Professor Depew talked about the mothball strategy in Tuesday’s dose of Five Things. Following is my point by point synopsis of how and why it will fail.

The Wall Street Journal is reporting Home Builders Opt for Mothballing

As the glut of unsold home remains stubbornly high and housing demand slides, home builders face a dilemma: to sell, or not to sell?

Lennar Corp., for one, has joined the “not to sell” camp at its development in Orange County, Calif. The Miami company plans to finish building 259 homes — the first phase of a 1,100-unit development in Irvine — but it has decided not to sell any of them until the constrained mortgage market and swollen housing inventory improves.

My comment: This is a very dangerous strategy. Sitting on homes until “swollen housing inventory improves” is begging for trouble.

Is this what behind a huge 178.5 point increase in Lennar (LEN) credit default swaps since September 25? Only Standard Pacific (SPF) fared worse.

See Homebuilder Credit Default Swaps November Update for relative ordering of homebuilder bankruptcy probabilities.

“We are better off holding off on sales at this asset and not discounting as steeply as the market is discounting right now,” says Emile Haddad, Lennar’s chief investment officer, who oversees the company’s large West Coast projects.

My comment: I disagree and judging from credit default swaps so does the market.

“It doesn’t make sense for us to sell it in an environment that as strained as it is right now.”

My comment: It makes even less sense to build in an environment that as strained as it is right now.

Lennar Chief Executive Stuart Miller recently called some price cuts “unrealistic and maybe even ridiculous.”

My comment: What was unrealistic as well as ridiculous was the price Miller, Lennar, and all the homebuilders were willing to pay for land. Also ridiculous was the prices people were paying for Lennar homes.

“The market has just deteriorated more and more. We don’t want to go below a certain floor, and that is the floor of reasonableness,” Mr. Miller told analysts on a conference call in late September.

My comment: The ceiling of unreasonableness stretched almost to the moon. The floor is a long, long way down.

Lennar’s move in Orange County is unusual in that the company is mothballing homes. Builders typically mothball partially developed or undeveloped land because vacant homes require watching. One alternative would be for builders to sell their land instead, but that market is even more dismal than the one for housing. Recent land transactions in California, Phoenix and Southeast Florida, while few in number, have fetched discounts of 70% and 80% on finished lots, according to Zelman & Associates, an independent housing research firm.

My comment: Unusual is not the right word. Those land price discounts shows just how wrong the homebuilders were.

Lennar is now betting the company that housing will turn around in time for it to unload mothballed homes. I believe Lennar is wrong. My basis can be found in When Will Housing Bottom?

Luxury builder Toll Brothers Inc., based in Horsham, Pa., said last week that it is willing to hold prices, even if that means generating few sales. Mr. Sood says such a strategy amounts to the “effective mothballing” of certain developments.

Chief Executive Robert Toll said builders with cash problems may need to reduce prices more aggressively. “But fortunately, for the time being, that’s not us,” Mr. Toll told analysts on a conference call last week.

My comment: Those who keep building homes no one is buying in the belief they know better than the market are guaranteed to bleed their cash dry.

“Many builders are stuck between a rock and hard place,” says Jonathan Dienhart, director of published research at Hanley Wood Market Intelligence, a housing research firm in Costa Mesa, Calif. “They can’t make money by building, and they can’t make money by not building. They have to choose the lesser of two evils.”

My comment: This is interesting. There are only losing moves.

A spokesman for Lennar’s partner in the project, San Francisco-based Stockbridge Real Estate Fund, said, “We are under no pressure to sell strong assets into a weak market, especially where the market’s long-term prospects remain favorable.”

My Comment: Given that we are clearly headed into a consumer led recession, both the short and long term housing prospects are miserable. The mothball strategy is thus doomed to failure.

Mike Shedlock / Mish
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