Joint Ventures May Bury Builders

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