Homebuilding Revival Sparks Rush for Best California Land

By John Gittelsohn – Aug 26, 2012
Bloomberg News

Guy Asaro, president of McMillin Homes LLC, bought three land parcels in Texas this year while coming up empty in the San Diego area, where the closely held builder is based.

Ready-to-build lots around San Antonio, where McMillin has constructed houses since 2005, cost $55,000 to $70,000, or as little as one-sixth the going price in San Diego, Asaro said. He keeps searching in California, the most populous state, because a little land in the right place can yield a big return.

“In Texas, land is like lumber — something to build a house for somebody to live in,” Asaro said in a telephone interview. “In California, the land is what’s valuable. The house is just how you monetize it.”

The nascent recovery in new-home sales has U.S. builders rushing to buy up a diminishing supply of well-located, ready- for-construction land. They added more than 18,000 lots during their most recent quarter, the biggest gain since their inventory hit a nadir in the fourth quarter of 2009, according to data compiled by Bloomberg Industries. Demand is becoming so overheated in areas such as coastal California that developers are forced to pay more or shop in less-favorable markets.

Around the California coast, where the technology and health-care industries are fueling job gains, plots are selling faster than developers can prepare the dirt. The supply of finished lots — which have permits, streets and water and power lines, enabling construction — will fall to zero within a year in San Diego, Orange County and San Jose, said the Concord Group, a Newport Beach-based consulting firm.

‘Running Out’

“We’re running out of inventory,” Richard Gollis, a Concord Group principal, said by phone.

U.S. new-home sales rose in July to an annual pace of 372,000, up 25 percent from a year earlier and the fastest since April 2010, the Commerce Department reported last week.

Land prices probably will climb an average of 5 percent this year and next, faster than home values, according to Paul Diggle, property economist for Capital Economics Ltd. in London.

“We expect the early stages of the recovery to be characterized by demand for land that can be relatively easily developed and which is within a reasonable commuting distance of downtowns,” Diggle said in an e-mail. “Speculative buying of land in the desert, miles from business hubs, is unlikely to make a quick reappearance.”

Job Growth

California payrolls increased by 25,200 positions in July, the most of any state, the U.S. Bureau of Labor Statistics reported on Aug. 17. The unemployment rate in the 10 largest cities varied from a low of 7.3 percent in the San Francisco- Silicon Valley area to a high of 14.7 percent in Fresno, in central California, according to the state Employment Development Department. The statewide 10.7 percent jobless rate was the third-highest in the U.S., behind Nevada and Rhode Island.

Lot shortages are also looming in and near Seattle; Raleigh, North Carolina; and Washington, D.C., where job growth has outpaced the addition of home sites, Gollis said.

In Phoenix, where 48,500 jobs were added in the 12 months through July, prices for finished plots in desirable areas have tripled since 2010, said Nate Nathan, a Scottsdale, Arizona- based land broker. He completed two deals in the Phoenix area this month, totaling $54.5 million for 1,061 lots.

“This market is on fire,” he said in a interview.

Bubble Warning

Permit applications for new U.S. homes climbed last month to an annual rate of 812,000, the most in almost four years, according to the Commerce Department. While that’s up 30 percent from July 2011, housing construction must reach an annual pace of about 1.2 million to accommodate population growth, said Mark Kiesel, managing director for Pacific Investment Management Co. in Newport Beach.

“New inventories are at 50-year lows,” he said during an Aug. 14 interview on Bloomberg Television. “Housing starts are really half of what the long-term average is.”

Kiesel became a homeowner again in May, six years after he sold his last house and said that over-construction and easy credit had created a housing bubble.

Robert Shiller, a Yale University professor of economics who also forecast the property crash, said this month that real estate is still prone to busts.

“California is the worst,” Shiller said during an appearance with Kiesel on Bloomberg Television’s “Street Smart.” “There are the repetitions of the bubble psychology. It could be building up in some places.”

Inland Markets

In the San Francisco Bay area, the median home price jumped 13 percent in July from a year earlier to the highest level in almost four years, according to DataQuick. The increase was 8.1 percent in Southern California, the San Diego-based information company said.

While the coast recovers, California’s inland real estate markets remain among the weakest in the country. The five U.S. metro areas with the highest rates of foreclosure filings in the first half of the year were Stockton, Modesto, Riverside-San Bernardino, Vallejo and Merced, all inland California cities, according to RealtyTrac Inc.

Vallejo filed for bankruptcy in 2008, followed by Stockton and the city of San Bernardino this year, after declining property values and rising public-employee costs left them insolvent.

Even some inland areas are starting to experience rising demand for lots, said Layne Marceau, Northern California division president for closely held builder Shea Homes LP. Shea manages development of Mountain House, a planned community for 15,000 homes 58 miles (93 kilometers) east of San Francisco. The California Public Employees’ Retirement System wrote down its $1.12 billion investment in the project to $96.8 million as land values plunged, according to the fund’s 2011 annual report.

‘Future Inflation’

This month, builders agreed to buy almost 300 finished lots in Mountain House, at prices 50 percent higher than a year ago, Marceau said.

“They’re paying today for projected forecasted future inflation,” he said in an interview. “It’s been amazing.”

