by Les Shaver

Albert Praw knows land deals. The CEO of Landstone Communities, a division of San Francisco-based residential development investor Hearthstone, has observed many of the deals coming to market right
now. And one thing he’s not seeing much of is the “old-fashioned” use of brokers to sell land.

“The normal broker angle isn’t working,” Praw says. “Brokers are still successful in hooking up builders with little guys. Builders will sell finished lots at deep discounts, and little guys can survive on low margins. Other than that, going to brokers to sell lots has not been a successful strategy.”

Indeed, with prices slashed so much, it can be too costly to give brokers a commission. Others see this as well. “The gap between asking is so great that there’s no room for a broker,” says Chris Ward, managing principal of Magnolia Florida, a Lake Mary, Fla.-based developer. “There are very few transactions closing right now.”

The numbers tell the story. From January through August of 2006, roughly $16.4 billion in land deals closed; in 2007, a whopping $27.2 billion closed in the same time frame, according to data from Real Capital Analytics, a New York-based firm that tracks real estate transactions. That velocity has not continued in 2008, however—only $7.1 billion worth of land deals have closed since the beginning of
the year , a drop off of roughly 74 percent.

“Developers keep building as long as lenders keep providing debt for new construction,” says Dan Fasulo, managing director for Real Capital Analytics. “But the music has definitely stopped.”

Even if debt financing was available in the marketplace, Ralph Grebow, CEO for The Atlantic Cos., a developer based in Florham Park, N.J., says the numbers just won’t work until land prices come down.
“There is a lot of land for sale, but a lot of it is still not priced realistically,” Grebow says. “Everybody is standing there waiting for the ground to be valued at nothing. The metrics of the ground is really difficult to make work.”

Grebow believes the central problem is the plummeting value of homes. Take the average sales price of a single-family home, subtract the impact fees, land improvement investment, construction costs, and overhead, and developers are finding that lands need to be worth next to nothing to make a deal work, Grebow says.

And that’s probably not going to happen anytime soon. “We’re going to see land prices stay fairly depressed until builders sense that there is supply and demand in the marketplace,” he adds. Despite these challenges, as the tax year draws to a close and home buyer traffic continues to slow, more land holders may opt to try and move their assets so long as their banks don’t have too tight a grip on the land. Here are three strategies that avoid the broker-negotiated sale—any one of which could tidy up your balance sheet and keep you in business through the downturn.

THE DIRECT SALE
Sometimes, the most direct method—from buyer to seller with no middle man— is the easiest and most inexpensive tack, costing less than a deal that would involve a broker. That’s what Orleans Homebuilders in Bensalem, Pa., found to be true at the end of 2007. Orleans, which ranked 42nd on Builder magazine’s 2006 Builder 100 list with 2,079 closings, sold 1,400 lots across the country with an aggregate net book value of approximately $86 million. While the firm used a broker to sell a couple parts of the portfolio, lots were mainly sold directly to buyers. Ultimately, Orleans received about $32 million for the land, but it nabbed $20 million to $25 million of federal income tax refunds.

Fort Worth, Texas-based home builder D.R. Horton recently did the same thing, selling 2,000 residential lots in Southern California’s Inland Empire for $7.8 million as well as a 4-acre parcel in Escondido, near San Diego, for $4.4 million. In the San Diego transaction, the county assessor said Horton got 25 percent of what it paid for the property in 2005, The Wall Street Journal reported. In the Inland Empire deal, the Journal says one bidder estimated that Horton paid $110 million for the land before spending money “to prepare the property for development by grading and installing nfrastructure such as sewers.” In June, Horton told investors that it expects to reap a tax refund of $519 million over the next two years from land sales, though they didn’t specifically cite these sales.

Pros: The main advantages of direct sales are slashing burdensome land from your books and scoring tax refunds. Orleans was able to secure these refunds because it turned a profit in 2005 and 2006. If a firm, whether public or private, can take the loss on its transaction and apply that loss to the prior year’s earnings, it can get a refund based on the previous taxes paid.

In fact, Ward of Magnolia Florida wonders why other public firms aren’t doing more direct sales. “As long as they have any kind of tax incentives, they should be doing those transactions to build as much cash as possible,” he says.

Cons: Public land owners are often the main beneficiaries of the tax advantages of these direct sales; private players typically aren’t in the same position. “The problem with the privates is that they typically can’t do it because the banks truly own the land,” Ward says. “But if the banks go along with it, privates can do it.”

