Home Builders Mothball Homes To Avoid Selling at a Loss
By Michael Corkery From The Wall Street Journal Online As the glut of unsold home remains stubbornly high and housing demand slides, home builders face a dilemma: to sell, or not to sell?
Lennar Corp., for one, has joined the “not to sell” camp at its development in Orange County, Calif. The Miami company plans to finish building 259 homes — the first phase of a 1,100-unit development in Irvine — but it has decided not to sell any of them until the constrained mortgage market and swollen housing inventory improves.
“We are better off holding off on sales at this asset and not discounting as steeply as the market is discounting right now,” says Emile Haddad, Lennar’s chief investment officer, who oversees the company’s large West Coast projects. “It doesn’t make sense for us to sell it in an environment that as strained as it is right now.”
Mr. Haddad says Lennar will monitor the Orange County market on a monthly basis, but “this might be put on hold for the whole year of 2008.” Lennar also is halting development of a large community planned near Angel Stadium of Anaheim, despite preparing the land to support the project.
Analysts expect more builders to mothball projects in the coming months, as they decide that the losses from selling homes at huge discounts are greater than the costs of carrying properties on their books. But it’s not an easy decision. Builders are facing increasing pressure from lenders to service their debt and also have overhead expenses to support.
“It’s the next natural step in the evolution” of the housing downturn, says Nishu Sood, a home-builder analyst at Deutsche Bank. “This normally happens during a recession when you just don’t have a base of demand. But it’s like that now. In some of these locations, you just can’t give a house away.”
Some builders don’t have the luxury of waiting for a brighter day. The more highly leveraged companies are slashing prices to move inventory to generate cash and pay down debt. This fall, builder Hovnanian Enterprises Inc., based in Red Bank, N.J., offered discounts on homes of as much as 30%, while Standard Pacific Corp., of Irvine, Calif., has been offering discounts and other incentives of as much as 25% on certain homes. Both companies say their recent, heavily marketed discounts have sparked sales in the difficult market.
Lennar Chief Executive Stuart Miller recently called some price cuts “unrealistic and maybe even ridiculous.” “The market has just deteriorated more and more. We don’t want to go below a certain floor, and that is the floor of reasonableness,” Mr. Miller told analysts on a conference call in late September.
Outside some of its Orange County developments, Lennar continues to discount homes in many markets to make sales under increasingly tough conditions. In the third quarter, Lennar delivered 7,636 homes at an average price $296,000, including discounts or amenities of $46,000 per home. That compares with an average price of $316,000, including $35,900 in discounts and amenities in the year-earlier period.
Lennar’s move in Orange County is unusual in that the company is mothballing homes. Builders typically mothball partially developed or undeveloped land because vacant homes require watching. One alternative would be for builders to sell their land instead, but that market is even more dismal than the one for housing. Recent land transactions in California, Phoenix and Southeast Florida, while few in number, have fetched discounts of 70% and 80% on finished lots, according to Zelman & Associates, an independent housing research firm.
“They have all this land that they need to turn over, so they keep building,” says Paul Puryear, an analyst at Raymond James & Associates. “We would recover so much quicker if you could just turn it off, but you can’t turn it off.” Lennar may be in a better position than others to mothball certain developments and land. The company was one of the first large builders to discount homes through much of 2006, burning through its unsold inventory and generating cash. At the time, the company was criticized for softening prices, but “it ended up being the right move given the subsequent deterioration in the market,” says UBS analyst David Goldberg. Although it posted a $514 million third-quarter loss, the company ended the period with a net debt-to-capital ratio of 36% compared with an industry average of 43%, Mr. Goldberg says.
Luxury builder Toll Brothers Inc., based in Horsham, Pa., said last week that it is willing to hold prices, even if that means generating few sales. Mr. Sood says such a strategy amounts to the “effective mothballing” of certain developments. “They might have a salesperson in these communities, but it’s effectively fallow,” Mr. Sood says. “They are selling less than one home a month” in some communities. Chief Executive Robert Toll said builders with cash problems may need to reduce prices more aggressively. “But fortunately, for the time being, that’s not us,” Mr. Toll told analysts on a conference call last week.
Builders continue to put up new homes, though in far fewer numbers than during the housing boom. According to the Census Bureau, builders started construction on 79,400 single-family and 21,200 multifamily homes in September, which was down 33% and 31%, respectively, from the same month a year earlier. Housing starts are off by about 48% from a peak in January 2006.
Considering there are too many houses already looking for buyers, it might seem surprising that builders are building at all. But unlike auto manufacturers that can ramp production up or down in a matter of weeks, it can take years for a housing development to makes its way through the development pipeline. By the time the builder has spent money putting in roads and sidewalks, the housing market may have turned. “Many builders are stuck between a rock and hard place,” says Jonathan Dienhart, director of published research at Hanley Wood Market Intelligence, a housing research firm in Costa Mesa, Calif. “They can’t make money by building, and they can’t make money by not building. They have to choose the lesser of two evils.” Lennar’s Mr. Haddad says the builder had to finish constructing the first phase of its Irvine project, called Central Park West, where the mix of condos and town homes had an average price of $700,000. “You create a stigma for a community if it’s only half built,” Mr. Haddad says. The 14 buyers who signed contracts for the 259 homes got their deposits back. A spokesman for Lennar’s partner in the project, San Francisco-based Stockbridge Real Estate Fund, said, “We are under no pressure to sell strong assets into a weak market, especially where the market’s long-term prospects remain favorable.” Mr. Haddad says Stockbridge has a larger equity stake in the project than Lennar, but he declined to elaborate. Mr. Haddad says the lender on the project, Britain’s Barclays PLC, is “fully aware of what we are doing.” Barclays declined to comment.