So one CEO is upbraiding another, and for what? For increasing production instead of cooperating to keep production down. Isn't this as close as we get to seeing an anti-trust violation out in the open?
What is so astonishing is that despite all of hand writings on the wall, HB stocks are stubbornly staying high. Question is how and who is manipulating these stocks?
p.s. if you havent listened to the UBS "State of the US Housing market" from that same conference I suggest doing so, lots of good stuff there. Check any IR section of a homebuilders website for a link to the UBS conference.
Let me understand this: one home builder is accusing other home builders of building homes? Well, if a greater profit/smaller loss can be had by selling a house than a piece of land, then why not build and sell the house? Oh yeah, building more homes would add to the glut creating more pressure on prices to drop, thus reducing the value of their existing inventory. However, it's unlkely--at best--that the one home builder's added supply would surpress prices further to the point that building the other homes would be a net loss. It is the aggregate construction across all of the builders that would definitely alter that decision. And like the person above me said, when did it happen that all of the CEO's of an industry were allowed to meet and collectively agreee on each other's business decisions-legally?
What I find most humurous is that the Toll CEO was incensed over being "accused" of building homes. Does this strike anybody else as being strange? If these guys are willingly admitting that the situation is bleek for the next year or two, the reality of the situation must be UGLY, and destined to become UGLIER.
Let me understand this: one home builder is accusing other home builders of building homes? Well, if a greater profit/smaller loss can be had by selling a house than a piece of land, then why not build and sell the house? Oh yeah, building more homes would add to the glut creating more pressure on prices to drop, thus reducing the value of their existing inventory. However, it's unlkely--at best--that the one home builder's added supply would surpress prices further to the point that building the other homes would be a net loss. It is the aggregate construction across all of the builders that would definitely alter that decision. And like the person above me said, when did it happen that all of the CEO's of an industry were allowed to meet and collectively agreee on each other's business decisions-legally?
What I find most humurous is that the Toll CEO was incensed over being "accused" of building homes. Does this strike anybody else as being strange? If these guys are willingly admitting that the situation is bleek for the next year or two, the reality of the situation must be UGLY, and destined to become UGLIER.
Since we've been anticipating a housing bust off and on for the last three years or so last year (and then some, this is by memory) the WSJ ran an interesting this time it's different story on the builders. The gist of the theme, drawing on the Street analysts, was that a)this time they'd all been conservative and repaired balance sheets and b)added to their inventories of raw land so carefully that they didn't need to move them and could wait out the downturn. Where are they when you need 'em ? Or that was then and this is now. That sounds like they're desperate to move land they can't afford, which says over-extended to me which also say bad balance sheets and we're just started into this.
And, oh yeah, my drinking buddy in my favorite dive mentioned that quality and materials was as bad as he'd seen it in a long time. Hmmm..wonder what's up with that ?
If house prices are at a maximum right now, a maximum unlikely to be revisited for many years, then the NAR sees 6% of maximum price for their profits.
Also, after the housing crash (and the subsequent hanging of David Lereah), the NAR may very well lose their monopoly and be forced to get less than 6%.
Max percent x Max price = Max profit EVER!!
Does anyone really wonder why the NAR is spending enormous sums to rope in suckers TODAY?
Actually, to go one step further, every single financial services player in the mortgage market stands to make their MAX profit now, IF house prices are at a level that won't be seen for a long time (as in Japan 1989).
So shouldn't we all expect that EVERYONE in the industry with a hand in the pie will promote purchasing today?
Maybe fixed fees are the future.
Since I don't know enough details, nor work in the mortgage industry, anyone out there care to educate us on the topic of point-based fees versus fixed fees throughout the entire mortgage market? Are their presently any fixed fees? I understood that mortgage brokers get larger commission from option ARMS, but are they fixed or percentage? If fixed, wouldn't they most likely lower the 'fixed' commissions if housing prices fell?
The UK has had a similar bubble that seems to have peaked (from old articles on the internet) about two years ago. However, since then it seems to have just been flat in the soft landing arena, their stock market however has continued to rise and there doesn't appear to be any overall fallout. The had a huge rise in MEW in 2003 that slowed alot, and similar articles on the reduction in MEW hurting the economy, has been shrugged off and spending is on the rise again. The just raised the rates to 5% to fight inflation.
The bubble in Australia is similar in that it was described as the "canary" for the rest of the world, and it hasn't tanked yet. Seems this is taking along time in all markets.
Does anyone know if the markets in the UK and Australia were full of exotics and no-doc's? How are we different here? What is gonna be the impetus for the correction that has been absent in these foreign markets?
I must be missing something, because if it's easier to sell land if they build a spec house on it, then it seems like a smart thing to do -- and hardly unethical. (Like that should start mattering to any of them)
What's Toll suggesting - just sit on the land? What for?
The reason Toll was mad/shocked/stupified was because the homebuilders know that they have to bring down supply for the downturn to be "not as bad". But what DR Horton is doing is building spec homes (homes with no contract first) just to move land off the books and get the money back. So you have some of the builders on the "we arent adding to supply" train and others arent because they want to churn through the high cost (or less desireable) land on their books as fast as possible.
Toll Bros executives already pulled their millions out, yes? (year ago?) So I find the CEO's remark/interruption a little distracting in his effort to bolster Toll shareholder value/reputation.
No, I find both the CEOs' presence in defending shareholder value more than a little bit of a strain. The land which they have cultivated (bought and rezoned) and profited from in their ever-so-sophisticated development (buy, rezone and contract out servicing), needs this box, this house on it to sell. Without a box on it, the real estate is just so much dirt --possibly useful for farmers and those commoners that eat, but not for real movers and shakers who are made of different stuff.
Maybe not. Could be they eat too. It does look like less harmonious relations in a falling market than the relationships forged in the last decade. Yes, almost human.
Good point on how bad is it really. Kind of like Fannie Mae. If these guys are publicly making these negative statements, can you imagine the talks taking place behind closed doors and within their own minds? Of course they might not care. This bubble has ensured their families will be wealthy for generations to come.
fratt1, the marginal propensity to consume (MPC) from real estate wealth is about three times higher than the MPC from financial wealth, probably because financial wealth is more volatile than real estate. The difference in MPCs has policy implications. For example, after the dot com bust consumer spending from real estate offset the fall in spending from financial wealth. If the decline in real estate continues, it will spill over into consumption. Specifically, every $1 of net equity lost should immediately translate into about 8-9 cents of lost consumption. If financial wealth also turn down, this will subtract about another 3 cents of consumption for every $1 lost.