What to Watch For: Since most builders weren’t turning profits after 2006, this year may signal the end of direct sales. “[Direct sales] have happened once before, and it might happen again towards the end of this year,” Ward says. “Then, that will be done. For most builders, this is their last year where they can reach back two years to their last profitable year and actually apply losses.”

PARTNERING UP
If a direct sale is not really an option, another solid strategy is to enter into a joint venture. These types of land partnerships generally occur between two builders or a builder and capital provider. Unlike broker-negotiated deals, partnerships don’t have a middle man.

Take Lennar Corp., a Miami-based home builder. The firm, which built 33,283 homes in 2007, raised the bar for land sales in 2007. It sold 11,000 lots nationally, originally worth $1.3 billion, for $525 million to a joint land venture with New York-based Morgan Stanley Real Estate. Lennar got a 20 percent stake in the venture, managed the land venture’s operations for a fee, and moved burdensome land off of its books. It also received $270 million in tax refunds by selling before the fiscal year end of 2007.

Pros: In a lot of ways, Lennar made out well. The partnership allowed the firm to get rid of excess land, retain management fees, and recoup money on its taxes. “They really didn’t lose anything when you consider the tax benefits,” says Jack McCabe, CEO of McCabe Research and Consulting, a real estate research firm in Deerfield Beach, Fla.

That’s why this could be an attractive option for other overwhelmed land holders. “If you own 90 [percent] or 100 percent of a deal, and you bring in a partner that gives you 50 percent, it could help you work through it,” says Richard M. Gollis, principal and co-founder of The Concord Group, a Newport Beach, Calif.-based real estate consulting firm.

Cons: The key problem with this strategy is the loss. Michael Rehaut, a home building analyst at J.P. Morgan Securities, wasn’t crazy about the loss Lennar took. “[We] believe the $775 million book loss
on the sale is a net negative, not only for Lennar but the industry, as it points to still significant asset impairments ahead for the sector,” he said in a statement at the time of the sale.

What to Watch For: A decline in these types of partnerships. For the public operators, joint ventures might still work, but on the private side, Ward is pessimistic about seeing many others. He thinks prospective JV partners may just be waiting for builders to crumble instead of entering new ventures. “There’s no value left,” Ward says. “With almost every private builder, their debt is greater than the value of what they hold.”

THE SHORT SALE
Short sales aren’t getting publicity, but that doesn’t mean they aren’t happening. In this scenario, the land seller can’t sell property at or above debt levels but negotiates a sale below debt level. This exit strategy is ideal for builders because they can get out from under a bad loan.

Pros: It’s actually a pretty good way out of a bad situation. “The builder or developer encourages a short sale because he gets off his guarantee [note from the bank],” Praw of Landstone Communities says. “It’s done because the bank thinks they’ll do better by putting it in a portfolio format [and selling it themselves].”

Cons: The main problem is convincing the bank to follow suit. To get past this issue, you must build a good case. “The lenders don’t have to go through a foreclosure process and also avoid paying insurance, taxes, utilities, and maintenance while waiting for a foreclosure sale,” McCabe says. “It has benefits for the lender, although they still wind up taking a haircut on the loan amount.”

Still, even if the lender can be convinced to go for a short sale, sellers may also face issues, particularly with taxes. Ward has seen cases in the home sales market where a lender will take $500,000 for an $800,000 home. Unfortunately, the IRS sees the $300,000 difference as a gain. “The IRS comes after him for the $300,000 because they think he made income,” Ward says.

What to Watch For: In Florida, McCabe says realtors are currently giving and attending classes on short sales—how to write the offer, present to the bank, and what to expect. That’s a clear indication that the option is getting more popular. “Earlier in the downturn, banks would take 60 to120 days to return an answer, which in most cases was no,” he says. “Now, they’re responding much faster to short sale offers—sometimes the same week—and are accepting many more of them.”

Buying Tips
Here’s how to position yourself to be ready when the dirt you want becomes available.

1) Know your bank. To position himself for land deals, Chris Ward, managing principal of Magnolia Florida, a Lake Mary, Fla.- based developer, tries to keep the lines of communication open with banks that may be putting land on the market.

2) Do little things. In addition to maintaining an open relationship with his banks, Ward will provide services to the banks such as offering to assess the value of their land portfolios.

3) Know the price. Over the past year, prices for land are less than half of what they once were in certain metros. Buyers need to know if prices will continue to fall before jumping in.