As a land subdivider, I know that a lot of single family home developers use rolling options on subdivisions, so they can develop in phases and treat each phase as if it was a separate build out.
For example, let’s say they want to take down a 150 lot subdivision with the first phase being 25 lots and the remaining phases the same (six phases of 25 lots each).
There are certain costs — fees, mass grading, architecture, engineering, improvement plans, etc. which represent an upfront load that may take two or three phases to recapture but the last three phases could work on a stand alone basis as they move through the buildout.
If the market tanks, the developer walks on the last few phases, the landowner retains the balance of the final map /subdivision with mass graded lots and attempts to resell them again to another developer, holds them until the market recovers or sometimes builds out the project himself (much lower land basis).
I have heard that several large builders (and condo converters) are letting go of their marginal deals that are under option and focusing only on deals that make sense in a softening market (those deals that were purchased a few years ago and still have plenty of upside).
I recently read that one large public builder in particular let go of several optioned projects across the country, at a cost of $ 5 Million in lost option consideration (just a cost of doing business).
By using options, builders minimize their exposure and reduce market risk and, as opposed to buying, also show no debt on their books (a big plus for a public company) while controlling a project as if they owned it. It also improves dramatically their Internal Rate of Return (IRR) because they have much less cash out at any one given time. So a difficult deal under a purchase scenario can pencil quite nicely on a rolling option scenario.
So, builders have other choices than to continue building out a losing project. Believe me, they have learned a lot during the last few housing recessions. These are large, well diversified and extremely successful companies that operate in many markets across the US. Many of them have been in business for several decades and are often passed from father to son. They’ve made it through past recessions and they will make it through this one too.
