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The Coming (already came) Land Recession (now depression), Pt II
This is part 2 of my reposting of the coming land recession, originally published in October of 2007.
{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.
Supply
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.
Demand
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.
- advertisements -
Farmers will simply pass those costs on to consumers. Food is not a luxury.
I have a story that may tie into this article. My neighbor is a senior mortgage broker, and I met a real estate agent through him who not only made deals, but at one point a couple years ago decided to be a developer. He knows nothing about construction and decided to build out lots for resale to builders. He tied up two developments, floundered through most of the construction and subsequently went bust.
At this point one would think he would be bankrupt, but in a world where up is down he is not. Frontier bank forgave a 1.5 million dollar loan to him. No future obligation and no hit to his credit report. I asked him how how he did that and he told me that they were banking on his bringing them future business...not just at frontier, but wherever they ended up once Frontier was bust. Around the same time that he made this deal I was discussing with Frontier about purchasing REOs for rentals. I have banked with them for a long time and figured they would want to do business with me. When they gave me their list they showed me 3 properties. I actually laughed at them and asked for the real list, and they came up with a story of how they are actually doing pretty well blah blah blah. This was a year ago.
After hearing this agent get this amazing deal i asked him why I wasnt seeing his lots show up on the reo list. He told me that you have to know someone there, and that they are holding out the good deals for specific people and trying to sucker the rest of us into buying at a still inflated market price. Needless to say I won't be looking at property anymore. This to me is a perfect reason we have to put a knife in these insolvent banks fast.
Just wait until the feds pull agricultural subsidies and initiate a federal real estate tax like the states and locals. Even the farmers will be SOL.
Perhaps, subsidies will be pulled from small-time farmers. That would make sense in our Government's drive to do everything for the upper class at the expense of all other classes.
However, I think it is not likely that the Government will pull agricultural subsidies for trans-national agribusiness corporations, because it is an inherent part of globalization. The subsidies enable trans-national agribusiness to under cut Third-World farmers so that they cannot compete. The transnational can offer a lower price precisely because the subsidy takes up the slack. Ultimately, this situation drives local farmers into bankruptcy and seeking work with trans-nationa agribusiness. The trans-national agribusiness then focuses on exporting one or few crop types. In the meantime, the Third-World country agriculturally becomes a monoculture. This is directly related to farm subsidies that give ADM, Cargill and others leverage in globalization. Oh, by the way, it also explains why a country such as Haiti formerly agriculturally diverse, recently found the population eating mud to ward off starvation. The corporate creed of Globalization will destroy all of us.