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Sunday, August 05, 2007

Home Builder Myths Meet Reality

by Calculated Risk on 8/05/2007 01:04:00 AM

"We can earn our way through any economic cycle, except one like the Great Depression."
Donald Tomnitz, CEO, D.R. Horton, Dec 1, 2005
D.R. Horton Inc, the largest U.S. home builder, on [July 26, 2007] reported its first quarterly loss as a public company ...
Reuters, July 26, 2007
From the WSJ: Home Myths Meet Reality
It wasn't supposed to happen like this. Today's home builders were thought to be better-capitalized, savvier and more geographically diverse than many of their predecessors in the last downturn, in the early 1990s. While many are expected to weather the slump, concern is mounting about the balance sheets of a growing number of companies.
What's going wrong? An array of business assumptions that both builders and housing analysts propagated have turned out to be misguided.
One big assumption had to do with their cash flow: The common wisdom among some analysts was that builders would turn into "cash machines" in the event of a housing downturn, because they would pare construction and land buying.

In reality, most builders haven't been able to stockpile as much cash as expected. That is partly because they have had to keep building large housing developments, even though demand dropped off sharply.
Also eating into that cash flow: the sharp drop in sales and home prices.
The article discusses a few more challenges for home builders, but unmentioned are two key points:

First, the home builders are still building too many housing units because that is the only way they can liquidate land and pay down debt. This overbuilding will extend the duration of the slump in new home construction.

Second, there is way too much home building capacity in the U.S., and competition will be fierce until enough home builders exit the business.

Meanwhile, with the growing credit crunch, bankers might be quick to call loans:
Until recently, many analysts believed banks would be forgiving of the builders. But it now looks as if some companies could run into trouble with their banks.

That is because some builders' net worth is eroding so quickly -- as they write down the value of land -- that some may be getting close to tripping contractual agreements ...