Builders Profit From Distressed Land Acquisitions

At a time when home sales are down in the central Pennsylvania region, where Charter Homes & Neighborhoods has been building homes for the past 30 years, Robert Bowman says he and his team have never worked harder. “You’d think we would not be working very hard these days, but we’ve been extremely busy,” he says.

Over the next few months, the privately-held builder — which was honored with a 2011 National Housing Quality Award from Professional Builder — will open three new communities offering homes at extremely low price points for the area — as much as 20 percent below the current lowest-priced product in the market. How? “We simply have a lower land basis,” says Bowman.

Charter is among the many builders nationwide that are taking advantage of the depressed housing market to snatch up land at bargain-basement prices — not only as a long-term investment, but also as a tactic to generate cash flow in the next 18 to 24 months to help ride out the stormy market.

Moving Product Quicker to Make Money Now

For Charter, the distressed/REO market has been a plentiful source of finished lots. Two of its three new neighborhoods were bank-owned property. “In one case, we bought lots at about 35 percent of what they were on the market for before the downturn,” says Bowman. “They’re truly below the cost to acquire, develop, and approve land — probably 75 percent of that cost today. What this is allowing us to do is in a market where the lowest single-family home price is $199,999, we’re opening at $159,999.”

By undercutting the competition and resale market on price, Bowman believes Charter will be able to move product at a much quicker pace. “We’re looking for deals that will provide cash flow and profits within the next two years,” he says. “I think there’s a lot of acquisitions being made by builders that believe three to five years down the road there will be some value. Our strategy is about making money now.”

Many builders share Bowman’s point of view on land, but major obstacles stand in the way of jumping back into the land market. In fact, more than 55 percent of builders that responded to our January 2011 survey on land acquisition trends said they believe now is a great time to buy land. However, only about a quarter actually bought land during the past year, and just a third said they plan to buy in the next 12 months. Difficulty in obtaining financing and the high cost for debt and equity for land deals were among the biggest hurdles cited by respondents.

In Charter’s case, the builder was able to work with the banks from which it acquired the land to finance the purchase. But not all builders have been as fortunate.

“There simply is no financing from banks,” says Dwight Sandlin, president and owner of Signature Homes, Birmingham, Ala. “For us, it has to be equity, because there is no debt available.”

Last year, Signature Homes formed a family-and-friends network specifically to help finance distressed/REO land acquisitions throughout the Birmingham, Ala., area. The regional builder, which sells about 350 homes annually, recently closed on three bank-owned subdivisions, paying about half what a buyer would have paid about three years ago.

“It appears that, at least in our area, the banks are getting healthy enough to dispose of the real estate,” says Sandlin. “We’re starting to see a big difference in the banks’ position with regard to real estate, and that’s what we’re trying to take advantage of. We’ve seen deals as low as 75 percent off.”

The firm’s land strategy focuses on “loading up on as much distressed property as we can in areas that are going to grow to position ourselves for the balance of 2011 and into 2012 and 2013.” This approach has forced the builder to move away from its traditional business model — building communities from scratch — into buying developed lots in partially completed neighborhoods.

“We’ve never been an advocate of going into a community where other builders are operating,” says Sandlin. “But the deals are so good that even if we can’t monetize the lots this year, we’re confident we can double our investment by selling them or building on them in the future. It’s changed the way we do business.”

Large national builders, some flush with cash reserves, have also been active in the distressed market. Toll Brothers CEO Doug Yearly estimates that at least half of the luxury home builder’s land acquisition activity during the past 12 months came from the distressed market.

“I think all builders realize that the opportunity to buy distressed ground is upon us, and we don’t want to miss good deals,” says Yearly. “We’re either competing with [other national builders] or we know of them pursuing other opportunities that we passed on.”

And, like Charter and Signature, Toll Brothers is buying with short-term profit in mind. “We underwrite today’s acquisitions at today’s price and today’s sales pace,” says Yearly. “It has to make us a good return, and we’re not building in price inflation. We’re not buying ground to bank it on the hope of the world improving; that’s what got people in trouble in 2005.”

Longer-Term Investment

Yet not all builders share the short-term view when it comes to land acquisition strategies. In fact, of the builders surveyed by Professional Builder in January that purchased land in the past 12 months, only about a third (36.3 percent) plan to develop or build on it within the next 12 months. Nearly half (46.6 percent) indicated that they plan to wait for the market to rebound before they either develop/build or sell the property.

“There is a lot of distressed land out there, but builders are bemoaning the fact that there is a real shortage of distressed land that can produce great returns within the next two to three years,” says John Burns, CEO of John Burns Real Estate Consulting, Irvine, Calif. “Those that are able to look out five-plus years have a tremendous opportunity to load up on land, primarily because they have so little competition and land will probably never get cheaper. I think the key point of the whole land story right now is patience.”

Tips for Shopping the Distressed/REO Property Market

Just keep calling — “My experience is that the people in REO are inundated with work right now,” says Robert Bowman, president of Charter Homes and Neighborhoods. “These departments were two people three years ago and now they’re scrambling to find the staff to figure stuff out. In our case, we were told ‘no’ multiple times before the banks called us back and decided to move forward.”

Be relentless in your pursuit of new opportunities — The opportunities do not come to you, you have to go find them, says Doug Yearly, CEO of Toll Brothers. “We’re not trading stocks here; land deals don’t come up on a computer screen, and there’s no E*Trade. We have land hawks throughout the country. They’re on the road chasing deals every day. They’re in the townships pulling tax maps, they’re driving streets, they’re networking with every local engineer, architect, land planner, lawyer, banker, and Realtor to find the deals.”

Have an exit strategy — If you’re looking to the debt market for land financing, you’ll see that the game has changed dramatically. “Very few people want to help with land money,” says Doug Shipman, managing partner of Developer’s Financial Solutions. “We’ve had some successes with land financing, particularly if we can tie the vertical to it and tell the complete exit strategy of the project.”

The key, says Shipman, is to think the project all the way through sales, factoring in land purchase cost, cost of remaining construction, permits, approvals, and, for instance, if existing approvals have expired. “You’ll need a marketing study for the vertical product you’re going to put there and know precisely what your absorption rate is going to be,” he says. “It has to be a completed story. Most of the time people are not ready to tell the whole story going in.”

Become the expert — “You have to understand the development game in every single municipality, inside and out,” says Bowman. “You have to understand where the bank is, where you are, and you have to know exactly where the market is and have plan to get cash flowing as quickly as possible.”

Master the due diligence process — “If you’re good at due diligence, get better,” says Bowman. “You cannot be on the hook for fulfilling every commitment that was promised by another builder. The municipality, homeowners’ association, and inspectors have to be 100-percent clear on your plans so they can’t come back and hold you responsible.”

Watch out for the commitments that are not documented, or “are buried in the documentation,” says Shipman. “For example, we consulted on a project in California that looked terrific — it had 126 lots, and by all the numbers it looked like it could get acquired and done for $130,000 to $140,000 a lot. Then we discovered on page 126 that the original developer agreed to build a $6 million bridge, and that was the only way to get to this project. It was just another in a long line of broken deals.”

Know when to walk away — If the municipality, homeowners’ association, and local inspectors are not willing to work with you to get a development re-started, head for the door. “Our biggest deal-breaker is when we sit down and tell them what we want to do, they say, ‘Boy we have a list for you.’ That’s a walk-away,” says Bowman.