Builders face a desert reckoning

Source: The Wall Street Journal

Some of the nation's largest home builders might be forced to buy hundreds of acres of desert 10 miles from the Las Vegas Strip at boom-era prices as part of a legal battle with a group of banks led by J.P. Morgan Chase & Co.

If a judge rules in favor of the banks over builders such as KB Home and Toll Brothers Inc., it could cast a shadow over a popular but controversial form of off-balance-sheet accounting used when buying land. The strategy is used by builders to insulate themselves from debt and other obligations.

The development, called Inspirada, is another housing-crisis casualty in Nevada, one of the hardest-hit U.S. states. Just 635 homes out of the planned 14,500 were sold before financial problems and fighting erupted.

When a venture formed by the home builders bought the land in 2004, the companies thought their liability was limited to $370 million, in return for 2,000 acres where they envisioned a sprawling $1.5 billion planned community.

The J.P. Morgan-led group, which lent the builders $585 million, now says the home builders are on the hook to buy hundreds of millions of dollars in raw land and develop it as they agreed to when the deal was struck. That would repay the lenders, and buyers of homes in Inspirada would get more of the infrastructure promised by developers.

Builders contend they shouldn't be forced to buy the land because the agreements were made with a separate entity named South Edge LLC, not the banks.

Last month, the banks moved to force the Inspirada venture into involuntary bankruptcy proceedings. If the effort succeeds, the banks expect a bankruptcy judge to appoint a trustee that would force the builders to buy the land.

The banks believe they are in a strong position because of a confidential arbitration panel ruling in July in a related lawsuit brought by one of the group's smaller members, Las Vegas developer Focus South, against the others. In that decision, recently made public, the panel found that the builders breached their agreement to buy the land. The builders are appealing.

"The lenders have made every possible attempt to resolve this consensually with the builders," said a J.P. Morgan spokeswoman. "The involuntary filing was a last resort needed to protect the property."

A KB spokesman said the company is "disappointed" that J.P. Morgan decided to "pursue a bad-faith legal maneuver, rather than continue to work with the builders who are endeavoring to find a resolution."

Toll Brothers Chairman Robert Toll said the legal action is without merit. "It's like the rest of Vegas. It didn't go as it should, but the question is: Who should take the loss?" said Mr. Toll.

Builders did hundreds of off-balance-sheet deals during the boom for land valued at billions of dollars, because the deals enabled companies to secure large parcels without putting much debt on their balance sheets.

Such ventures have been criticized because they lack transparency and sometimes haven't let investors know the extent of the risk the company is assuming.

"People felt like [joint ventures] were a black box…and that included who, in the end, would be responsible for the debt," said Robert Curran, an analyst with Fitch Ratings.

In 2008, Florida home builder Tousa Inc. filed for bankruptcy protection after defaulting on a $500 million loan related to a joint venture formed to buy land assets of another home builder. Tousa believed it was insulated from that debt, but was forced to take much of it onto its books.

Since the recession hit, most builders have purchased land directly because it has fallen in value. Many of their former joint-venture partners also have gone out of business. Still, housing analysts expect joint ventures eventually to regain momentum.

Lennar Corp., the nation's third-largest home builder by number of homes sold behind D.R. Horton Inc. and PulteGroup Inc., was the industry's most aggressive user of the tool. Ventures including Lennar had $5.6 billion of debt outstanding in 2007. KB Home, which owns 48% of the Inspirada deal, was involved in ventures with as much as $1.72 billion in debt.

In most ventures, the builder would own less than 50% so that the risk in the venture could be kept off the builder's balance sheet under accounting rules. Builders typically reported only in footnotes of their regulatory filings the amount of recourse debt they were on the hook for in case of default.

Most builders escaped losses by selling off land assets or walking away from the deals made with nonrecourse debt. In other cases, they negotiated with banks to get out of agreements to buy land. Lennar and KB have reduced the debt exposure of their ventures to $1.7 billion and $374 million, respectively.

At Inspirada, $370 million of the $585 million borrowed from the J.P. Morgan-led group is recourse debt, meaning the builders are required to repay that portion of the loan no matter what happens.

The banks claim their deal requires the builders to buy land from South Edge for more than $500,000 an acre, or nearly twice its current value. In a mediation session in San Francisco in April, the builders offered to buy the land at 50% to 60% of their 2004 offer, according to a person briefed about the meeting.

J.P. Morgan rejected the offer, the person said. A bankruptcy court in Nevada has scheduled hearings on the involuntary petition for this month.

URL to original article: http://www.housingwire.com/2011/01/05/builders-face-a-desert-reckoning