Subdivision Absorption and DCF

[Jon Savage]

I have a subdivision assignment with 56 lots left out of 140. Absorption has been 2 home sales per quarter over the past year. I have 18 active home listings. At 2 per quarter, I have a 27 month, or 9 quarter supply. On my DCF should I show no lots sales for a period of time until existing inventory gets absorbed, or just go flat 2 lot sales per quarter to begin with, starting in quarter 1? Also, what have you been seeing as far as discount rates & ent. profit factors?

 

[Calvin the Airedale]

I have a subdivision assignment with 56 lots left out of 140. Absorption has been 2 home sales per quarter over the past year. I have 18 active home listings. At 2 per quarter, I have a 27 month, or 9 quarter supply. On my DCF should I show no lots sales for a period of time until existing inventory gets absorbed, or just go flat 2 lot sales per quarter to begin with, starting in quarter 1? Also, what have you been seeing as far as discount rates & ent. profit factors?

Going back 12 months, how were the 8 lot sales distributed? evenly at 2 per quarter, or more per the first quarter then less and less as the year wore on? Also what has absorption been like in the tracts with which this SD competes. What is the current inventory in those tracts? What shadow inventory might be lurking in the closet (ie. have builders given back many lots that have not yet hit the market?)

I won't venture any estimates as to the discount rate, but obviously, this a is market in which the only buyers are vulture investors or people that have not yet had their meds adjusted.

 

[Vernon Martin]

As for lot sales, I would assume no lot sales for the period of time it would take to deplete the inventory of unsold homes. There's no particular reason for a homebuilder to buy lots before then.

In today's markets, DCF models are rather speculative, though. If you can find bulk lot sales data, sales comparison would be the more reliable method.

 

[Howard Klahr]

In addition to previous comments, what is the inventory for similar lots within the subject market area? What percent of the market based on the inventory identified above does your subject represent? What makes you believe that the subject project will sell lots faster, slower or the same as the other competing projects?

All of this goes into your analysis to support your absorption conclusion as well.

 

[Terrel L. Shields]

If you can find bulk lot sales data, sales comparison would be the more reliable method.

I might use that to extract a market discount rate...You have to report a DCF for a federally regulated transaction. I would vet the transactions with lot sales.. Some argue that a lot is not "absorbed" until the house is built and sold to the end user (not to an investor).. Either way, you either have to predict a future spike in sales or estimate the existing sales from the last quarter of sales....If zero, you have an infinity problem...never absorbed.

EP? I would ignore that. It isn't "real". These are now losers big time. Calculate an IRR for the developer or your competing subdivisons for a discount.

A local Greenfield subdivision has sold 3 lots (only 2 houses) out of 60 in 2½ years...hmm. 50 years to sell out? They have to be hurting. $700,000 land; $900,000 for construction; $160,000 interest and holding costs.. negative value.

 

[Calvin the Airedale]

I might use that to extract a market discount rate...You have to report a DCF for a federally regulated transaction. I would vet the transactions with lot sales.. Some argue that a lot is not "absorbed" until the house is built and sold to the end user (not to an investor).. Either way, you either have to predict a future spike in sales or estimate the existing sales from the last quarter of sales....If zero, you have an infinity problem...never absorbed.

EP? I would ignore that. It isn't "real". These are now losers big time. Calculate an IRR for the developer or your competing subdivisons for a discount.

A local Greenfield subdivision has sold 3 lots (only 2 houses) out of 60 in 2½ years...hmm. 50 years to sell out? They have to be hurting. $700,000 land; $900,000 for construction; $160,000 interest and holding costs.. negative value.

For an answer to how long it might possibly take to absorb not just the inventory in this problem but the entire pool of vacant buildable tract lots, perhaps its time to reflect on an earlier day.

From 1924 through 1928, construction and development of tract housing proceeded at a fever pace. In 1929, the housing market softened but much vacant land was developed on spec. The stock market crash of '29 signaled the end of the stock bubble and it took several years to reach its depth. Housing too started to slide and hit its bottom in 1934(in greater Cleveland it fell 85% from the top of the market). Large swaths of Cleveland and its suburbs had new streets with few homes. While new home construction picked up slightly in 1939, most of these lots were not absorbed until the early 1950s. When one searches for comps in most of greater Cleveland, one finds that almost no homes were built between 1932 and 1939. Very few between 1939 and 1942. And again, almost none from 1942 through 1948.

While any lack of absorption suggests infinity, the above scenario (at 15+- years) is more likely the worst case. In some greater Cleveland suburbs, it took four to five years beyond 1985 to absorb all the lots that were in the pipeline when the builders were wiped out by high mortgage rates and recession in the early 1980s. So there are two perspectives, 5 years to 15 years. But hey, this doesn't factor in the new age of Obama and big government. I'm sure Geithner will have this situation turned around any minute. Bernake even tells us the recession could end this year.

 

[Terrel L. Shields]

8 acres with about 14 remaining lots in a "Greenfield" subdivision just sold in a forced sale by the Bankruptcy court. $20,000. Lot prices were $32,000 at one time. Whatzat? 4% of their retail value? And so the 'market' is anticipating say 20-30 years holding time?

 

[Howard Klahr]

And so the 'market' is anticipating say 20-30 years holding time?

What is the area inventory of residential lots? Historical and projected population growth rate. Yes, the market is likely anticipating a 20 - 30 year holding period. How does that economic principal go ... oh yeah supply and demand - the intersection reflects equilibrium pricing. Its funny how things work. Kind of like the laws of gravity.

 

[PropertyEconomics]

8 acres with about 14 remaining lots in a "Greenfield" subdivision just sold in a forced sale by the Bankruptcy court. $20,000. Lot prices were $32,000 at one time. Whatzat? 4% of their retail value? And so the 'market' is anticipating say 20-30 years holding time?

Id say the market is anticipating a time period shorter than 20 - 30 years, but has built in the additional risk of the holding period as well as a tremendous rate for return on equity should the market return in say 10 - 15 years for these properties.

The best way to know the answer is to interview the purchaser and find out what they were thinking.

 

[Terrel L. Shields]

What is the area inventory of residential lots?

We have a 11 year inventory of residential lots "as is"...and since construction is dropping daily, that inventory is increasingly longer...This subdivision is a "greenfield" subdivision, 15 miles from town. Those subdivisions have been completely paralyzed for 2 years...zero sales in most of them. Some (actually many) are 90% complete, have tax liens against them, builders are in bankruptcy, banks don't want to touch them, etc.