The ripple effect of builder bankruptcies

A couple of weeks ago, the L.A. Land blog of the L.A. Times asked me to write a guest post in opposition to an article by Daniel Gross in Slate magazine. Gross had labeled the potential tax credit to builders -- which would allow them to extend the tax-loss carryback from two to five years for losses incurred in 2007 and 2008 -- as "peverse, absurd, and unwarranted."

But where I took special issue with his thesis was this idea: "Homebuilders should look to the capital markets first, rather than to the government, especially when their financial situation is serious but not critical. The stocks of potential beneficiaries of the expanded carrybacks—big homebuilders like Lennar, Pulte, and KB Home—have plummeted. But they're nowhere near bankrupt."

The problem is that Gross ONLY focuses on larger builders, and conveniently ignores the tens of thousands of smaller companies which simply don't enjoy that same access to capital.

So of course I hope he sees an interesting series of articles now posted at BuilderOnline.com, which focuses on the ripple effect of builder bankruptcies on suppliers, contractors and homebuyers. Perhaps it's easy for him to sit in an armchair and wave his index finger at perceived flakes and scofflaws, but I'm not sure it's that obvious:

Andrew Maletich says hedoesn’t trust builders anymore. His company, Bolingbroke, Ill.–based flooring contractor RiteWay Tile & Carpet, got stiffed for $120,000 when Burnside Construction went bankrupt a year ago. RiteWay is also one of seven companies on the unsecured creditors committee in the Neumann Homes Chapter 11 case and had $850,000 in mechanics’ liens filed against 80 to 90 of Neumann’s homes his company helped build.

As 2008 began, Maletich’s mistrust spilled into his relationships with other builders, two of which owed RiteWay $240,000 and $98,000, respectively. “They’re all in trouble, and they’re all on the same string with me,” meaning he will file a lien against any builder that doesn’t pay RiteWay within 75 days of its being billed. (In Illinois, contractors have 90 days to file a lien after submitting an invoice.)...

Neumann Homes had been struggling financially well before it filed for bankruptcy. “We knew they were having trouble [because] they weren’t paying their bills, which unfortunately was ­normal from year to year with them,” says Jim Hoffman, who owns J & E Nursery, a landscaping contractor in Libertyville, Ill., which had worked with Neumann since 1999 and was owed $45,818 when the builder went bankrupt.

Contractors filed a torrent of mechanics’ liens against Neumann’s properties in February 2007, according to Merritt Credit Bureau, a Chicago-based research firm that prepares ­mechanics’ lien notices and claims. (A mechanic’s lien is a lien on property that secures the payment of debts ­related to materials and labor. Construction on that property cannot continue until liens are resolved.) By the time it entered Chapter 11 eight months later, Neumann had $12 million in lien-­related claims to contend with (out of $151 million in secured claims), to say nothing of $134 million in unsecured claims, some of that owed to contractors, too. As of late January 2008, 75 companies in eight Chicago-area counties alone had filed 2,214 mechanics’ liens naming Neumann as first defendant, and another 130 where the builder is named second defendant...

The mechanics’ liens are complicated by the fact that several were filed against homes Neumann had sold prior to filing Chapter 11. Others were filed against unfinished or unsold homes on properties that five of Neumann’s eight bank lenders took back in exchange for debt relief. (In mid-March, for example, Neumann turned over six developments to Residential Funding, its largest lender, which agreed to reduce Neumann’s $90 million debt to $13.6 million.) The banks themselves must now resolve these lien obligations before construction can resume on those properties, if they decide to continue building on the land they took back...

Several of Neumann’s 22 communities were unfinished when it filed for Chapter 11. The builder was active in two subdivisions in Antioch, Ill., where about half of the proposed 1,400 homes had been completed and another 50 were under construction. Jim Keim, the village’s acting administrator, said in early February that infrastructure, such as street lighting, and amenities, such as clubhouses and pools, hadn’t been installed. Performance bonds ensure that this infrastructure gets built, said Keim, “and we’ve had talks with bond agencies about forcing the start of that construction by the spring.”...

