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The Coming (already came) Land Recession (now depression), Pt I
This is a reposting of part on of an article I published on my blog in October of 2007, over two years ago. This is a two part series, and I found that it is necessary to rehash the recent as well as the not so recent past in order to develop a more astute view of the future. As you read through this and part two of the series, keep the following chart in mind:
This chart was taken from the post, Bad CRE, Rotten Home Loans, and the End of US Banking Prominence?
Enjoy!
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.
(2) There is a dis-connect between the land and housing
markets. When a housing market takes off, the first to know are the
builders because they are looking at the sales data. Eventually, the
land market catches on and begins raising prices. However, when a
market is in decline, the builders are the first to know and the land
owners hold their pricing until it is too late and they realize the
downturn is for real. Did you hear that banks?
(3) Types
of Land Owners. The most ignorant is the farmer or long time owner.
This person has a basis of practically zero because it has been in the
family forever or 30 plus years. They are not sophisticated and don't
really understand the full value of their land. Next up are the
speculators. These guys bought land 5-20 years ago hoping growth would
come there way. Their basis is higher, but they have no debt and don't
have to do a deal if they don't want to. The next group of land owners
is the Investor who put together an LLC with a time frame of less than
5 years to either entitle or entitle and develop to sell to either a
dumber investor or a builder. These guys are highly leveraged and
their loan is based on a project basis. Thus, unless the bank changes
the terms of the loan, then the loan expires when the project was
supposed to be mature (sold). You can make a lot of money here in a
good market and in a bad market you lose everything.
(4)
Land location. Most people segment land into A, B and C parcels. An A
parcel is usually an infill piece in a top tier submarket. In any
given MSA such as Tampa or Atlanta you may have 20-40 submarkets
representing geographical areas that everyone recognizes. Your top
tier submarkets are usually 90% plus built out with commercial,
residential, retail, etc... These are the built out cities that have
the better school districts and the higher household incomes and home
prices. A B parcel is usually found in your middle tier submarkets
most of which are not built out fully. So there are opportunities to
do large master planned communities in addition to infill projects.
However, these submarkets don't have the prestige of the A submarkets
for the most part. They are still good and represent your bread and
butter. Finally there are C parcels. These parcels are located in the
fringe areas of your MSA. You know when you live in a fringe area when
your friend says you live where!!!!! Dude, that is way out there. C
parcels are mostly in rural locations with less than 20% of the area
built out. The reason why it is a C parcel besides being on the fringe
is that it is surrounded by a lot of open space land, thus there is
plenty of supply. Why does a big builder buy C parcels? When housing
demand gets really hot and affordability decreases, where do people
move to get a big house? They move way on the outskirts of the general
population. However, when housing is in the tank, these same people
can now get great deals in better communities in A and B locations.
Thus, making C parcels worthless.
(5) Land Type. Land
can be categorized into un-entitled dirt, entitled dirt and finished
lots. Un-entitled dirt is basically raw land that is not zoned for
residential and has no P.U.D. or the proper zoning to build a
residential community. The worst kind of un-entitled dirt is that
which has future land use (FLU) of non-residential. It is extremely
difficult to get a planning commission to change its FLU. Most
intelligent builders buy un-entitled dirt that has current zoning of
say agriculture and FLU of residential. If you own un-entitled dirt in
a downturn you are (4 letter word). No one wants this land, especially
for what you paid for it, in a downturn. I can think of several top 5
builders that have 100 million dollar un-entitled land plays in Orlando
and SW Florida. Tsk tsk. The next higher grade of land is entitled
land. Land magically doubles in price or more when the gavel drops and
you get entitlement. This means that the land you own is now entitled
to be developed for the purposes you set forth, which is to build a
residential community. You can start moving dirt and developing the
property. Finally, there are finished lots. Basically, this means you
have streets in, sewer and water connections, etc... start building
that home!!!
(6) Due Diligence Period. Before you buy a
piece of land you always want time to do due diligence work.
Environmental and soil studies, investigate the zoning, etc... Only a
complete idiot buys land without understanding if there are obstacles
to converting land to the purposes he chooses. Normally you get 90
days. However, in the go go days some sellers would only give you 30
days to close. Less time means sloppier due diligence.
(7)
Land Takedowns. Another condition on how you buy land is timing and
takes. The big pig builders would buy 500 entitled raw lots in one
take. The problem is that you need to have some really strong sales
absorptions to plow through this many lots. In the go go days there
were communities in which the entire 500 lots were bought and developed
all at once. Think of the ROIC if you have 500 lots at 30k a piece and
you spent another 35k to develop the lots. What if your absorptions go
from 12 a month to a trickle of 3 a month? Not exactly a great ROIC.
Read lesson (5 of 20). You're especially in big trouble if you
financed this land with a lot of debt. The smarter builders would buy
this land in two takes, 250 in year one and 250 in year two. In year
two you may pay 7% more per lot, but you have the option to walk away
from the second take or re-negotiate the price in a down market.
Haven't you seen in statements by builders where they say they are
walking away from options or renegotiating. Now you understand. So
why do one take instead of two. See lesson (5 of 20) again. The
market was so red hot, builders were doing anything to land a deal
including ill advised terms in addition to overpaying. Finally, you
can buy the land on a finished lot basis, where the seller takes on the
risk of development and sells you the land in finished lots. The best
way to do this is on a rolling option where you take down finished lots
on a monthly or quarterly basis and not all at once. Does it cost
more? Yes, but you take on virtually no debt to buy land and when the
market turns down you can walk away from options or renegotiate.
Now
that you understand the 7 basic concepts, in the next lesson we will
apply these concepts to understanding the land recession that is upon
us.
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Good work Reggie. This 2004 study shows that land as a percentage of total value has been increasing. Do you have data after the peak 2006-07?
"Our analysis of these new data reveal that since the mid-1980s residential land values have
appreciated over a much wider range of cities than is commonly believed. And, since 1998, almost
all large U.S. cities have seen significant increases in real residential land prices. Averaging across
the cities in our sample, by year-end 2004, the value of residential land accounted for about 50
percent of the total market value of housing, up from 32 percent in 1984. An implication of our
results is that the future course of home prices — their average rate of appreciation and their
volatility — is likely to be determined even more by the course of land prices than used to be
the case."
http://www.federalreserve.gov/Pubs/feds/2006/200625/200625pap.pdf
This is a global balance sheet recession, so deflation is the destructive force,
http://www.nomura.com/research/research/Quants/NomuraLectures/2009Richar...
Listen Reggie homogenize your posts. Leave out the "at my blog" shit. If people want to Google you they will. In this day and age I'd think you'd understand that spam==diminished_opinion==no_credibility.
The second I read "I published on my blog" was the second that you lost me. I don't entertain desperate blogger's unless of course it's Zebra Privet. Tarzan like.
If I lost you and you don't like how I write, why are you bothering to comment? Simply move on to a writer who better strikes your fancy and don't waste your, or my, time or energy.
Personally, I think the stuff that I post on ZH is rather informative and entertaining, but I suppose I am a little biased...
+1
I know a fair amount about this, and this is a quite good general introduction.
This is what na na Pelosi had in mind when she pulled her fish trick to turn Cali farm land into affordable housing. She and her CRE tycoon husband are neck deep in worthless California real estate.
Just picturing her in debtor's prison
Pretty sure botox injections are forbidden in prison.
Oh my!