In a typical real estate cycle, homebuilders buy land when it's cheap, develop homes as the market heats up and then make big bucks selling them during a boom before starting all over.
But this is no typical cycle.
During the biggest real estate crash in decades, local homebuilders KB Home and Ryland Group Inc., and others are going into virtual hibernation. They're slashing jobs, closing offices and unloading inventory on the cheap while shying away from picking up land even at its lowest prices in years.
These measures are translating into surprisingly good cash flow for the companies and may prove to be the ticket to survival in an industry that has seen scores of homebuilders close shop. But at least one analyst frames the general strategy more harshly, even as he applauds it.
"In a sense, they are slowly liquidating the company," said Fox-Pitt Kelton analyst Robert Stevenson, who covers Westwood-based KB Home and Ryland of Calabasas, and doesn't think they are going out of business.
Tough words to be sure, but the housing market has been even tougher. First crimped by the credit crunch two years ago, home sales are now being hit hard by rising unemployment and a deepening recession that has continued to force homeowners into foreclosure and lower prices.
Last week, the federal government released figures showing housing prices declined 8 percent in November, the largest drop since those records began being kept in 1991. That's left the national median at just $181,000 in November, about 20 percent off its peak and the bust has been far worse in boom markets such as Los Angeles County.
That has forced homebuilders to try and compete in a market filled with dirt cheap foreclosed homes that in many cases have been occupied for less than a year. Earlier this month, John Laing Homes of Irvine said that it was cutting jobs and looking to raise billions of dollars. And veteran builder Barratt American Inc. of Carlsbad filed for Chapter 11 bankruptcy protection Dec. 24.
KB Home, the nation's fifth largest homebuilder, and Ryland, the 11th largest, have not been immune, recording losses in the hundreds of millions of dollars in their last quarterly reports a huge change from record earnings of just a few years ago. That has been reflected in their stock prices, both of which traded at a fraction of highs that topped $80 in 2005.
But both companies have surprisingly been able to increase their cash reserves by essentially following a similar strategy: hunkering down, cutting costs and finishing off most but not all of the projects they have under way.
"It's a fight for survival," said John Burns, chief executive of John Burns Real Estate Consulting Inc., which covers the housing industry. "The last three years have been horrendous for them."
In some ways, KB Home is doing what every builder has done when it is faced with a market bust.
As a result of the downturn, KB Home is leaving or has closed its operations in at least three markets Atlanta; Indianapolis; and Baton Rouge, La. The company also consolidated seven divisions and reduced its work force by 11 percent during the fourth quarter, according to a company conference call.
Those sorts of actions helped KB Home narrow its 2008 fourth quarter loss, which hit $773 million in 2007, to $307 million. Still, its problems were multiple, not the least of which was the fact that the company had to record a $309 million noncash charge because of the declining value of its land and other assets.
However, Chief Executive Jeffrey T. Mezger noted that once the impairment charge was excluded, the company recorded the first positive income from operations in five quarters. It also ended the fourth quarter with $1.25 billion in cash, up nearly $100 million from the prior quarter not what would be expected from a struggling company. So how did KB Home do it?
Here's how Mezger put it in January's conference call: "In early 2006, we recognized that the housing market was changing, and we were among the first builders to begin shifting focus from growth to inventory reduction and cash generation."
What that means is the company has largely stopped land acquisitions, but is proceeding to sell off homes, some of which have been built and others it builds on a customized basis once a deal has closed. (See the article on page 21.) The company also is selling them even if it has to book a loss because of the high prices it paid for land during the boom, since the sales will still generate positive cash flow.
"You can't hide a loss. If you are selling it at lower than fair market value, what do you do?" asked Jeffrey Gault, a former executive with KB Home who is now chief executive of L.A.-based LandCap Partners, a residential land company that purchases distressed residential assets.
"(But) I think it is a strategy of survival. They have no other choice, do they? Owning a lot of land and debt with no cash is a terrible thing. So they are liquidating reducing their debt as much as they can and getting rid of bad inventory so they have as much cash on hand to weather this storm."
The company also is building smaller, simpler and less expensive homes. In the fourth quarter, the average selling price of a home was $232,000, 3 percent lower than the third quarter and down 6 percent from fourth quarter 2007, according to Stevenson.