In San Diego, well-capitalized public builders such as Lennar Corp. (LEN) are driving up land prices beyond the reach of smaller competitors, said Bill Davidson, president of Davidson Communities, a closely held builder based in Del Mar, California. Lennar recently outbid him for a 10-lot parcel near San Diego, a property so small that large builders would have ignored it a few years ago, he said.

“They’re here with a vengeance,” Davidson, whose company has built 5,000 homes since 1978, said in a phone interview. “I’ve seen land prices go up 50 percent.”

Lennar, Toll

Lennar, the third-largest U.S. homebuilder by revenue, spent $287 million on land and lots in its most recent quarter, a 74 percent increase from a year earlier, according to President Richard Beckwitt.

“We continued to acquire great deals in Florida and Texas, but invested more heavily in some extremely high-margin opportunities in California and the Mid-Atlantic,” Beckwitt said on Lennar’s June 27 earnings conference call.

Lennar declined to comment further, said Allison Bober, a spokeswoman for the Miami-based builder.

Toll Brothers Inc. (TOL), the largest U.S. luxury-home builder, agreed in May to pay about $110 million for half of an Orange County subdivision with permits to build 1,780 single-family homes and 414 apartments. The Horsham, Pennsylvania-based company is raising prices for its California homes because demand is so strong, Chief Executive Officer Douglas Yearley Jr. said on an Aug. 22 earnings conference call.

“Silicon Valley: hot,” Yearley said as he ranked California’s markets. “We just wish we had more. San Francisco: strong. Coastal Southern California, Orange County and northern San Diego County: very strong.”

Higher Risk

Publicly traded builders recorded more than $32 billion in losses on land purchases and options contracts from 2005 through the first quarter of this year, and should restrain from depleting their cash to buy land “in these still uncertain times,” according to a July report by Fitch Ratings.

California, among the states hit hardest by the housing crash, offers a high-risk path to profits compared with Texas, where home prices have moved in a narrower range, said Brad Hunter, chief economist for Houston-based Metrostudy, which tracks new construction.

Land in Texas — the second-most populous state, which has a quicker development approval process — offers steady returns while it “isn’t particularly sexy or exciting,” Hunter said in a phone interview from his office in Palm Gardens, Florida. “People in California have to bite their fingernails and stomach the risk that there won’t be another wave of foreclosures.”

‘Big Dollars’

D.R. Horton Inc. (DHI), the largest builder by volume, spent $938 million on land in the first three quarters of its fiscal year, up from $582 million a year earlier. While recent deals boosted the Fort Worth, Texas-based builder’s nationwide lot count to more than 130,000, the most since mid-2008, little of the new land was in California because prices seemed “overheated,” CEO Donald Tomnitz said.

“It takes big dollars and it’s a higher risk, given the state of California’s economy,” Tomnitz said on a July 27 earnings call. “So we’re trying to choose land and lot positions in low-risk areas to provide us the best return.”

Approval Process

Developers preparing California land for construction face an approval process that delays projects and pushes up costs. Newhall Ranch, a master-planned community north of Los Angeles, received initial county approval in 1998 for 20,000 homes. Its developer, Aliso Viejo, California-based FivePoint Communities Inc., doesn’t expect to break ground until next year, after delays caused by litigation and a 2009 financial restructuring, CEO Emile Haddad said.

“The barriers to entry are so lengthy and complicated, it makes the supply limited,” Haddad said in phone interview. “Unless you’re working on deals and entitlements today, you’re going to miss the next cycle.”

Builders are required to foot the bill for infrastructure development, further driving up land costs. FivePoint is in talks to pay $1.2 billion for parkland, roadways and schools for the right to construct as many as 10,700 homes at the former El Toro Marine Corps Air Station in Orange County.

Environmental regulations, such as requiring developers to report the potential impact of greenhouse gases generated from new projects, discourage investors with limited time to get a return on their money, said Bob McLeod, CEO of Newland Co., a planned-community developer based in San Diego.

‘Expensive Place’

California’s “not expensive because everybody’s running to buy land, but because it’s an expensive place to do business by a wide margin,” he said. “It takes three to five to 10 years to get a project approved.”

Lots at Newland’s Cinco Ranch, a 12,000-home master-planned community outside Houston, cost about $65,000, compared with more than $338,000 for similar properties at the company’s 4S Ranch north of San Diego, McLeod said.

Builders pay a premium for California land with the expectation of wider profit margins, Asaro of McMillin said. His company, which sold 456 homes last year, lists a 2,800-square- foot (260-square-meter) house in San Diego for $459,900, compared with $246,900 for a similar property in Texas.

KB Home (KBH) sold its average California house for $402,000 in its most recent quarter, a 32 percent jump from a year earlier. That compared with an average of $163,700 for homes in its central region of Texas and Colorado, where prices dropped 7.7 percent, the Los Angeles-based builder said.

Those price differences will increase as California lots become more scarce, Asaro said.

“I see immense price pressure here in the next couple years,” said Asaro, this year’s chairman of the Building Industry Association of San Diego. “It’s going to be very hard to meet the upcoming demand. The future of homebuilding is where people are and people are where jobs are.”