Recently developed financial instruments made it easier to tap into home equity over the past few years, thus tightening the statistical relationship between rising real estate prices and consumption from the wealth effect.
I think it's obvious that the HBs have a gentlemans agreement to curtail spec and to not bring raw land into supply inventory. I could only think of an OPEC production meeting. These companies are still massively profitable by most standards. Their problems haven't even started yet. Their PE/E ratios are not even going to be such a problem given their low numbers to start and expected volitility. It is the book value that will raise the white flag. Their supply of raw land is grossly overvalued and some they don't even own merely option. Expired options and writedowns of all the cheaply bought land will wipe billions from TOLs asset ledger. When that happens I don't see how how all these corporate officers can avoid the perp walk.
Here comes either stagflation or deflation as everybody has to start paying some of that money back in an environment where loaning money is risky. The outcome depends on how hard Bernanke defends his Monopoly money.
I don't think 'overbuilding' has ocurred to any great extent in the UK, even with demand going through the roof. There are a lot of planning constraints on where and how much housing you can build. So there isn't much (if any) of an overhang to work off. Demand is also high due to relatively low interest rates and a fairly sudden influx of immigrants from Eastern Europe. This is just speculation however, I don't have figures to back this up. Certainly here in Ireland our property market has been booming for the last 7 or 8 years due to extremely low interest rates and a massive population boom.
wawawa, in re the resiliance of HB stocks in the face of mounting negative fundaments, no one can tell for certain who or why these stocks go up, but one thing that is noticeable is that they always move in unison. I have read speculation that this is someone or a group buying the housing index to force a short squeeze. The short interest is high (although it came down a bit in Sept.), but it provides the rocket fueled for this kind of thing.
Couple that with the fact that a significant amount of the float in these companies is held by institutions. People like J. Gendell and Bill Miller at Legg Mason, who bought the HBs in '05, when they were at their peaks. Their investment losses in these stocks are huge, but they have stubbornly refused to sell.
When they do finally sell, the damage to these stocks will be swift and brutal, imo.
I have no idea what sparked today's rally. But sure as morning follows night, theses stock will reach no farther than the top of their recent trading range before doing another about face. Why? Because, despite the raving of media hypsters like Cramer, no one is buying these stocks for the long-term.
Smart management can keep them profitable during the downturn, I suspect even more profitable when they fully get a grasp of things and learn to lead the market down instead of fighting it. Smaller communities with quick buildouts at market prices. Instead of fighting the resale market they be at the forefront.
Not all land was purchased during the boom so many of these guys are sitting in the fabled cat bird seat. The amount of writedowns and walkaways wont be nearly as bad relative to the amount of money they have and can make. The use of options is really saving their bacon, and many of the large land deals have a considerable cushion because of the lead time it takes to get land to market. These guys arent dumb and they've learned from their past mistakes. Just because the market turned and they are going to take some losses on writedowns and options doesnt mean they lose their jobs. It is actually the fact that they structured the deals in an intelligent way that will be the reason they keep their jobs and shareholders/banks happy.
Cal, I aree that the well managed firms may do decently. Reduced construction costs may help them reduce land inventories at a profit. As previously pointed out this hurts other builders with high priced inventory. Perhaps, more importantly this supply hurts the prices of existing houses and the holders of high risk mortgages on them. If the economy weakens or lending standards materially firm this could cause very weak conditions in some real estate markets and for high risk mortgage securities.
Cal, you are right. You repeat what I said more than a year ago; they learned from their past mistakes. Yep, they are making entirely different mistakes this time. The biggest so far is underestimating the speed of the contraction. As to land values please correvt me but I thought they used current valuations not purchase prices meaning the land bought cheap is the msot overvalued on the books. I'd find it strange that an asset be on the books at purchase and not assesment but what do I know? Yes, the options are saving their cash flow, one of the things they learned but when the options expire the asset is taken off the book value as well. I'm thinking a book to price is going to kill these stocks as surely as P/E.
Rob't Cote - I think you are right, land value on the books is at market value not price paid.
However all their land holdings are 'overvalued' to the same extent if you consider book value to current market condition... some of it is 'paper profit' from buying cheap, letting it appreciate and some of it is out of pocket investment from buying expensive.
Regardless their current book values are to a great extent set by these recent past valuations (and also the finished & in-process inventory they own - also priced to a year ago or so).
Land is normally valued at the lower of cost(plus capitalized costs)or market at yearend. Builders will have to write down some land bought recently. Based on other downturns the accountants won't force big writedowns for another year.(when sales of lower priced land or lots are common) Most say they are trying to turn over land within 3-5 years so they may not have much cheap land on their books. However. builders may also sell land to each other so they can book profits to cover operating losses.
Building houses on vacant lots in order to sell the whole in a declining market!! I thought putting good money after bad happens only in the stock market - averaging down.
A good example of how greed and fear are endemic in all speculative markets. Human psychology is the same everywhere.
The housing market here in the UK is indeed booming again, following an initial downturn. But prices have risen so far that they are unaffordable to first time buyers, and others. There are plenty of non traditional mortageges around and one very large lender recently announced it was relaxing its lending criteria to 'officially' provide mortgages five times earnings. I think it is only a matter of time before the market here tanks again. What we have in the western world is a slow motion, drawn out real estate collapse that is not following a straight line. the trend globally, though is most definately down and has a long way to run.
The housing market here in the UK is indeed booming again, following an initial downturn. But prices have risen so far that they are unaffordable to first time buyers, and others.
dryfly, I'm fairly certain that home builders are required to value the land they own at the price paid rather than the current valuation. This is why a company like St. Joe (JOE) can claim they are much more valuable than their pathetic quarterly earnings -- which has negative momentum.
