Have many homebuilders and residential developers signed their own DNRs?

My uncle, who is 101 years old, was admitted to the hospital with pneumonia last week.  Although he is as sharp as ever, he has been experiencing some medical “issues” for the past few years and after preliminary tests the doctors decided that there were indications of a possible malfunction in his heart.  They requested his permission to do another test which, due to his age, bears some risk.  He agreed to the test but to the surprise of his doctors declined to sign a DNR (Do Not Resuscitate order).  The last of his six grandchildren is getting married later this month and his first great-grandchild is celebrating his Bar Mitzvah the following month and he has every intention of attending both functions.  I am certain that I will be seeing him at both the wedding and the Bar Mitzvah as my uncle is a fighter and does not know the meaning of giving up. 

My uncle used to be a homebuilder in the Chicago area and gave me my first job in the business.  He was my role model in the industry, an intelligent entrepreneur who took the time to understand his market and provide what was required to satisfy the indicated demand.  The standard new home in the inner city at that time was a three bedroom/two bath tri-level, designed to fit the prevailing narrow urban homesites. In fact my family lived in one of his homes.  But when every other builder was selling the almost identical product, my uncle re-subdivided some of his homesites and had a new plan designed, a two story home that effectively maximized the living space available, creating what is now the popular “big box” design, but which he brought to market well over 50 years ago.  The new plan doubled his sales.    

In one economic downturn several decades ago, mortgage financing required high downpayments and was difficult to obtain so instead of just accepting reduced sales, my uncle arranged for a pool of private investors to provide second mortgages for his buyers and created far more attractive financing terms than the competition could provide.  He had again analyzed his market and implemented an appropriate plan to solve their needs and provide his company with a competitive advantage.  My father served as my uncle’s attorney, making certain that everything was done “by the book” and that my uncle was fully protected at all times.  Under their second mortgage program, they also made certain that the buyers were fully qualified for the purchases and that their investors were also protected and not a single default occurred.  This concept was “rediscovered” a few years ago but unfortunately without the necessary care and safeguards and became known as the sub-prime fiasco.

Although the current housing downturn is arguably more severe than in previous cycles and has its own special and even unique circumstances, my background in the industry has made me somewhat less sympathetic towards homebuilders and developers who encounter difficulties and then just “give up”, effectively signing their own DNRs.

I observed with sadness as a homebuilding company that I have been watching for several years went out of business this summer. Their lender called their A&D loan, even though the interest payments were current, the community was continuing to sell (at the time they had eight firm sales on which they had not even started construction) and the property had little value except as an ongoing homebuilding operation.  The principles agreed to a “friendly” dissolution of the business as they were unsuccessful in their search to obtain replacement financing and they had signed personally for the financing.  As they had not created any asset preservation programs, they had no power in the negotiation with the lender and had no choice but to accept failure even though a continuation of their operation would have been far more profitable to all the parties involved. 

I was in New York last week at the NAHB fall board meetings and had the opportunity to visit with a homebuilder from a Midwestern city.  As he explained his market position I saw a similar situation just waiting to occur.  This builder had again signed personally for all construction financing and had similarly failed to do proper personal financial planning.  With a continuation of his current rate of sales, his operation would only generate sufficient cash to last for the next twenty months and his attitude was that he “had tried everything and was just going to wait it out”.

The builder had lowered the prices on his standing inventory but the buyers had not responded.  I was familiar with this market and suggested that if he had performed a proper competitive analysis it would have showed that his homes were still overpriced. Speculative homes are not like wine and cheese, they do not improve with age, and adjusting pricing insufficiently not only did not create sales but it used up the potential sales momentum that could have been created if the pricing was correct initially.  Now he will have to mark these homes to market, with reductions probably greater than would have initially been required, and also spend additional marketing dollars to get the message out to the public and the brokerage community to restart the community’s momentum.  I suggested that he present this liquidation in as positive a light as possible, perhaps calling it the “2010 Grand Closeout Sale”.  Moving forward, I suggested that he should design new, exciting, smaller, more cost-efficient and affordable homes for his remaining sites, perhaps calling these new homes the “2011 Collection”, and introduce them to the market immediately with a pre-sale campaign, taking advantage of the traffic that would be generated by his simultaneous closeout sale.

That evening my wife and I were standing outside a theater during intermission and I noticed a young man wearing a tee shirt that I initially found both pithy and funny –  it read “Broke is the new black”.    As I thought more about the message on that shirt, however, I decided it really was a sad commentary on society and on the residential industry today.  While the economy may still be struggling and homebuilding may well have several more challenging months before a recovery is visible, we do not have to accept that being broke is the only possibility and we need to do everything possible to get ourselves off life support so that the DNR order is not a factor.  Broke may be a common factor today but we do not wish to join their ranks.  

We need to realistically examine and analyze every development and every homebuilding operation based on thorough market research to create a strategy to maximize sales, values and profits from this point forward.  We need to get our lenders on board with the program, proactively reaching out to them and proving that our proper and well documented course of action will maximize the values of “our” assets.  We need to liquidate undesirable inventory and create new homes that address the needs and wants of the markets that are viable today.  We need to intelligently, creatively, effectively and thoroughly market our homes and our communities to consumers and brokers and professionally sell those products.  And we need to plan for the future by protecting and preserving our assets so that if needed in the future we have adequate leverage in our negotiations.  But that’s just my opinion (although my clients who are implementing these programs would agree).

Please visit our company’s website at www.levitanassociates.net. to learn more about our background, qualifications and services to the homebuilding industry and how we can assist homebuilders, developers and lenders achieve success.

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One thought on “Have many homebuilders and residential developers signed their own DNRs?

  1. Dan –
    I truly loved this post. Thanks for sharing your personal and family background and giving us a frame of reference for your advice as well as your always “right on the money” tips for success.

    Nikki

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