| NEW YORK
NEW YORK Since the beginning of the U.S. housing downturn two years ago, builders have strived above all to slim down, selling off land and homes to buttress their balance sheets, even at the expense of profits.
Now that's changing. Lennar Corp, KB Home, Hovnanian Enterprises Inc, Meritage Homes Corp are buying and developing land again -- or at least talking about it -- and analysts have misgivings.
"No one should be buying land just yet," Raymond James analyst Buck Horne said. "They should be building cash until the full extent of the available land supply is revealed."
Investor confidence in builders has been waning. The group index is off 22 percent this year and 33 percent since May 16.
Land purchases now are just a fraction of what they were in the boom, when builders bought thousands of lots at a time. And builders still consider much of the land for sale too pricey.
"It's happening, it's starting to move, but it is starting to move slowly and it will take a long time," said analyst Jim Wilson of JMP Securities.
Lennar spent $162 million on new land in the second quarter and will spend at least $200 million more by the end of the fourth quarter, JP Morgan analyst Michael Rehaut wrote in a note to clients. KB expects to spend $300 million on land and $400 million on land development this year, Rehaut said.
Hovnanian is working on a land development joint venture, company spokesman Jeffrey O'Keefe said. And Meritage is "beginning to shift from defense to offense," looking to buy land in the second half of the year, wrote Wachovia analyst Carl Reichardt after meeting with Meritage management.
Land shortages in relatively healthy markets are spurring purchases, Morningstar analyst Eric Landry said, noting that Meritage, for one, is light on land in parts of California.
Some of the buying is a contractual obligation, said Horne at Raymond James. Lennar recently bought land from a joint venture partner, meaning it might have been executed according to a previous agreement at prices above current levels.
A new twist on land buying is private equity teaming up with builders, said Stephen Emery, a vice president at Mission Capital Advisors, which specializes in loan portfolio sales.
As the slump batters builders and homeowners alike, banks are moving to sell construction loan and mortgage portfolios backed by land that's losing value, but could be a tempting long-term investment.
"The majority of these deals are what we call 'loan-to-own,'" Emery said. "You're buying the loan to own the real estate."
At first, no buyers would bite because banks were pricing portfolios too high, aiming to minimize losses, Emery said.
But recently the bid-ask spread has narrowed sufficiently to entice private equity firms who can afford to buy now and profit when the market rebounds. Those firms are enlisting builders as partners for their industry expertise.
Mission Capital brokered its first portfolio sale to a home builder/private equity group partnership at the end of the first quarter, said Emery, who wouldn't disclose their names.
In theory, buying land now is a smart move, said Todd Lowenstein of HighMark Value Momentum Fund, which owns 187,000 shares of Pulte Homes Inc.
"You have to be a predator in these down markets to position yourself for the upturn," he said. "The problem is, people don't know the depth and duration of this cycle."
JMP's Wilson says builders should buy in areas that bottom first. "They will nibble around before the final bottom is here because the market doesn't bottom everywhere all at once."
Buying is happening in Arizona, California, Florida, and Nevada, Emery said. Buyers are betting the regions that led the housing slump and were hit hardest will recover first.
Furthermore, builders need some land to maintain their presence in key markets, JP Morgan's Rehaut said.
Yet buying remains risky as long as the slump lasts. Even new assets bought at attractive prices might lose value, Rehaut pointed out in regards to Lennar's and KB's land buys.
The bottom line is land purchases could compromise the very cash generation efforts companies touted as downturn survival strategies.
A 50 percent cut in land spending was key to their meeting cash generation goals in 2007, according to Rehaut. But many large builders will be spending in the range of $500 million to $1 billion on land this year, jeopardizing those goals.
"Net-net, we believe cash flow generation will remain flat or decline over the next 18 months, and hence reinforce investor concerns regarding this metric," Rehaut wrote.
(Editing by Braden Reddall)