JOE owns 800K acres in Florida, most of it unlivable. But it was purchsed long ago, at a very low cost. Investment "geniuses" like those at 3rd Ave. Partners claim this makes JOE an outstanding value. It's not. It would take decades to convert those land holding into anyting representing true value for shareholders. The stock deserves to trade much lower.
At any rate, the same basic accounting formula applies to home builders. The irony here, of course, is that most are carrying a significant amount of land purchased at the peak of the market. And yep, as Hovnanian revealed, they are desperate to get that off their books. The irony is that in the meantime it makes their price-to-book look better than it should. The "value" in that book is quickly eroding.
I read that Hovnanian is discounting homes as much as 28%. With a ton of land and his company poised to start posting negative earnings, that reads like desperation to me. Who knows, maybe he was engaging in what psychologists call projection?
Maybe someone else can chime in here, because I am by no means an expert on how this works. But I believe accounting rules for the builders also require that they state the value of cost or current value, whichever is least. If so, that would add even more pressure on them to unload that high basis land.
In Northern Calif the price of land is the driver behind property valuations. Over the past 10 years cow pastures in Tracy have gone from
$800 an acre to 20K, which also drives up land prices in San Francisco Bay proper. Over the next 10 years these rural land prices may drop significantly back to 90's valuation and take the wind out of the Bay Area RE valuations with it.
I'm not an accountant, but I've been yelled at by some of the best CFOs in the business. I consider this a credential.
It damn well better be Lower of Cost or Market (LOCOM to you civilians). There's a similar issue with mortgages. If you originate a loan as "held for sale," you get to carry it at market until you actually sell it. If you fuck it up bad enough (or your investor suddenly exits the market, ahem) and have to move it over to "held for investment," you book it at lower of. In my day, we called that Doing the LOCOM-Motion, complete with Martha and the Vandellas-style back-up singing and hand gestures. Outside the CFO's office. If I can't dance, I don't want to be part of your balance sheet impairment.
In any case, I have a theory about the HFS pipelines of some of those builder-owned mortgage companies that you all don't want to hear about if you're eating.
"Building houses on vacant lots in order to sell the whole in a declining market!!"
It makes more sense if you think of it on a subdivision level. If a builder has a development halfway built, they have two options: keep building or stop building.
Profit margins are still positive in most places, so the "keep building" option is a no brainer.
If they choose the "stop building" option, they are stuck with the lots and development costs in inventory. The lots and development costs are usually paid for with debt, so they're accruing interest (which is capitalized to inventory).
There are also cash-flow issues associated with choosing the "stop building" option. Gotta pay the bills.
The only logical choice is to keep building until the profit margins go negative. And then to keep building to outsurvive the competition in the downturn. Builders build, if they stop they're unemployed.
"There is no sign of a bottom in the housing market. This week, Toll Brothers, Hovnanian and Beazer Homes reported preliminary fourth quarter results. Toll Brothers experienced a 10% drop in revenue to $1.81 billion. Additionally, net orders continued to plunge, down 56% compared to last year due to cancellations surging to 37% from only 2% last year. Its developments in Orlando and Northern California had the largest increases in cancellations. Toll Brothers expects to take $50 million to $100 million in land or land option write-downs during the fourth quarter. The company also lowered its guidance for the number of deliveries for 2007 to between 6,300 to 7,300 homes. Previously it expected to build between 7,000 and 8,000 homes. The company commented that, "We continue to look for signs that a recovery is imminent but can't yet say that one is in sight." Beazer's CEO, Ian McCarthy, iterated similar comments, "Despite recent references to signs of a bottoming or even the beginning of a recovery, we have not yet seen any meaningful evidence to suggest that a rebound in the housing market is imminent." Hovnanian announced the largest large charge off of the major homebuilders thus far. The builder said it will take a $300 million charge during the fourth quarter. It's likely that the charges homebuilders take during the fourth quarter will be high than the charges taken in the third quarter. Not only has the market softened since the third quarter, year end results will be audited. This will likely cause land values to come under more scrutiny."
I am an accountant, but I've been yelled at by some of the worst CFOs in the housing business. I'm jealous of the obscene bonuses they've collected recently. Please let there be one more housing bubble in my life time...
Sorry for the length of that snippet (it looked a lot shorter in my browser).
Anyway, the last sentence provides our answer that home builder who were most active purchasing land in 2004-2006 ought to show significant downward adjustment to their inventories when they file their 10-K's.
No doubt that helps to explain the anxiety on display at the recent conference.
HB look like hero's when they buy rural land and get it rezoned for commerical or SFH or both!. The local city council which is usually a combination of local land owners (exfarmers)etc are more then willing to provide the zoning needed since they have a large pool of property waiting in the wings. but how to deal with this rezoned property that may again become a cow pasture?
Optioned land normally appears in "Other Assets" at the value of the deposit on the option. Most of the writedowns that have been showing up recently are due to the forfeiting of the deposit.
But in some cases (due to FIN 46) the full value of the optioned land and related liability appear on the balance sheet.
Land OWNED is NOT carried at market value unless that value is LESS than what they paid for it.
I'd bet the majority of their holdings are now worth less than they paid for it... the question is will the 'assessments' show that or will they have to wait for more comparables to make that obvious.
BTW - getting accurate assessments of land value is a big problem right now. We are trying to liquidate an estate and the assessors are completely at a loss where to value about 15 acres on the edge of residential & rural due to the volatility.
Dryfly, Your problem is typical of early in a downturn. Later on comparable sales (often foreclosures or distress sales) provide a better basis for determining values. At that stage large writeoffs of land values by builders will become common.
For the record, because I've seen a lot of non sense out there, land is carried at the book value of the purchase, unless a compelling decrease in value causes it to be written down. It is never carried at "market". Options are certainly not valued at any land value and not booked until they close unless the homebuilder has deposits exceeding 20% of the purchase price (which they don't). This is driven by Sarbox.
And the questions about builders being profitable during this inventory correction......they most certainly will be profitable on any land purchased up to this point before 2005. If the market declines more then it will back up, but that has not happened yet.
AZ_Cowboy: "The only logical choice is to keep building until the profit margins go negative. And then to keep building to outsurvive the competition in the downturn. Builders build, if they stop they're unemployed."
