Joint Ventures May Bury Builders
Nicholas Yulico
12/27/07 - 06:27 AM EST
Even after homebuilders' disastrous 2007, it's still not time to buy the stocks.
Builders are heading into 2008 facing a perfect storm of rising homeowner foreclosures, tightened credit markets and record housing inventories.
Many of these dangers are already well known, but there are also hidden issues that have yet to play out. Don't be surprised if there are some big negative headlines in the first half of 2008 -- such as the first public homebuilder going bankrupt or a couple of joint venture investments blowing up.
The possibility of bankruptcy is tied to many issues, from falling asset values to large debt loads coming due. To date, much of the homebuilding sector has been hanging on by a string, thanks to the mercy of lenders.
But industry watchers say that it's problems within joint ventures that could tip some builders over the edge next year. These joint ventures -- whose financials are largely opaque to investors -- are in danger of causing big losses for builders and potentially creating liquidity crises.
Tousa, formerly known as Technical Olympic, warned last month that it may be forced to file for bankruptcy. The stock now trades on the pink sheets.
Tousa's downfall came after the company was forced to record $520 million of previously off-balance-sheet debt onto its balance sheet after its Transeastern joint venture went bust.
"They were the 14th-largest builder in the country, and they made one JV that has practically bankrupted them," says Alex Barron, a homebuilder analyst with Agency Trading Group. "I think JVs could come back to haunt other builders."
Looming Losses
During the housing boom, joint venture structures proved very beneficial to builders, since they allowed the companies to boost profits while not putting up 100% of the capital for construction.
But with the markets now in a downturn, falling housing and land values are forcing builders to fund margin calls on their joint venture loans.
Already,
Standard Pacific(SPF Quote) has been forced in recent quarters to supply capital to weak joint ventures in California. That was particularly bad news for a company already facing liquidity problems.
"Joint ventures allowed [builders] to adhere to off-balance-sheet accounting rules and not have to consolidate all of the venture debt and the asset base on their books, so it made them look a lot leaner from a net asset base and have better debt-to-equity ratios than what was really out there," says Patrick Starley, president of Buffington Capital Holdings, a Texas-based private real estate investment firm that worked with several public builders on joint ventures.
"These big public homebuilders are in a pretty substantial cash crunch, part of which is a result of all this unconsolidated debt now causing big problems for them," Starley says.
Most public homebuilders have participated in joint ventures, with the exception of
D.R. Horton(DHI Quote) and
MDC Holdings(MDC Quote).
The extent of the potential issues for each company, however, is essentially a black box for investors. Disclosures in
Securities and Exchange Commission filings vary substantially from builder to builder, as the table below shows.
"We don't know the extent of the joint ventures, JV-lites, JV-minis and anything else they want to call them," says Mike Morgan, CEO of Morgan Florida Real Estate Group, a real estate consulting firm.
The Next Wall to Fall Down
Builders' Joint Venture Risk, in Millions of Dollars |
|
LEN |
SPF |
PHM |
HOV |
WCI |
TOL |
BZH |
CTX |
KBH |
RYL |
| Equity Investment in JVs |
1,077 |
328 |
153 |
205 |
n/a |
240 |
128 |
269 |
388 |
30 |
| JVs' Total Assets |
9,900 |
2,162 |
N/A |
1,019 |
N/A |
N/A |
N/A |
N/A |
2,750 |
781 |
| JVs' Total Liabilities |
6,900 |
1,028 |
701 |
473 |
16 |
1,324 |
789 |
796 |
1,720 |
506 |
| Net Recourse Exposure to JV Debt (plus loan commitments) |
911 |
498 |
178 |
*** |
9 |
534 |
19 |
341 |
226 |
42 |
| Net Earnings of JV for Latest Quarter |
(426) |
N/A |
N/A |
(16) |
N/A |
N/A |
N/A |
N/A |
N/A |
N/A |
| Builder Share of Net Earnings |
(147) |
(39) |
(52) |
(3) |
0 |
4 |
(8) |
(32) |
(17) |
0 |
| Builder Share of Impairments |
139 |
42 |
51 |
N/A |
N/A |
N/A |
7 |
N/A |
17 |
N/A |
***HOV says it only has completion guarantee exposure, but doesn't quantify it
Source: Latest 10-Q filings |
"You haven't seen any of the builders take any big impairments on their joint ventures. That's going to happen in the next quarter or two," says Rich Knowland, a partner in Pacific Terra Holdings, a California firm that is eyeing distressed land deals.
