Home Builders Using “Writedowns” to Offset Market Woes
In accounting circles, it is known as the “big bath” when companies try to wash away as much bad news as possible with the hope that charges taken all at once will make their finances look better in the quarters to come.
That’s something the nation’s home builders could be up to lately.
With profits plunging due to a sharp drop in sales of new homes, many are taking big write downs in their land values and other assets because they are worth less than they paid for them, the Newark Star-Ledger reports.
Since they have much discretion over the size and timing of such charges, the builders could be calculating that taking big hits now while investors already know the housing market is tanking is a smart move.
Conditions in the market having deteriorated over the last 12 months. Home builders have seen a significant pullback in demand, surging cancellations, gains in inventory and pricing pressures that have led to massive discounting and incentives just to get deals done.
That’s quite a change from the not-so-distant past, when home builders — along with mortgage brokers, real estate agents and anyone else with ties to the housing industry - were riding a five-year boom.
The turn in the market has left most home builders with assets - including everything from already built homes to the land they bought to potentially build on - that aren’t going to generate the kind of cash-flow that had previously been expected.
When that happens, they have to test for impairments, meaning that they have to see whether the expected returns from a project are sufficient to cover their fixed costs. Should there be a deficiency, accounting rules dictate they must take a writedown on the assets.
KB Home announced December 8 it expects to take non-cash charges in its fiscal fourth quarter of between $235 million and $285 million to write down the value of its holdings and an additional $90 million related to its abandonment of certain land-option contracts.
The Los Angeles home builder said the charges reflect a challenging environment, which includes an oversupply of inventory, a decline in new home prices and an increase in sales incentives to generate orders.
Dallas-based D.R. Horton took a pre-tax charge of $199 million to write down the value of land, options to purchase additional land, and pre-acquisition costs. Luxury home builder Toll Brothers took a pre- tax writedown of $115 million, a big jump from the $1.4 million charge the company took in the same quarter last year.
Investors seem to be taking the big writedowns in stride. As with home mortgage company stocks, they’ve been buying up home building stocks in recent months. The S&P 500 Homebuilding index has risen nearly 21 percent since July, a turnaround from the 33 percent decline during the first seven months of the year.
That blind-eye approach has put some Wall Street analysts on edge, and they are warning investors the home builders might be taking them for a bit of a ride with their massive writedowns.
Home builders might see this as the right time for large writedowns. While market conditions are tough, they still have profits to show this year. Their earnings are likely to deteriorate more in 2007.