I think this is someething that is being influenced by th eincreased market share of publicly traded builders. A small builder who mainly builds custom homes, might do a few specs when the market is clearly rising. That's what happens here. They can quite easily stop doing that when things contract, just higher fewer subs. They have really good years and some bad years, but they maximize their total profits.
Larger privately held builders have a lot more fixed costs, but can still afford to contract significantly.
But a publicly traded builder reports quarterly to Wall St and can't just say, "we stopped building..."
The bigger the builder, the greater the reward to build full-tilt in the boom, and the more difficult it is to stop at the bust.
This trend to publicly traded builders has definitely made the boom/bust cycle more pronounced.
It could be that this is just one of those businesses that would be best held privately.
Down turns are always interesting from a micro econ perspective... unless you are viewing it from the INSIDE.
Typically a company will continue to produce AT A LOSS under the following conditions:
Item 1) They are able to sell the product at a price sufficiently high to cover ALL their direct cost (materials, labor, direct overhead) and hopefully have some margin left over to apply toward all the indirect cost though probably not enough (hence the loss).
In this situation they are losing money but are losing LESS money than if they shut down.
Item 2) They need to have sufficient cash or sufficient bankable equity to borrow for cash to cover the 'temporary' conditions described in Item 1 (above).
This is the classic 'cash burn' situation so often discussed in the dotbomb implosion. The question is will the firms have enough cash to carry them through to the end? Can they cut enough overhead & sunken cost (like land) to reduce indirect cost to get profitable at the lower selling prices & margins?
And how long is 'temporary'? Even a slow cash burn becomes a problem given enough time.
No one knows any of this, that's why we all watch... it's the economic equivalent of a guy on the ledge.
And what happens if the margins deteriorate so badly that the sell prices no longer cover the direct costs let alone leave anything for indirect? Then 'shut down' is the only rational decision.
I believe Bob_in_MA hit on a key difference this time compared to past boom/busts... the public builders really can't shut down, the stock price would absolutely tank & stockholders would revolt.
Like I said - it will be interesting viewing... from the outside that is.
I am a contractor and I was there in 1980's bust. In a severe contraction book value doesn't matter. Builders can't "eat their assets" They need CASH FLOOW to survive. With cancellation running at up to 50% at some builders they are being slowly starved to death. After insane, mania driven boom of the last few years the corresponding bust will be a lot more severe then the most people think. By the time it is over 3/4 of the builders will be bankrupt by the debt they are carrying but are not be able to service. The remaining 1/4 will be rduced to cripples. IT IS A CASH FLOOW STUPID. With millions of baby boomers moving to the old folks homes the supply of houses will only get larger. This will just add inventory to the already glutted market. The RE is going to be a very bad investment for the next 20 or so years.
"By the time it is over 3/4 of the builders will be bankrupt by the debt they are carrying but are not be able to service. The remaining 1/4 will be rduced to cripples."
Thank you for eliminating any doubt, if there ever was any, as to the level of accurate analysis available on this blog.
Well, Buchanan, I suggest you purse your vinegar-stained little lips, pivot sharply on your kid heels, lift your frilly crinoline in both lace-mitted hands, and storm out of the drawing room. That will show us! You get extra Huffy Points if you never speak to us again.
I'm always grateful for the education I get around here, which implies that I occasionally need one, which implies that I don't know everything, which must mean I'm not fit to lick your boots, I guess. How fortunate I'm not a bootlicker.
I was really enjoying this thread, since there are so few places on the web where you can get a healthy discussion going of a flipping accounting principle in a manner that is both interesting and useful. I learned something, and I am so glad that our resident accountants (vicjim, Lama, AZ_Cowboy, and others) hang out here to keep the rest of us from getting too confused and who exhibit such patience with our occasional egregiousness. If you're here just to feel superior, I for one won't miss you if you decide to shun us. If you're here to help us see where our analysis went wrong, you might want to revisit your tactical decisions, or else people might conclude that you're merely a jerk.
The image of cow pasture going to residential subdivision and back to cow pasture reminds me of what I saw last May. I was in the Guwarti airport in Assam (NE India, north of Bangladesh), neear the banks of the Bramputra,and right in the partking lot were goats, and in a field not far away were a bunch of cows. Perhaps there really is a convergence coming between the first and the third worlds. As for the prices of the HB stocks, longer term some of them mayd do ok, since it is a very fragmented industry and there are economy's of scale. I suspect in theis cycle most of the mom & pops will be wiped out, and the publically traded firms will emerge in the next cycle with twice the market share they have now. However there is a long valley ahdead before we start to climb out the other side.
Remember folks, it is the exec's will in a publicly traded company that is important.
They can burn though all sorts of OPM(other people's money) to stay employed. They can direct the accountants to do tricks so they get bonuses. They have the bully pulpit at the meetings. They control the media about the company.
All that trumps fiscal responsility as an outside sees it or an owner sees it. But it is logical from the point of the exec.
Not only that, but in the case of BK, these folks get a bonus to stay on to manage the salvage of what they wrecked.
Not only that, but in the case of BK, these folks get a bonus to stay on to manage the salvage of what they wrecked.
That's what beat the evil empire right there - not Ronny, Afghanistan or rock-n-roll - but good old Yankee know how. If they had our CEOs armed with creative book keepers they'd still be goose stepping down Red Square.
So one CEO is upbraiding another, and for what? For increasing production instead of cooperating to keep production down. Isn't this as close as we get to seeing an anti-trust violation out in the open?
What is so astonishing is that despite all of hand writings on the wall, HB stocks are stubbornly staying high. Question is how and who is manipulating these stocks?
That clip is great Bob Toll looks like someone shot his puppy when he hears that specs are being built to move land.
What you are seeing is the difference between "churn and burn" and "wait and see" philosphies of homebuilding.
p.s. if you havent listened to the UBS "State of the US Housing market" from that same conference I suggest doing so, lots of good stuff there. Check any IR section of a homebuilders website for a link to the UBS conference.
Let me understand this: one home builder is accusing other home builders of building homes? Well, if a greater profit/smaller loss can be had by selling a house than a piece of land, then why not build and sell the house? Oh yeah, building more homes would add to the glut creating more pressure on prices to drop, thus reducing the value of their existing inventory. However, it's unlkely--at best--that the one home builder's added supply would surpress prices further to the point that building the other homes would be a net loss. It is the aggregate construction across all of the builders that would definitely alter that decision. And like the person above me said, when did it happen that all of the CEO's of an industry were allowed to meet and collectively agreee on each other's business decisions-legally?