Part of the reason for a lack of joint venture impairment charges to date is that the partnerships often require unanimous approval of key decisions by all parties. Private players involved in the venture might be more eager to protect their capital, whereas public companies might now be looking to unwind the ventures and sell assets at a loss to create cash. This creates additional impairments.
Shaky Ground at Lennar
Lennar (LEN Quote) probably has the best disclosures relating to joint ventures, but it also has the largest JV exposure.
At the end of the third quarter, Lennar had a $1 billion equity investment in various joint ventures. These JVs had total assets of $9.9 billion and total liabilities of $6.9 billion. About $911 million of that debt is recourse to Lennar.
The joint ventures were unprofitable in the latest quarter -- even if you add back the $139 million of impairment charges that Lennar recorded on its share in them.
Of course, not everything is in the financials.
On the basis of conversations with several industry sources familiar with some of the ventures, it appears that there are several issues set to unfold at the company.
A good portion of the JVs -- mostly the ones in better locations -- have 10% to 20% equity from Lennar. But some of the ventures are 50/50 partnerships with weaker secondary players, says a former Lennar employee.
"Some partners had no money at all but had a piece of family land," the person says.
Such deals were in tertiary markets where landowners had land with a low cost basis but had no capital to build out the project and make money. That's where Lennar would step in, by agreeing to pay much of the development cost.
In some of these deals in secondary markets, banks are now likely becoming uncomfortable with the value of the underlying collateral. "Banks are going to start calling guarantees," the person says.
The problem for Lennar now on such ventures is that "when things go bad, you have no partner to go shoulder to shoulder with," the person says.
Lennar, which declined to comment for this story, has already begun unraveling some deals. Pacific Coast Associates, an affiliate of private developer Taki-Sun, bought Lennar's interest in the development of SeaPort Marina in Long Beach, Calif. Terms were not disclosed.
Brookfield Homes(BHS Quote) in December acquired Lennar's interest in Heritage Shores, a single-family home development that the two parties were planning to build together in Bridgeville, Del. Terms were not disclosed.
Cash-Strapped
The housing downturn has left Lennar and other public builders cash-strapped, which is hurting their negotiations with better-capitalized JV partners when trying to sell off stakes.
"We're executing buy-sells at lower than true market value," says one land investor who has worked with Lennar. "Public builders can't come up with the cash to do [the project] or will be heavily penalized by the market if they do," he says.
In a recent research note, Deutsche Bank analyst Nishu Sood downgraded Lennar to hold because of the firm's joint venture exposure. The company's exposure is more than three times larger than any other builder's, Sood noted, while its recourse amount is nearly five times bigger than any other builder's.
"Apart from these quantifiable exposures, less apparent risks include more difficult to measure completion guarantees, reimbursement risk and various other indemnifications the company provides," he wrote. "We think joint venture operations are inherently riskier as well, in that they are more highly leveraged and more involved in longer-term land investments."
The end result of all this could spell danger for homebuilder investors and the broader housing market.
In markets where housing became overinflated, there are record inventories of existing and new homes. But if builders sell land at firesale prices, that makes it easier for vultures to sweep in and build new houses because of the new cheaper land base.
This, in turn, will put more pressure on existing home prices in these formerly hot markets, industry sources warn.
So wait for this ugliness to play out before dipping into the homebuilder stocks.
