Three years into the worst housing downturn since the Great Depression, three dozen major builders have declared bankruptcy. Yet for every builder that has gone under, hundreds more are on life support, hanging on only because their lenders choose to look the other way.
“I know many cases where builders imploded a year and a half ago, and they are still working out their problems with banks,” Doug Yearly, a regional president of Toll Brothers, said at an investment conference in September. “Lots of builders are hanging on by their fingernails,” adds Joel Shine, the former president of CityView, which works with builders to provide workforce housing, “and banks are letting them hang on by their fingernails. That’s not going to end well.”
Nearly everyone in the industry knows someone who remains in business, struggling mightily to generate enough cash to pay off debt and fund operations, only out of the good graces of a lender. From a financial perspective, these companies are upside down, without the assets to pay off their debts. As we move into the winter months, with builders and lenders both starved for cash, the pace of builder liquidations and bankruptcies is likely to markedly increase.
Apocalyptic forecasts, made early in the downturn, that industry ranks could be trimmed by at least 50 percent may well come true. Housing analyst Ivy Zelman of Zelman & Associates believes that the current debt crisis may push that figure as high as 75 percent. “As more and more banks are forced by regulators to clean up their balance sheets,” she says, “private builder failures will accelerate. Even well-performing builders will struggle to obtain financing to move forward with projects.”
Many builders have quietly wound down their operations to avoid bankruptcy, selling off land and unfinished homes to investors. Some, such as Houston’s Royce Homes and Taylor-Morley of St. Louis, attracted considerable attention in the process. Others remain in pitched battles with bank workout departments.
The banks, of course, would like an immediate repayment in full of loans they’ve made. But most builders don’t have the money, or the inclination, to do this, especially if they have gone to outside equity for funds, and those equity sources are looking for a 20 percent to 25 percent return.
“That leaves the banks with only three choices,” says one builder who has been negotiating with his banks for more than a year. “They can foreclose and pursue any guarantees, which is likely to put the builder out of business. They can continue funding the build-out of the neighborhood with the hope of maybe getting full repayment or minimizing their losses. Or they can accept a discounted repayment of the debt.”
Most builders faced with this situation would prefer to build their way out of the mess. They would like to get the financing to build another project, or complete the ones they started. But throughout the country, banks have virtually shut off the AD&C spigot. “There’s no debt available,” confirms Jack Haynes, executive vice president of builder loans for Countrywide Home Loans. “The only way to finance deals is with equity through institutional sources, and that’s a very expensive option.”