What I find most humurous is that the Toll CEO was incensed over being "accused" of building homes. Does this strike anybody else as being strange? If these guys are willingly admitting that the situation is bleek for the next year or two, the reality of the situation must be UGLY, and destined to become UGLIER.
Let me understand this: one home builder is accusing other home builders of building homes? Well, if a greater profit/smaller loss can be had by selling a house than a piece of land, then why not build and sell the house? Oh yeah, building more homes would add to the glut creating more pressure on prices to drop, thus reducing the value of their existing inventory. However, it's unlkely--at best--that the one home builder's added supply would surpress prices further to the point that building the other homes would be a net loss. It is the aggregate construction across all of the builders that would definitely alter that decision. And like the person above me said, when did it happen that all of the CEO's of an industry were allowed to meet and collectively agreee on each other's business decisions-legally?
What I find most humurous is that the Toll CEO was incensed over being "accused" of building homes. Does this strike anybody else as being strange? If these guys are willingly admitting that the situation is bleek for the next year or two, the reality of the situation must be UGLY, and destined to become UGLIER.
Since we've been anticipating a housing bust off and on for the last three years or so last year (and then some, this is by memory) the WSJ ran an interesting this time it's different story on the builders. The gist of the theme, drawing on the Street analysts, was that a)this time they'd all been conservative and repaired balance sheets and b)added to their inventories of raw land so carefully that they didn't need to move them and could wait out the downturn. Where are they when you need 'em ? Or that was then and this is now. That sounds like they're desperate to move land they can't afford, which says over-extended to me which also say bad balance sheets and we're just started into this.
And, oh yeah, my drinking buddy in my favorite dive mentioned that quality and materials was as bad as he'd seen it in a long time. Hmmm..wonder what's up with that ?
If house prices are at a maximum right now, a maximum unlikely to be revisited for many years, then the NAR sees 6% of maximum price for their profits.
Also, after the housing crash (and the subsequent hanging of David Lereah), the NAR may very well lose their monopoly and be forced to get less than 6%.
Max percent x Max price = Max profit EVER!!
Does anyone really wonder why the NAR is spending enormous sums to rope in suckers TODAY?
Actually, to go one step further, every single financial services player in the mortgage market stands to make their MAX profit now, IF house prices are at a level that won't be seen for a long time (as in Japan 1989).
So shouldn't we all expect that EVERYONE in the industry with a hand in the pie will promote purchasing today?
Maybe fixed fees are the future.
Since I don't know enough details, nor work in the mortgage industry, anyone out there care to educate us on the topic of point-based fees versus fixed fees throughout the entire mortgage market? Are their presently any fixed fees? I understood that mortgage brokers get larger commission from option ARMS, but are they fixed or percentage? If fixed, wouldn't they most likely lower the 'fixed' commissions if housing prices fell?
Likewise in the MBS market, is anything fixed?
Thanks in advance.
Question:
The UK has had a similar bubble that seems to have peaked (from old articles on the internet) about two years ago. However, since then it seems to have just been flat in the soft landing arena, their stock market however has continued to rise and there doesn't appear to be any overall fallout. The had a huge rise in MEW in 2003 that slowed alot, and similar articles on the reduction in MEW hurting the economy, has been shrugged off and spending is on the rise again. The just raised the rates to 5% to fight inflation.
The bubble in Australia is similar in that it was described as the "canary" for the rest of the world, and it hasn't tanked yet. Seems this is taking along time in all markets.
Does anyone know if the markets in the UK and Australia were full of exotics and no-doc's? How are we different here? What is gonna be the impetus for the correction that has been absent in these foreign markets?
Any insite is appreciated.
I must be missing something, because if it's easier to sell land if they build a spec house on it, then it seems like a smart thing to do -- and hardly unethical. (Like that should start mattering to any of them)
What's Toll suggesting - just sit on the land? What for?
The reason Toll was mad/shocked/stupified was because the homebuilders know that they have to bring down supply for the downturn to be "not as bad". But what DR Horton is doing is building spec homes (homes with no contract first) just to move land off the books and get the money back. So you have some of the builders on the "we arent adding to supply" train and others arent because they want to churn through the high cost (or less desireable) land on their books as fast as possible.
Toll Bros executives already pulled their millions out, yes? (year ago?) So I find the CEO's remark/interruption a little distracting in his effort to bolster Toll shareholder value/reputation.
No, I find both the CEOs' presence in defending shareholder value more than a little bit of a strain. The land which they have cultivated (bought and rezoned) and profited from in their ever-so-sophisticated development (buy, rezone and contract out servicing), needs this box, this house on it to sell. Without a box on it, the real estate is just so much dirt --possibly useful for farmers and those commoners that eat, but not for real movers and shakers who are made of different stuff.
Maybe not. Could be they eat too. It does look like less harmonious relations in a falling market than the relationships forged in the last decade. Yes, almost human.
Dave N -
Good point on how bad is it really. Kind of like Fannie Mae. If these guys are publicly making these negative statements, can you imagine the talks taking place behind closed doors and within their own minds? Of course they might not care. This bubble has ensured their families will be wealthy for generations to come.
fratt1, the marginal propensity to consume (MPC) from real estate wealth is about three times higher than the MPC from financial wealth, probably because financial wealth is more volatile than real estate. The difference in MPCs has policy implications. For example, after the dot com bust consumer spending from real estate offset the fall in spending from financial wealth. If the decline in real estate continues, it will spill over into consumption. Specifically, every $1 of net equity lost should immediately translate into about 8-9 cents of lost consumption. If financial wealth also turn down, this will subtract about another 3 cents of consumption for every $1 lost.
Recently developed financial instruments made it easier to tap into home equity over the past few years, thus tightening the statistical relationship between rising real estate prices and consumption from the wealth effect.
One final point re my comment above. Estimates of MPCs vary, but these numbers are well within the range of what has been observed.
