JTS... to leave Castle Oaks

Here's an interesting little tidbit from the last few weeks that has seemingly not made it into any press yet. It appears that JTS Communities, Inc., the housing developer behind the current Castle Oaks development in Ione, is in the process of selling all of its Castle Oaks development to an investor. Assets would include the lots, unsold homes, and information center on the corner of Fairway and Castle Oaks drive.

As of now, JTS is aggressively marketing the remaining finished homes with a "Foreclosure Pricing" campaign and has also place the model home for sale.

The last estimate by the sales staff of JTS was a lot inventory of at least 10 years, up from an original estimate of 5-7 years back in 2005. Obviously the housing slowdown has severely impacted the amount of homes sold and thus the timeline of lot consumption, estimated to be 700+ lots.

It is not known if the sale of assets would include Amador County land outside of Castle Oaks that is part of the JTS land portfolio.

This is not the first time a developer for Castle Oaks has left the development. JTS is the second developer after the original developer filed for bankruptcy after building 215 single-family homes. The original 1989 development agreement called for 670 single-family and 360 multi-family homes.

Lennar (LEN) 2007 Q1 Profit Sharply Drops

Well, it was starting to happen and now it's prevalent: National Homebuilders have lower profits and see no home price stabilization in sight. From Marketwatch, Lennar reported first-quarter net earnings of $68.6 million, or 43 cents a share, for the three months ended Feb. 28, down 73% from the $258.1 million, or $1.58 a share, earned in the year-earlier quarter. Revenue overall dropped to $2.79 billion from $3.24 billion as revenue from home sales fell about 10% to $2.62 billion. Orders were down nearly 30%

In a maverick move and one in which I applaud, Lennar withdrew its previously (read Jan '07) stated target of topping 2006 numbers, and going as far as not issuing new guidance. I applaud this move because with the housing bubble bursting, instability of home prices, unknown land impairments, increased difficulty for buyers to qualify for loans, and increasing inventory, any homebuilder trying to issue numbers would be trying to pin down a moving target.

Home Builders' Cancellation Rates and Impairments

Part 2 - Land Impairments

The headlines that have gained some traction from the national home builders since Q4 2006 have been standing inventory, cancellation rates, and land impairments. Yet, the Philadelphia Housing Sector Index (^HGX) has been up 10% since mid-December, and this increase takes into account the 10% February drop for the index.

The market appears to place greater weight on the latest headlines declaring reduce inventory and lowered cancellation rate (even though I question how those number are presented) and lesser weight on the issue of land impairments. What exactly are land impairments? Periodically home builder must review the value of the raw land (among other things) held in inventory. Under accounting rules, when the value of the land has decrease at the time of the review, a land impairment must be entered as one-time non-cash expense against earnings. Well, many home builders were snapping up raw land at ever exorbitant rates in the last few years with the expectation the housing boom would continue for years to come. Unfortunately, the housing market has slumped and many home builders are sitting on land options that are not going to be exercised and raw land that has greatly decreased in value.

In Q4 2006, these were the land impairments and options write-downs reported by selected home builders:

Hovnanian Enterprises - $336M (12/2006)
Pulte Homes - $88M (2006 Q3)
Toll Bros - $60M (projected in 12/2006); revised range of $60M to $160M+ (2/2007)

It is this last example that has piqued my interest. The markets have treated these write downs as one-time charges and have not punished the stock. Given the continued housing slump, these write downs going to continue. What also worries me is the methodology in calculating these land impairments. Land options losses are relatively easy to calculate as the money used to purchase the options is lost.

So is there a standard in which the home builders use to value their land impairments? It's apples to oranges comparison but this reminds me of the accounting irregularities during the dot com era when companies would hold back reporting of revenue if the company knows they will meet the current quarter's earnings estimates. The held back revenue would be used in future quarters in case the company did not meet estimates.

Home builders could decide that since the current quarter is already "lost", they could apply more land impairments during that quarter. The thought is that if they're already going to miss earnings estimates by a significant amount, what's another few millions dollars recorded as a lost? If more is written off now, less can be written off later. Or conversely, if the home builder is close to meeting the newly lowered earnings estimates based on recent land impairments, why not report less land impairments now to meet estimates, and record the impairments in a future quarter?

It's appears to be a giant loophole home builders can exploit to manipulate their stock price, especially during earnings time.

Home Builders' Cancellation Rates and Impairments

Part 1 - Cancellation Rates

I'm going to pick on Robert Toll, CEO of Toll Brothers Inc, the luxury home builder. If you remember, Toll put on his swami hat late last year and called the housing market bottom to be in Q1 of 2007. Toll had to then eat his words a few weeks ago when the bottom was still not in sight.

Baghdad Bob Toll struck again during a March 7th webcast during a Citigroup-sponsored conference by saying "the company's cancellation rate has recently moved down to 16% from a peak of 36%."

Ok, great Bob! How about reporting the number of contracts signed during this same period? Those statistics by themselves tell us absolutely nothing. For academic giggles, let's make up some numbers that Bob has thoughtfully omitted. If Toll Brothers had 100 buyers under contract in the previous period and only 33 buyers under contract this period (based purely on the 67% drop in Q4 earnings), the number would shake out as such:

• Previous period > 100 buyers * (1 - 0.36) = 64 buyers
• This period > 33 buyers * (1 - 0.16) = ~28 buyers

The bottom line numbers are totally ignored when Bob only mentions the cancellation rates. How the mainstream media (MSM) doesn't call Bob out for his smoke and mirrors tactics is pathetic. I can't be the only person who questions these soundbites the MSM latches onto, can I?

Part 2 - Land Impairment Figures

...to be continued.