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Their love affair with traditional lenders is on the rocks, so some residential real estate developers have found a new partner: private equity. More than 20 firms are looking to team up with homebuilders to go bargain shopping for distressed properties.
For developers, private equity firms bring much-needed cash. For investors, it's a classic contrarian play, adding new homes to a market flooded with inventory. That would be a doomed strategy if pursued on a large scale, but analysts believe a few well-chosen projects could pay off. "I've been getting the question: Why aren't housing starts at zero?" says Megan McGrath, an industry analyst with Barclays Capital (BCS) in New York. "The answer is they're probably as close to zero as they're going to get, and in some cases it still makes sense to build."
Smelling opportunity, private equity managers raised at least $12 billion in 2009 for development projects and other residential real estate deals, according to an analysis by Bloomberg BusinessWeek . And some older funds are just putting their money to work. Last year Hovnanian Enterprises (HOV), the seventh-largest U.S. homebuilder by revenue, announced joint ventures with two New York private equity firms in which the investors put up 80% or more of the money. GoldenTree Asset Management joined Hovnanian for 11 projects around Chicago and Palm Beach, Fla.; Angelo Gordon & Co. signed on for other Florida deals. "For every [private equity firm] that we're doing business with, there are 10 more that we're talking to," Ara K. Hovnanian, the builder's CEO, told an industry conference in November.
It takes plenty of courage to bet on housing these days. The inventory of new homes, which had steadily fallen throughout much of 2009, began creeping up at the end of the year. It would now take 7.9 months to work through the supply, compared with a five-year average of 7.2 months. With unemployment and foreclosures still at quarter-century highs, demand could remain weak for some time, especially with federal tax incentives for home buyers set to phase out in April.
That's why investors say they're being picky about projects. A $100 million fund begun in 2007 by the U.K.'s Grosvenor and Cleveland's KeyBank (KEY) took two years to make its first investment. The fund managers wanted to buy ready-to-build lots from troubled builders for about 20 cents on the dollar and hoped to avoid ugly markets such as Las Vegas, South Florida, and Southern California. So far, the fund has done five small deals for subdivisions, including ones outside Philadelphia and Raleigh, N.C.
Reuben S. Leibowitz, managing director of JEN Partners, a New York private equity fund, said he invested $50 million last year in land and construction deals in Southern California and Arizona, where he believes buyers are coming back. In May he bought Canta Mia, a 600-home senior community outside Phoenix, and hired local builder Carl Mulac to run the project. The original developer, Tousa, filed for bankruptcy, and Leibowitz acquired the project—complete with model homes—for less than the cost of putting in roads, waterlines, and other essentials. Leibowitz expects to recoup in four to seven years, but he says he doesn't see a lot of other good deals out there.
At least one private equity fund has pulled up stakes. In 2006, Rockpoint Group, a Boston firm, raised $470 million from investors, including the California State Teachers' Retirement System, for a residential real estate fund. Rockpoint closed the portfolio in August—because it couldn't find enough workable deals.