I think it's obvious that the HBs have a gentlemans agreement to curtail spec and to not bring raw land into supply inventory. I could only think of an OPEC production meeting. These companies are still massively profitable by most standards. Their problems haven't even started yet. Their PE/E ratios are not even going to be such a problem given their low numbers to start and expected volitility. It is the book value that will raise the white flag. Their supply of raw land is grossly overvalued and some they don't even own merely option. Expired options and writedowns of all the cheaply bought land will wipe billions from TOLs asset ledger. When that happens I don't see how how all these corporate officers can avoid the perp walk.
fratt1,
UK bankruptcies are going up.
uk bankruptcy - Google News
Australia is experiencing pretty significant problems from what I have read recently.
The Housing Bubble Blog » “For Sale Signs Abound” In Australia
Here comes either stagflation or deflation as everybody has to start paying some of that money back in an environment where loaning money is risky. The outcome depends on how hard Bernanke defends his Monopoly money.
I don't think 'overbuilding' has ocurred to any great extent in the UK, even with demand going through the roof. There are a lot of planning constraints on where and how much housing you can build. So there isn't much (if any) of an overhang to work off. Demand is also high due to relatively low interest rates and a fairly sudden influx of immigrants from Eastern Europe. This is just speculation however, I don't have figures to back this up. Certainly here in Ireland our property market has been booming for the last 7 or 8 years due to extremely low interest rates and a massive population boom.
wawawa, in re the resiliance of HB stocks in the face of mounting negative fundaments, no one can tell for certain who or why these stocks go up, but one thing that is noticeable is that they always move in unison. I have read speculation that this is someone or a group buying the housing index to force a short squeeze. The short interest is high (although it came down a bit in Sept.), but it provides the rocket fueled for this kind of thing.
Couple that with the fact that a significant amount of the float in these companies is held by institutions. People like J. Gendell and Bill Miller at Legg Mason, who bought the HBs in '05, when they were at their peaks. Their investment losses in these stocks are huge, but they have stubbornly refused to sell.
When they do finally sell, the damage to these stocks will be swift and brutal, imo.
I have no idea what sparked today's rally. But sure as morning follows night, theses stock will reach no farther than the top of their recent trading range before doing another about face. Why? Because, despite the raving of media hypsters like Cramer, no one is buying these stocks for the long-term.
Smart management can keep them profitable during the downturn, I suspect even more profitable when they fully get a grasp of things and learn to lead the market down instead of fighting it. Smaller communities with quick buildouts at market prices. Instead of fighting the resale market they be at the forefront.
Not all land was purchased during the boom so many of these guys are sitting in the fabled cat bird seat. The amount of writedowns and walkaways wont be nearly as bad relative to the amount of money they have and can make. The use of options is really saving their bacon, and many of the large land deals have a considerable cushion because of the lead time it takes to get land to market. These guys arent dumb and they've learned from their past mistakes. Just because the market turned and they are going to take some losses on writedowns and options doesnt mean they lose their jobs. It is actually the fact that they structured the deals in an intelligent way that will be the reason they keep their jobs and shareholders/banks happy.
Cal, I aree that the well managed firms may do decently. Reduced construction costs may help them reduce land inventories at a profit. As previously pointed out this hurts other builders with high priced inventory. Perhaps, more importantly this supply hurts the prices of existing houses and the holders of high risk mortgages on them. If the economy weakens or lending standards materially firm this could cause very weak conditions in some real estate markets and for high risk mortgage securities.
Cal, you are right. You repeat what I said more than a year ago; they learned from their past mistakes. Yep, they are making entirely different mistakes this time. The biggest so far is underestimating the speed of the contraction. As to land values please correvt me but I thought they used current valuations not purchase prices meaning the land bought cheap is the msot overvalued on the books. I'd find it strange that an asset be on the books at purchase and not assesment but what do I know? Yes, the options are saving their cash flow, one of the things they learned but when the options expire the asset is taken off the book value as well. I'm thinking a book to price is going to kill these stocks as surely as P/E.
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Toll Brothers will build approximately 7000 homes this year.
They have 72,000 lots in inventory. They have cancelled numerous other land contracts. That is 8-10 years of land banking.
The writedowns are coming.
Also take a look at Standard Pacific which has over 60,000 lots.
Ara Hovnanian let the dirty little secret out of the bag.
The builders need to cover their large fixed overheads and the land costs. They would love to breakeven.
Rob't Cote - I think you are right, land value on the books is at market value not price paid.
However all their land holdings are 'overvalued' to the same extent if you consider book value to current market condition... some of it is 'paper profit' from buying cheap, letting it appreciate and some of it is out of pocket investment from buying expensive.
Regardless their current book values are to a great extent set by these recent past valuations (and also the finished & in-process inventory they own - also priced to a year ago or so).
It will all have to be revalued. Yikes.
Land is normally valued at the lower of cost(plus capitalized costs)or market at yearend. Builders will have to write down some land bought recently. Based on other downturns the accountants won't force big writedowns for another year.(when sales of lower priced land or lots are common) Most say they are trying to turn over land within 3-5 years so they may not have much cheap land on their books. However. builders may also sell land to each other so they can book profits to cover operating losses.
Building houses on vacant lots in order to sell the whole in a declining market!! I thought putting good money after bad happens only in the stock market - averaging down.
A good example of how greed and fear are endemic in all speculative markets. Human psychology is the same everywhere.
Rao.
The housing market here in the UK is indeed booming again, following an initial downturn. But prices have risen so far that they are unaffordable to first time buyers, and others. There are plenty of non traditional mortageges around and one very large lender recently announced it was relaxing its lending criteria to 'officially' provide mortgages five times earnings. I think it is only a matter of time before the market here tanks again. What we have in the western world is a slow motion, drawn out real estate collapse that is not following a straight line. the trend globally, though is most definately down and has a long way to run.
My take on the Toll CEO's remark was that he seemed surprised because he had never thought of doing that to move his land.
The housing market here in the UK is indeed booming again, following an initial downturn. But prices have risen so far that they are unaffordable to first time buyers, and others.
Middle Eastern Petrodollars.
