Declining lot values add to homebuilders' pain

One of our biggest concerns is our clients' land and lot holdings and the lack of land price adjustments in general. We sense land owners are holding their breath, hoping the market will stabilize or even improve during 2008, allowing them to wait it out. However, housing prices climbed above local affordability in most markets, and recovery is predicated based on both housing and lot prices ratcheting down until builders can afford to buy lots, deliver affordable homes on them and make a fair profit.

When we established valuations of building companies for acquisitions prior to the current downturn, we analyzed the value of land holdings in excess of book value. Today we question whether book value can be trusted, because the land and lots on the balance sheet are probably not worth their historical costs. The key points are when the land was purchased and the accounting for costs incurred. Land purchased 4–5 years ago might be OK, providing holding costs were expensed rather than capitalized. Even for land bought 4-5 years ago, we are finding capitalized costs must be written off to reprice the land, so that market value and historical cost match up.

Some clients are learning that their land holdings have no value today, regardless of what they paid to purchase or develop. In addition, many builders are close to or have already busted debt covenants regarding loan-to-value ratios, which trigger the potential for repayment demands. With a goal of negotiating with their lenders, we guide clients through a tough analysis of the market for their land or lots today, ignoring any sunk costs, the bank loan amount, or especially an appraisal.

Assume that you have just one shot at negotiating, so you must determine the best course of action for each site and meet your lender armed with thorough market research and worst-case projections to support your request. You may need to negotiate for no interest accrual while you mothball a project or give back a project and request forgiveness of debt.

At the heart of this analysis is the land's value to a third party to build and sell houses on it. You must determine your costs per "net saleable square foot" to do this, and there are many moving parts to address. Most projections we see underestimate the indirects and other soft costs, as well as tricky-to-predict development costs. If you've never negotiated with banks in a downturn, hire an expert to help you analyze options, and communicate and negotiate with your lenders.

While many investors are eyeing the housing sector, they are not generally looking at land deals because they recognize that most are still overpriced and better buys will be available in 12-24 months. Land with amenities such as waterfront or infill locations will have future value and big upside potential but may still have no value today. Developers and lenders are going to have to absorb some losses before land and lots descend to values that can sustain new home building.