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Supply and Absorption Timelines

One of the difficult things to do in the current land/land development market is to forecast when absorption of space (residential, industrial, commercial) will allow for development of new projects.  Land has been the biggest loser in the real estate recession, losing in some cases as much as 95% of its value.  Land is worth whatever the value of the asset that occupies it, less the cost to actually build the asset.  When asset values tank, it’s not the case that the costs to build the asset decrease by a like amount.  So in a land development project, the actual land itself is where the value comes out. 

We sold a project in the summer that consisted of 115 residential lots that had been improved to what you could call a “finished” state.  All of the streets, curbs, gutters, sewer, water had been installed in the project.  The cost of these improvements was probably in excess of $50,000.  We sold the lots for $8,000/lot.  The reason was that housing in that area had undergone severe price contraction.  For a builder to come in and build on the lots, they aren’t going to pay what it cost to improve them, they will pay whatever is left after estimating what they can sell a house for, the cost to build the house, and the cost of the carry for however long they might guess it will be before the market can absorb new product.

Trying to guess when the market might be able to absorb new product is a real act of witchcraft.  It’s simply too difficult to predict absorption in the market, especially when we don’t know the impact of any future unannounced government interventions.  Try being a homebuilder today and planning your finances for the next year without any idea as to whether or not there will be a homebuyer tax credit there to give the market some legs.

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October 21st, 2009 | Category: Housing Bust, Housing Recovery | 5 comments

Viewing 2 Comments

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    Is it possible to structure the deal in a way that gives both parties downside absorption protection? Take a slice out of the deal that will give the buyer a credit should the absorption take longer than reasonably expected or give the seller a credit should the absorption happen faster than expected?

    The risk would be putting the money into a sinking-type fund or hold it in escrow, along with getting both parties to agree on the terms, but if both sides share in the aborption risk (like a participation lease) it may be possible to get a few more deals done.
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    Interesting idea. Generally this is a tough structure to make work because it requires that the bank retain some interest in a deal that they just want to be out of. Also, from an institutional politics standpoint, it is very difficult to get bank REO managers to buy into this structure and then sell it up the chain of command to someone that can actually make a decision.

    But I agree that it is a way for the bank to put their money where their mouth is if they disagree with Buyer about market recovery timing.
 
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