"They have 72,000 lots in inventory. They have cancelled numerous other land contracts. That is 8-10 years of land banking"
Farm land to burb's now back to cow pastures-how many ghost town's will be created in this cheap energy debt driven credit cycle?
dryfly, I'm fairly certain that home builders are required to value the land they own at the price paid rather than the current valuation. This is why a company like St. Joe (JOE) can claim they are much more valuable than their pathetic quarterly earnings -- which has negative momentum.
JOE owns 800K acres in Florida, most of it unlivable. But it was purchsed long ago, at a very low cost. Investment "geniuses" like those at 3rd Ave. Partners claim this makes JOE an outstanding value. It's not. It would take decades to convert those land holding into anyting representing true value for shareholders. The stock deserves to trade much lower.
At any rate, the same basic accounting formula applies to home builders. The irony here, of course, is that most are carrying a significant amount of land purchased at the peak of the market. And yep, as Hovnanian revealed, they are desperate to get that off their books. The irony is that in the meantime it makes their price-to-book look better than it should. The "value" in that book is quickly eroding.
I read that Hovnanian is discounting homes as much as 28%. With a ton of land and his company poised to start posting negative earnings, that reads like desperation to me. Who knows, maybe he was engaging in what psychologists call projection?
Maybe someone else can chime in here, because I am by no means an expert on how this works. But I believe accounting rules for the builders also require that they state the value of cost or current value, whichever is least. If so, that would add even more pressure on them to unload that high basis land.
In Northern Calif the price of land is the driver behind property valuations. Over the past 10 years cow pastures in Tracy have gone from
$800 an acre to 20K, which also drives up land prices in San Francisco Bay proper. Over the next 10 years these rural land prices may drop significantly back to 90's valuation and take the wind out of the Bay Area RE valuations with it.
I'm not an accountant, but I've been yelled at by some of the best CFOs in the business. I consider this a credential.
It damn well better be Lower of Cost or Market (LOCOM to you civilians). There's a similar issue with mortgages. If you originate a loan as "held for sale," you get to carry it at market until you actually sell it. If you fuck it up bad enough (or your investor suddenly exits the market, ahem) and have to move it over to "held for investment," you book it at lower of. In my day, we called that Doing the LOCOM-Motion, complete with Martha and the Vandellas-style back-up singing and hand gestures. Outside the CFO's office. If I can't dance, I don't want to be part of your balance sheet impairment.
In any case, I have a theory about the HFS pipelines of some of those builder-owned mortgage companies that you all don't want to hear about if you're eating.
"Building houses on vacant lots in order to sell the whole in a declining market!!"
It makes more sense if you think of it on a subdivision level. If a builder has a development halfway built, they have two options: keep building or stop building.
Profit margins are still positive in most places, so the "keep building" option is a no brainer.
If they choose the "stop building" option, they are stuck with the lots and development costs in inventory. The lots and development costs are usually paid for with debt, so they're accruing interest (which is capitalized to inventory).
There are also cash-flow issues associated with choosing the "stop building" option. Gotta pay the bills.
The only logical choice is to keep building until the profit margins go negative. And then to keep building to outsurvive the competition in the downturn. Builders build, if they stop they're unemployed.
From an article on PrudentBear by Chad Hudson:
"There is no sign of a bottom in the housing market. This week, Toll Brothers, Hovnanian and Beazer Homes reported preliminary fourth quarter results. Toll Brothers experienced a 10% drop in revenue to $1.81 billion. Additionally, net orders continued to plunge, down 56% compared to last year due to cancellations surging to 37% from only 2% last year. Its developments in Orlando and Northern California had the largest increases in cancellations. Toll Brothers expects to take $50 million to $100 million in land or land option write-downs during the fourth quarter. The company also lowered its guidance for the number of deliveries for 2007 to between 6,300 to 7,300 homes. Previously it expected to build between 7,000 and 8,000 homes. The company commented that, "We continue to look for signs that a recovery is imminent but can't yet say that one is in sight." Beazer's CEO, Ian McCarthy, iterated similar comments, "Despite recent references to signs of a bottoming or even the beginning of a recovery, we have not yet seen any meaningful evidence to suggest that a rebound in the housing market is imminent." Hovnanian announced the largest large charge off of the major homebuilders thus far. The builder said it will take a $300 million charge during the fourth quarter. It's likely that the charges homebuilders take during the fourth quarter will be high than the charges taken in the third quarter. Not only has the market softened since the third quarter, year end results will be audited. This will likely cause land values to come under more scrutiny."
Tanta-
I am an accountant, but I've been yelled at by some of the worst CFOs in the housing business. I'm jealous of the obscene bonuses they've collected recently. Please let there be one more housing bubble in my life time...
Sorry for the length of that snippet (it looked a lot shorter in my browser).
Anyway, the last sentence provides our answer that home builder who were most active purchasing land in 2004-2006 ought to show significant downward adjustment to their inventories when they file their 10-K's.
No doubt that helps to explain the anxiety on display at the recent conference.
HB look like hero's when they buy rural land and get it rezoned for commerical or SFH or both!. The local city council which is usually a combination of local land owners (exfarmers)etc are more then willing to provide the zoning needed since they have a large pool of property waiting in the wings. but how to deal with this rezoned property that may again become a cow pasture?
RobertCote and dryfly,
Land OWNED is NOT carried at market value unless that value is LESS than what they paid for it.
Additionally, since when is OPTIONED land carried as a fully valued asset?
Optioned land normally appears in "Other Assets" at the value of the deposit on the option. Most of the writedowns that have been showing up recently are due to the forfeiting of the deposit.
But in some cases (due to FIN 46) the full value of the optioned land and related liability appear on the balance sheet.
Land OWNED is NOT carried at market value unless that value is LESS than what they paid for it.
I'd bet the majority of their holdings are now worth less than they paid for it... the question is will the 'assessments' show that or will they have to wait for more comparables to make that obvious.
BTW - getting accurate assessments of land value is a big problem right now. We are trying to liquidate an estate and the assessors are completely at a loss where to value about 15 acres on the edge of residential & rural due to the volatility.
The whole market is in flux.
Dryfly, Your problem is typical of early in a downturn. Later on comparable sales (often foreclosures or distress sales) provide a better basis for determining values. At that stage large writeoffs of land values by builders will become common.