Some of Neumann’s trade creditors told Builder they’d be willing to take on construction work or finish uncompleted homes, as well as any new homes the banks decide to place on the properties they’ve retrieved. Contractors are ­reluctant to turn down business in a bad market, but they are more careful about which builders they’ll work with. “What’s important is communication between our clients and ourselves,” says Steve Schwarz Jr., vice president of operations for Chicago-based SS Schwarz Construction, one of Neumann’s secured trade creditors. “What we’re saying to builders is that if someone sells a house, we’re ready to jump in and build it.”

But Hoffman thinks the “toughest question” contractors are asking themselves is, “When do you draw the line and tell a client you don’t want to work with them?” If market conditions don’t improve soon, the answer could become moot. “Even before Neumann, we’d recommend that contractors give customers a 60-day window,” says Cooney of Avenue Incorporated, who serves as outside counsel for other contractors. “That’s when I’d start sending letters demanding payment. Since Neumann, people are taking heed of that advice.”

Next, the fall-out for buyers:

The scene is all too familiar.Empty lots not maintained. Government foreclosure stickers and “for sale” signs litter the landscape. Potholes and partially paved roads offer visitors an uneasy entrée into this decade’s version of Paradise Lost.

This time it’s the Gardens at Stonebriar, an 80-unit subdivision in Memphis, Tenn., a housing development a mile or so down the road from many of the large warehouses that have made Memphis a major distribution center.

Memphis has had its share of housing debacles, such as when big builders Beazer and Levitt and Sons left the region last fall. That was about the same time that prominent local builder Matthews Brothers pulled up stakes at Stonebriar....

The residents say builder-owner Mark Matthews left them high and dry, with no one to address their warranty issues, pick up the garbage, or build out the community’s amenities. Many took on subprime loans and now can’t make the mortgage payments. While a different builder, Regency Homebuilders, plans to build out the rest of the project, many initial buyers are furious about what’s happened.

“Regency will be building out the Matthews Brothers models, but for $10,000 to $20,000 less and loaded with tile floors, granite countertops, and tall cabinets in the kitchen,” says Lamont Bethea, who paid $224,500 for his two-story, five-bedroom, 3,000-square-foot home when he and his ­family moved in during April 2006...

...almost all the residents have warranty issues, but many of them didn’t pester the builder the way they should have. Now that more than a year has passed for many homeowners, it’s unlikely that the warranty company, 2-10 Home Buyers Warranty, will honor any more claims... the problem many of the homeowners ran into was that as the home builder began to fail during the summer and into the fall of 2007, Matthews would refuse to go into arbitration on a warranty claim.

...unless the builder goes into arbitration, the home buyer cannot file a warranty claim. The alleged strategy essentially worked, as many of the homeowners are now long past the one-year warranty period.

And, finally, the smaller builders:

Jaguar Boulevard is a long,lonely testament to what has happened to the housing market in Southwest Florida. Miles from even a traffic light, it slices through the subtropical scrubland of the eastern edges of Lehigh Acres. Yet there are new houses here, dozens and dozens of them, many of them owned by residents who work—but can’t afford to live—in Naples, one county to the south...

For every neatly tended stucco ranch home, there are three or four that have been abandoned in some stage of construction. Some jobs got no further than the rough plumbing coming out of the ground before the money ran out and the builder walked away. Others are finished, sitting sadly on lots choked with weeds and strewn with trash.

This is the mess that builders in the market are dealing with and working against...

The impact on the builders who are still in the market has been painful and far-reaching. Aside from ­having to compete against thousands of foreclosures, short sales, and vacant spec houses, they are struggling to find subcontractors to complete the houses they do have under contract...

The situation turned particularly dark in February when a construction superintendent for a local builder was jailed. Local news reports said he pulled a gun on a subcontractor who had been stiffed for payment on a window installation and showed up on the jobsite to pull them out.

It’s also created a sizable—and understandable—skepticism on the part of prospective customers, who worry that the builder will shut down before their house is finished and leave them in the lurch.

Many builders, including Paul Homes, have added remodeling to their portfolio of services, often working with their ­previous buyers to upgrade their homes, hoping to hang on until the market ­improves. They’re also slashing prices on whatever spec houses they have left, trying to build up cash reserves to tide them over until the market starts to rebound.