Welcome to another senior level class. As I stated before, the purpose of senior level classes is to give you a peak behind the curtain of how homebuilders operated. The good (none), the bad (lies) and the ugly (incompetence). You may ask yourself how I define a lie... incompetence is pretty easy. A lie is when I listen to a conference call of a major homebuilder, the executives tell a story to the usual cast of dimwitted characters (analysts) and a strategic picture is painted. I then call my high level friend (VP of Finance) that works for that builder and walk him through what his executive team has stated. Hmmm lots of discrepancies, lots of items missing, lots of lies.....

However, a conference call is just that, a bunch of talking heads spinning stories. Thankfully we have the trusted auditor providing us an independent and unbiased review of management's statements (the financials). Well lets look at who these wonderful auditors are.... lets start with the top 5 homebuilders... Pulte Homes (Ernst & Young), DR Horton (Ernst & Young), KB Homes (Ernst & Young), Centex Homes (Ernst & Young), whew... Lennar (Deloitte)... wow what are the odds? Ok I live in Florida and it is a debacle today... so who are some of the big Florida players, the ones who are getting the $@#@@# kicked out of them... WCI (Ernst & Young), TOUSA (Ernst & Young), and KHOV (Ernst & Young)... KHOV did 3 acquisitions at the very peak of the bubble in Florida - Cambridge, Windward, and First Homebuilders.. have you seen the write offs on these 3 acquisitions!!!! huge!!!!

In lesson 9 I stated I would walk through a financial model in lesson 10 to show the huge reduction in book value (that isn't being taken by the builders). I got sidetracked and gave a macro view in lesson 10. So in lesson 12, I am going to walk you through all the moving parts (inputs) in a financial template and show you why book is substantially impaired.

Notice how almost every builder now is trading at 0.25 to 0.70 of book. If their land actually were worth closer to 1.00 of book like EScrooge thinks, then how come a private equity or hedge fund doesn't buy these companies at such huge discounts to book? Why are builders trading at liquidation or below liquidation prices? Why were hedge funds and private equity taking positions in builders earlier this year at higher book (0.8) and now you are not seeing it anymore at such low ratios? People the word is out on the street and yours truly is doing my part in educating people with substantial capital of what is really going on. I am not stating that I am moving the market, but I am educating my sphere of influence and everyone on Wall Street has a huge rolodex (talks). Wall Street hedge funds, institutional investors, private equity, etc... are picking up on this before the banks. The banks still are not in tune with what is going on.

{Before you read this post, you may want to read part 1 of this guest bloggers tutorial, since he is not going to explain basic terminology of land.} I feel this is one of my more important posts, whereas many of my other posts will add further proof to what I am stating in this post. That builder book value and equity is closer to worthless (zero) than many think.

Land is illiquid and for the most part does not generate income but does generate expenses. The exception being leasing land for someone to use for agricultural purposes. If the very nature of land is illiquidity, then what is its liquidity in the biggest real estate crisis since the depression? What is liquidity? Isn't liquidity the ability for a buyer and seller to meet at current market rates? Stocks for the most part are liquid because when I hit sell on my fidelity account someone else is on the buy side. With land, it is difficult to find a buyer at your price in a timely manner. How about now? How much is land really worth if you had to liquidate it today for cash. I believe as do many of the people in private equity, that land is down 50%, thus the land on builders books are down 50%. Bye bye equity.

When I say land is worthless what do I mean? I mean that you paid $100 for land with $25 of your money and $75 of the bank's money. If it is worth less than $75 then you lost all your equity and you are upside down. Yes it has a value to the bank, but for your purposes it is a liability that still generates expenses. It is worthless, because when you sell it, you have to bring money to the closing. It is worthless, because if I were to build homes next to your site, I would buy land at ½ what you paid giving me a huge cost advantage. Most public and private builder land falls into this worthless category.


The Aug 8, 2007 issue of big builder magazine had a piece that showed 3 reasons why housing tanks. Overbuilding (supply side), job loss (demand side) or both. I want you to think about this sentence real hard.... Real hard........... I love macro-economics and we are about to delve into that realm.



1) Existing inventory of resale homes from 1989 to 2005 has bounced between 1.5 million and 2.25 million. I sent this realtor report to MFKOPP of the fool. Today we stand around 3.8 million in resale inventory. That is 1.6 million over the peak from a 16 year period. Hmmmm... When you have oversupply what does that do to you as a builder to compete? Lower prices substantially. Normally, builders do not consider resale as competition. I am not going to explain this here. However, when oversupply of resale is at unprecedented levels then it has to be factored in. Why? Remember I stated in blog post 9 of 20 that most builders had B land with some A and C land. The reason why you buy a lower class of land is because it is more plentiful. The reason why people buy in a lower class of submarket (land) is because you get more house for the dollar or more yard for the dollar. However, if you live in an MSA where inventory is through the roof, then all of a sudden those great A submarkets or B+ submarkets that you couldn't afford are now affordable. In other words, people will take advantage of this downturn to buy in more desirable communities instead of newer communities that are farther from the job and retail corridors. This situation puts pressure on new home prices and land prices... downward pressure