Speaking of over-supply, Santa Clara Co. shows the following thru Sept'06:
this
Homes Sold: 1192
y-o-y volume: -32.2%
New permits last 12 mo.s: 5,358
For the record, because I've seen a lot of non sense out there, land is carried at the book value of the purchase, unless a compelling decrease in value causes it to be written down. It is never carried at "market". Options are certainly not valued at any land value and not booked until they close unless the homebuilder has deposits exceeding 20% of the purchase price (which they don't). This is driven by Sarbox.
And the questions about builders being profitable during this inventory correction......they most certainly will be profitable on any land purchased up to this point before 2005. If the market declines more then it will back up, but that has not happened yet.
AZ_Cowboy: "The only logical choice is to keep building until the profit margins go negative. And then to keep building to outsurvive the competition in the downturn. Builders build, if they stop they're unemployed."
I think this is someething that is being influenced by th eincreased market share of publicly traded builders. A small builder who mainly builds custom homes, might do a few specs when the market is clearly rising. That's what happens here. They can quite easily stop doing that when things contract, just higher fewer subs. They have really good years and some bad years, but they maximize their total profits.
Larger privately held builders have a lot more fixed costs, but can still afford to contract significantly.
But a publicly traded builder reports quarterly to Wall St and can't just say, "we stopped building..."
The bigger the builder, the greater the reward to build full-tilt in the boom, and the more difficult it is to stop at the bust.
This trend to publicly traded builders has definitely made the boom/bust cycle more pronounced.
It could be that this is just one of those businesses that would be best held privately.
Down turns are always interesting from a micro econ perspective... unless you are viewing it from the INSIDE.
Typically a company will continue to produce AT A LOSS under the following conditions:
Item 1) They are able to sell the product at a price sufficiently high to cover ALL their direct cost (materials, labor, direct overhead) and hopefully have some margin left over to apply toward all the indirect cost though probably not enough (hence the loss).
In this situation they are losing money but are losing LESS money than if they shut down.
Item 2) They need to have sufficient cash or sufficient bankable equity to borrow for cash to cover the 'temporary' conditions described in Item 1 (above).
This is the classic 'cash burn' situation so often discussed in the dotbomb implosion. The question is will the firms have enough cash to carry them through to the end? Can they cut enough overhead & sunken cost (like land) to reduce indirect cost to get profitable at the lower selling prices & margins?
And how long is 'temporary'? Even a slow cash burn becomes a problem given enough time.
No one knows any of this, that's why we all watch... it's the economic equivalent of a guy on the ledge.
And what happens if the margins deteriorate so badly that the sell prices no longer cover the direct costs let alone leave anything for indirect? Then 'shut down' is the only rational decision.
I believe Bob_in_MA hit on a key difference this time compared to past boom/busts... the public builders really can't shut down, the stock price would absolutely tank & stockholders would revolt.
Like I said - it will be interesting viewing... from the outside that is.
I am a contractor and I was there in 1980's bust. In a severe contraction book value doesn't matter. Builders can't "eat their assets" They need CASH FLOOW to survive. With cancellation running at up to 50% at some builders they are being slowly starved to death. After insane, mania driven boom of the last few years the corresponding bust will be a lot more severe then the most people think. By the time it is over 3/4 of the builders will be bankrupt by the debt they are carrying but are not be able to service. The remaining 1/4 will be rduced to cripples. IT IS A CASH FLOOW STUPID. With millions of baby boomers moving to the old folks homes the supply of houses will only get larger. This will just add inventory to the already glutted market. The RE is going to be a very bad investment for the next 20 or so years.
"By the time it is over 3/4 of the builders will be bankrupt by the debt they are carrying but are not be able to service. The remaining 1/4 will be rduced to cripples."
Thank you for eliminating any doubt, if there ever was any, as to the level of accurate analysis available on this blog.
Well, Buchanan, I suggest you purse your vinegar-stained little lips, pivot sharply on your kid heels, lift your frilly crinoline in both lace-mitted hands, and storm out of the drawing room. That will show us! You get extra Huffy Points if you never speak to us again.
I'm always grateful for the education I get around here, which implies that I occasionally need one, which implies that I don't know everything, which must mean I'm not fit to lick your boots, I guess. How fortunate I'm not a bootlicker.
I was really enjoying this thread, since there are so few places on the web where you can get a healthy discussion going of a flipping accounting principle in a manner that is both interesting and useful. I learned something, and I am so glad that our resident accountants (vicjim, Lama, AZ_Cowboy, and others) hang out here to keep the rest of us from getting too confused and who exhibit such patience with our occasional egregiousness. If you're here just to feel superior, I for one won't miss you if you decide to shun us. If you're here to help us see where our analysis went wrong, you might want to revisit your tactical decisions, or else people might conclude that you're merely a jerk.
The image of cow pasture going to residential subdivision and back to cow pasture reminds me of what I saw last May. I was in the Guwarti airport in Assam (NE India, north of Bangladesh), neear the banks of the Bramputra,and right in the partking lot were goats, and in a field not far away were a bunch of cows. Perhaps there really is a convergence coming between the first and the third worlds. As for the prices of the HB stocks, longer term some of them mayd do ok, since it is a very fragmented industry and there are economy's of scale. I suspect in theis cycle most of the mom & pops will be wiped out, and the publically traded firms will emerge in the next cycle with twice the market share they have now. However there is a long valley ahdead before we start to climb out the other side.
Remember folks, it is the exec's will in a publicly traded company that is important.
They can burn though all sorts of OPM(other people's money) to stay employed. They can direct the accountants to do tricks so they get bonuses. They have the bully pulpit at the meetings. They control the media about the company.
All that trumps fiscal responsility as an outside sees it or an owner sees it. But it is logical from the point of the exec.
Not only that, but in the case of BK, these folks get a bonus to stay on to manage the salvage of what they wrecked.
Not only that, but in the case of BK, these folks get a bonus to stay on to manage the salvage of what they wrecked.
That's what beat the evil empire right there - not Ronny, Afghanistan or rock-n-roll - but good old Yankee know how. If they had our CEOs armed with creative book keepers they'd still be goose stepping down Red Square.
Except with brief cases instead of Kalashnikovs.
Tanta, I suggest you go fuck yourself.
Got it?