by Zonda expressed concern about land prices. Sullivan said many builders believed “sticky” prices reflected market conditions in early 2022 and had not adjusted downward. AHV Communities’ Wolf says that land pricing needs to “fully adjust,” and many long-term holders “will likely wait out the situation since they don’t have to sell now.”
“Buying land at the right price is paramount. It is a process that involves an alignment of assumptions between the buyer and seller. You have to be committed to spending time with each and every seller to understand the market and their goals and educate them on current demand trends and costs,” Mitchell says. “The current high interest rate and inflationary environment is a cost reality that calls for appropriate deal structures.”
Heuser and Mitchell say by leveraging relationships with land sellers, there has been success in renegotiating timing, terms, or price as appropriate. Heuser says in Taylor Morrison’s most recent fiscal quarter, “the vast majority” of contemplated core business land spend that progressed through the investment committee “was restructured in some fashion,” and deals not meeting required thresholds were terminated.
2023 Outlook
The economic uncertainty that persisted during the latter half of 2022 is projected to continue into 2023. Due to a combination of economic factors, including continued high inflation and monetary policy tightening, many economists forecast the economy will fall into a recession this year.
“The outlook for the market is forecasting weak sales, and we should expect choppy roads ahead,” Wolf says. “Prudence is recommended, and we will continue to watch a confluence of factors, including inflation, interest rates, pricing, rents, and the overall state of real estate capital markets, including the availability of finance.”
Despite recessionary concerns, the land-light approach of many builders balances risk, emphasizes optionality and capital efficiency to improve returns, and limits exposure to market risk during periods of uncertainty. Heuser says Taylor Morrison’s mix of land portfolio provides the ability for the builder to continue to be opportunistic looking for land investment going into an uncertain 2023.
Mitchell says the long-term macro environment for the housing industry remains “bright” due to the lack of supply and the housing deficit, providing opportunities for well-capitalized and strategized builders to establish and strengthen market positions.
“While we are closely scrutinizing development plans for both new and existing projects with an eye on managing overall lot inventory, we continue to have meaningful opportunity to monetize our well-vintaged land and maintain competitive scale and positioning across our markets,” Heuser says. “This enables us to carefully monitor local resale conditions, competitor supply levels, and consumer sentiment and behaviors as we contemplate land acquisition opportunities in 2023 and beyond.”