At KB Home's new Sedona project in Lancaster which opened in December a 1,239-square-foot, three-bedroom home starts at $132,000, according to the company. In some homes, KB Home builds bathrooms that are back to back so it can cut plumbing costs, said Steve Ruffner, president of KB Home's Southern California coastal division.
The company also is ramping up marketing of its green building program in an effort to lure consumers away from the resale market. Ruffner said the company's new homes have more and better insulation that is "difficult to put in place on an old home without spending a lot of money."
Like KB Home, Ryland has for the last few years worked to cut costs and reduce prices on its new homes. The company also has begun a consolidating effort, according to Chief Executive R. Chad Dreier, who spoke during the company's third quarter conference call in October.
Ryland has combined its Austin and San Antonio offices in Texas, a move that will save Ryland about $1 million over the next year. And the companywide employee head count in the third quarter was 1,589, down more than 50 percent from peak staffing, Dreier said.
Eric Elder, senior vice president of marketing and communications for Ryland, told the Business Journal that in some markets the company has reduced field staffs in building and sales departments 40 percent to 50 percent. Those cuts have come with the closure of some offices.
"We have definitely right-sized our operation. We've reduced management to the size it ought to be. We have always been extremely lean on the management side," said Elder.
Elder also confirmed that Ryland had left the Dayton, Ohio; Winston-Salem, N.C.; and Yuba, Calif., markets. The company remains in 25 markets, but plans to leave Cincinnati this year.
In order to bring costs down at new projects, Ryland has reduced some of the specifications or options that might have been included in homes during the boom. It is also promoting more energy-efficient homes, though not as visibly as KB Home.
This reduction effort appears to have paid off to some extent. Ryland's cash from operations increased to $101 million in the third quarter, up from $37 million in the second quarter. That helped grow cash on hand to $345 million from $199 million over the same period, according to Stevenson.
"Their balance sheet is on a relative basis well positioned versus some of the peers," Stevenson said. "It's not as pristine as the best balance sheets in the space but certainly is above average. I think that at the end of the day that's what most investors are worried about these days."
Indeed, the company is still facing difficult times. Though Ryland chose to stay out of the L.A. County market, it has 15 projects in the Inland Empire one of the worst markets in the country that are either open, under construction, or winding down sales, Elder said.
Ryland and KB Home aren't the only local companies that have gone through massive changes as a result of the housing collapse. Take Newhall Land & Farming Co., a mainstay suburban housing developer that's been building in the county for 40 years.
The company built Valencia, a vast Santa Clarita community of sprawling subdivisions and shopping centers. But Newhall Land has been radically changed by the downturn, which has bankrupted the venture that now owns the company. The bankruptcy has thrown into question the fate of the 12,000-acre Newhall Ranch project, which would include 21,000 homes built over the next 20 years.
Newhall Land still hopes the massive development will break ground in 2010, said Marlee Lauffer, senior vice president of marketing and communications for Newhall Land, adding that the company is still in the process of Chapter 11 reorganization.
"Our creditors recognize there is great long-term value particularly in the Newhall Land asset," she said.
Other companies, such as private builder Pardee Homes of Los Angeles, are holding off on projects. Near Newhall Ranch in the east Santa Clarita Valley, the company has two residential projects it has placed on hold until the market picks up, said Jim Bizzelle, vice president of community development for Pardee. The developer has plans for a 498-home project called Golden Valley Ranch and a 1,600-home development called Fair Oaks Ranch, but there is no timeline for construction of homes.
Few real estate industry analysts interviewed by the Business Journal were willing to lay out timelines for a recovery in the homebuilding industry. But several agreed that before a recovery can begin, the resale home market needs to bottom out, which could happen this quarter though it's likely that it could take longer in Southern California.
Jeff Meyers, a principal of Meyers Builder Advisors LLC, a market research firm that covers the homebuilding industry, said he expects many more private companies will be bankrupt at the end of it all, while the major public companies will do business a lot differently.
"They are going to dip their toe in the water with selective small projects," he said. "They will buy in smaller increments and take fewer risks on the land. When they step back into the marketplace it is going to be very careful transition."
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