2) In 2005, I as well as other finance officers were projecting out the forecasted amount of lots we needed for 2006-2008. Most of us were projecting 10% growth. Per http://www.census.gov/, new home sales in 2005 were 1.28 million, which means we were projecting 1.41, 1.55, and 1.70 million unit sales through 2008. This means buying or tying up lots through options to meet these projections. In 2006 per http://www.census.gov/, 1.05 million units were sold and in 2007 the projection is 0.87 million and I would guess that 2008 will be 0.80. The difference in what builders forecasted and the actual sales is 1.94 million lots. That means that all builders not just publics had bought or optioned 1.94 million lots more than the actual 3 year demand. Now many of those options have been dropped, but who is the bagholder if they are dropped. See blog post 9 of 20. It is the LLC that bought the land and either developed it or entitled it using bank debt. That bank debt was on a project by project basis. Read my previous posts regarding bank risk. That land is worth 50 cents on a dollar... who is holding the bag now?

3) We are not even including all the speculators that I referred to in blog post 9 of 20 that never even got a deal under contract with builders. How much land did they buy with the intention of entitle, develop and flip or entitle and flip to a builder? At what point do the banks call in those loans?

4) Two million arms are set to reset this year. Realtors nationally are stating they can't close deals because the appraisal is coming in lower than the selling price. Why? Because homes are being appraised using new housing comps which are through the floor. So if you have an arm, how can you refinance if your appraisal is lower than your mortgage? do you smell a lot of future foreclosures?


These 4 facts show that the supply of land inventory or resale housing or future foreclosures is enormous. People wake up, there are 2 million lots available that shouldn't be available. Do you not think this has a significant impact on the valuation of builder land inventory. Builders are so stupid, they never had a class on Just In Time inventory. Maybe if some of them had an auto background they would realize how stupid they were in being vertically integrated and building up inventory before it was needed.



Here is the great part... I mean if you still own a builder stock after this blog post you are truly an bona fide idiot.


Remember my reference to big builder magazine (which is a great rag by the way). It said demand issues were related to job loss. Guess what? Jobs come back. Your city or MSA goes through a recession but in a few years or less jobs come back. Sometimes it takes a much longer time, but most markets in which public builders build have positive job growth. Everyone keeps talking about the economy doing well and creating jobs. Really, what happens if the economy doesn't create jobs or like last month loses jobs? That would really kill builders. But guess what, they are dead anyways because its not the economy stupid... here is what people are missing


40% of all mortgages for new housing in the markets that public builders were in were exotic subprime and alt-a loans. People took out these loans because they couldn't qualify for more conventional loans. These loan packages are gone for good... No one is writing this garbage any more. Liar loans, gone, interest only, gone, 5% down ARMS, gone.... Get it? They are gone people. If they do return, the interest rates and the scrutiny of the loan will be so high that most won't get done. The majority of that 40% of demand is permanently gone. Poof! Unlike job losses where demand comes back, this demand is not coming back.


The longer a builder is on land the higher the chance he goes bankrupt. The higher his debt to equity, the higher his chance of bankruptcy.


A parcels are still worth $1 on a $1. B parcels are worth somewhere between 50c to 60c on a dollar and C parcels are worth 30c to 40c on a dollar. Go back to blog post 9 of 10 and see what builders own. You cannot have the huge home and lot supply that we currently have without a major hit to land prices. If you're a farmer or a speculator with a 10 year plus time frame you don't care about this downturn. If you're a builder or an investor who had a 5 year or less timeframe, you are screwed. The macro economic data i showed you above is undeniable. If you truly understand supply and demand and its effect, how can you not see that builder book is worthless.


For those of you who still don't believe me, in my next blog post I am going to review multiple builder financial statements and 10Qs and walk you through how the builders are able to hide the fact that their land is worthless. When you walk through the logic with me, you will get it!!!!!! Remember I used to be on the builder team and understand how the game is played. You will see how right I am, I am going to show you the tricks and the illusions that builders are using.


This is actually a two part series within a twenty part series from an anonymous guest blogger.  I fully believe we are in a land recession.  In part one I am going to walk you through basic land theory and in part two (10 of 20) I am going to run a financial model and explain to you my reasoning on who is screwed and who will win during this land recession.  My goal is that you will come to the conclusion that for a lot of builders their land is worthless and thus they are worthless.

(1) Land and Debt are four letter words.  One of the golden rules to being a homebuilder is to finance land with equity and use debt for financing your homebuilding operations.  Why?  Because when you are highly levered and the market turns on you, then you will not be able to last during the downturn.  It is a rule that has proved out in every housing recession period.  Why then do builders double up their positions and try to grow faster than the market average?  Greed.  The bigger your company the bigger your compensation package.  If not greed, then stupidity.  This is such a basic concept and it holds true in every downturn.

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