Investors Aim To Buy Builders' Excess Land, Foreseeing A Bottom; Tax Benefits Spur Some Sales; But joint ventures, holdouts show builders don't intend to exactly sell off the farm

JOE GOSE

Builders beset with slow sales are swamped with land they don't need. Now buyers are lining up to take it off their hands, if only the builders will let go.

Betting that housing is bottoming, money managers have amassed billions of dollars to buy builders' excess land for pennies on the dollar.

They plan to re-sell acreage back when demand for new homes rises, and they anticipate getting at least a 20% internal rate of return, or annualized effective compounded return, building industry advisers say.

The interest that real estate investors are showing in land means they think home-price drops are getting low enough to finally draw sidelined homebuyers. By selling land, some builders are shoring up their balance sheets, cutting future development costs and shifting focus to core markets with better prospects. Builders can, in some instances, get hundreds of millions of dollars in tax benefits by selling off some of their land at a loss.

On Monday, builder Centex said it had sold some 8,500 lots in 11 states to a joint venture led by investment manager RSF Partners. The deal was for $161 million, $367 million less than what Centex had valued the land at, according to Securities and Exchange Commission filings. Centex owns a 5% stake in the venture and has the right to repurchase some lots.

That aids Centex's near-term goal of raising cash and paring land holdings. And it helps Centex "move to a more asset-light operating model," Chief Executive Timothy Eller said in a prepared statement.

The largest recent sale occurred late last year. Builder Lennar formed a joint venture with Morgan Stanley's real estate arm to move land off its balance sheet.

Deep Discounts

Lennar, which reported an $88.2 million loss in its fiscal 2008 first quarter ended Feb. 29, sold the venture 11,000 home sites in eight states for $525 million. That was a far cry from the $1.3 billion the land was valued at as of Sept. 30 last year. Lennar also has first rights to re-purchase some home sites. The venture aims to acquire, develop, manage and sell residential property.

Other sizable land sales include D.R. Horton's disposal of 6,800 acres of raw land in Casa Grande, Ariz., for $70 million last year.

A variety of real estate investors have shown willingness to buy. Yet builder resistance to accepting low prices has stymied activity, says John Trotter, senior vice president of Capstone Advisors, a San Diego-based real estate investment firm.

Capstone, which provides equity and debt to residential developers, has earmarked $200 million to buy troubled land in California, Nevada and Arizona. Late last year it acquired 377 Lennar lots bordering Menifee, in Southern California.

"Funds are looking around saying they have a lot of money," Trotter said. "But there aren't a lot of willing sellers right now."

Executives with national builders such as Toll Bros. and Hovnanian Enterprises say they want to avoid bulk land sales, particularly because of low-ball offers.

"We, like all builders, are kind of feeling around in the marketplace as to what opportunities are out there," Hovnanian Chief Executive Ara Hovnanian told analysts on the firm's fiscal first quarter 2008 earnings call March 11. "I would say (a large sale) is not something that is exciting to us right now."

Suburban Shedding

How much debt and undesirable land builders have dictates decisions to sell, says James Wilson, a builder analyst at JMP Securities. Builders are most apt to shed acreage on city outskirts that would take time to develop later, he says.

"My guess is that builders aren't going to sell their good stuff for a low price," Wilson said.

Still, a tax rule could bring more land to market in coming months, says Jeff Meyers, founder of Meyers Builder Advisors in Corona del Mar, Calif. The rule lets firms apply current losses to two prior years' gains and get tax refunds.

Lennar, for example, got $852 million in refunds related to net operating losses carried back to 2005 and 2006. Orleans Homebuilders expects to get up to $25 million, tied to a sale of 1,400 lots for $33 million, or $53 million below book value.

Builders generally recorded profits just through 2006, so they would need to act soon to use the tax break.

"These (sales) will stop as we get beyond the tax benefits, which for a lot of builders is going to be 2009," Meyers said.

While builders are wary of selling for too little, land buyers risk paying too much, especially in areas where values continue to drop. To judge value, analysts say, buyers typically consider current home prices plus home-building costs -- such as materials, labor and marketing -- and back-calculate a price for the land.

To cut risk, buyers may factor into their calculation annual home price declines of 5% to 10% for the next one to two years. Trotter says Capstone back-calculates to build in a four-year hold period, providing time for a market turnaround.

In Riverside County, Calif., where Capstone bought Lennar lots, the median home price in February fell 21% from a year earlier to $325,000.

"Home prices are heading toward 2003 levels, and we still have 95% employment," Trotter said. "These are areas where people want to live, and they're going to need housing."