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Homebuilders in a hole?

Posted by: Dean Foust on May 18, 2007

Was so busy earlier this week that I didn’t have time to make a shameless plug for a housing-related story I wrote for the print magazine looking at the deteriorating financial situation of many homebuilders. A number of small and mid-sized builders have filed bankruptcy across the country,for sale.jpg and Moody’s, the big credit-rating agency issued a report in April predicting that a number of large homebuilders could fall out of technical compliance with their debt agreements, leaving them at the mercy of their lenders to grant waivers. For what it’s worth, executives at some of the homebuilders I interviewed didn’t agree with the critics and hence, didn’t buy the premise of the story. They think the slowdown is entirely manageable and that the industry by and large is better positioned than builders were doing the ‘90-‘91 recession, when many more went bankrupt than have so far in this slowdown.

The real reason I mention my recent story, Homebuilders in a Hole, is not just to plug it, but because I’d like to solicit input from people in the real estate industry — suppliers, real estate agents, heck, the builders themselves — who have an ear to the ground. I was told by an Arizona attorney who represents several small builders that the talk on the street in that state was that some of the bigger builders were actually selling new homes below the construction and land costs. This theory: They’re anxious for the cash flow to stay in compliance with their debt covenants that they’re willing to sell for a loss if that’s what it takes to move the house. And since the land and construction expenses are already “sunk costs,” selling at a loss still creates cash flow. With that, I open the floor for intelligence from the front line. Comments?

Reader Comments


May 21, 2007 3:46 PM

I don't doubt they are completing construction and selling at lower prices, but probably not below cost. Most of the profit in homebuilding is in the appreciation of the land during buildout. Construction itself is usually little more than breakeven. Without appreciation though, there is no profit to be made which is why any recovery will be long in coming.


May 22, 2007 10:47 AM

I spent 11 years in the operational and management ranks of a top five homebuilder and rarely have seen much capacity for control of the business beyond meeting the short-sighted expectations of "the street," whether the issue be asset turns or cash flow. It's clear that profitability is not the driver now, as evidenced by recent earnings reports (some posting the first ever quarterly losses). Builders are walking away from millions in order to get land off the books, despite the looming need to replace it in order to keep building homes (the elephant in the room no one seems to want to discuss). Profitability will be further strained when the land cost in homes sold in 2008 and 2009 is so much higher due to this replacement premium. In the face of continuing high commodity prices, a lack of construction cost discipline, and the everpresent pressure to meet closing targets, sales at below cost are very likely over the next 18 months. It is unfortnate, however, that the market is unwilling to hold builders accountable, 1) for failing to anticipate, and act accordingly on, these changes in the market, and 2) for claiming "the slowdown is manageable," while refusing to offer performance targets for the coming year due to the "uncertainty in the market." Which is it!?!?!? It's also difficult to imagine what would compel a BOD to nearly double the compensation of their CEO in light of all this and a -21% return to investors (Tim Eller at Centex). The homebuilding industry is a good place for reckless executives lacking any real vision for building great companies to make a lot of money at the expense of the shareholder. Maybe this is a good opportunity for the investor to respond.


June 18, 2007 8:13 PM

As a former Division President with one of the largest builders I can say with certainty that they will sell below cost if that is what the market demands. Many times they've already written down the lots and/or houses, as required by their auditors, and their now reduced cost is much lower than private builders realize.

The most likely builder to go broke is the one who fails to adjust his price quick enough all the way to market and continues to incur costs while his competitor is liquidating inventory, generating cash flow and exiting his problem subdivisions.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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