Strategic Asset Analysis & Capital Negotiation
CASE STUDY 4
A real estate development company with many holdings can often be caught in a market downturn where taking on short-term debt can appear to be a way in which to maintain viability until markets improve. But this scenario has often led to poor decision-making and has resulted in projects being foreclosed upon by its lenders. This sort of environment can invite questionable management practices that further complicate an already unsteady corporate scenario. However, the most recent real estate downturn, by far the most severe in our history, is not unique in the U.S. And although development ceases in these recessions, as recoveries emerge, success is a function of how well management interprets the quality of the decision-making that contributed to its losses. Development Management Group is highly experienced in analyzing “what went wrong” and how to pick up the pieces once market conditions improve.
This involvement was with a southern division of a large community development and home building company. The company had been developing and building in the region for over 25 years. At the time of DMG’s engagement, the division was developing six projects in various locations throughout the state. These ranged in size from 200 to over 2,000 acres and spanned market segments from low-cost, manufactured housing, to million dollar single family homes. Additionally, it owned and operated a hotel and an internationally renowned spa, numerous golf courses, centri di tennis, country clubs, and two shopping centers.
Much of the company’s early expansion had occurred in the past, financed through the issuance of high interest rate bonds. During this time, the division began to experience losses. This continued for years as the division’s existing management was unable to restore profitability. Eventually, this management group was replaced when a new chief executive was recruited.
This individual proceeded to replace the top several levels of existing management. This new management team instituted numerous highly questionable practices in the way in which the company did business, particularly in the selection and engagement of sub-contractors. Within approximately twelve months, the company’s board of directors concluded that this group’s involvement should cease. This was effected shortly thereafter, generating a highly publicized series of law suits, counter-suits and investigations.
Due to this situation, the company attempted to operate the division from its northern headquarters.
The company had incurred large amounts of high-cost debt which was now draining its cash resources. In addition to interest payments, sinking fund payments were now coming due on a regularly scheduled basis. Asset book values generally exceeded net realizable values, and all of the various operations were generating losses and absorbing cash.
The company’s lenders were expressing increasing concern over the company’s ongoing ability to meet its obligations. They were becoming far less flexible in responding to requests for loan modifications and for new loans for construction of new products.
As cash was generated, it was required to be used for debt reduction and, thus, was not available to support operating costs. The extremely tight cash flow conditions resulted in work stoppages by sub-contractors, often precluding the completion of contracted units. This, in turn, prevented the receipt of vitally needed cash from closings.
The company had been organized along functional lines in an entirely centralized fashion. This had produced a series of operational bottlenecks and a lack of any individual sense of profit and loss responsibility for any of the communities or projects. Each functional area pursued its own agenda, and very little communication between functions took place.
The company was subject to constant changes in direction. Products were introduced and stopped, or changed in mid-stream, causing significant cost overruns. Strategies implemented one week would be reversed the next.
Operating and production costs were excessive as the result of both prior practices and the confusion which existed throughout the organization. The organization itself had been decimated for the second time in less than 18 months. As investigations into wrong-doing continued, a type of paranoia and distrust developed among remaining staff. Moreover, staff uncertainty was increased by press releases indicating the company’s intention to dispose of most of its southern assets.
Sales in the division had steadily declined. In response, products that had succeeded in the northern division were being constructed in the south without any concern for differences in the market or in lifestyles. Lawsuits had been filed by property owners who were picketing at community entrances and at the main sales center of the division’s flagship community. This was generating extensive negative local television and newspaper coverage.
The objectives set for Development Management Group were: to attempt to turn around projects that might be salvageable so that the company could maintain a presence in the region; to dispose of as much of the remaining assets as possible in order to reduce the debt burden on the company; and to minimize the drain on the company’s resources during this process.
DMG restructured the division and reorganized and decentralized it into geographic regions with a regional vice president in charge of each. These individuals had profit and loss responsibility for all aspects of the day-to-day operations of the projects in their regions.
Regularly scheduled management and general staff meetings were held to increase communications and to inform employees of the company’s plans with respect to the division. Property owner meetings were commenced, and negotiations over differences conducted.
Market studies were initiated to identify potential opportunities and to assist in the determination of asset salvageability. New products, designed to be market-responsive, were developed in those instances where the investment seemed merited. Advertising, product presentation, public relations, and merchandising programs were completely revised and oriented to specific target market segments.
A program of orderly asset disposition was developed and implemented internationally. Its objective was to maximize the values to be obtained despite public perception of the deteriorated condition of the company.
Negotiations with lenders were conducted to restructure debt and to permit asset dispositions to contribute to operating cash flow in addition to retirement of debt.
In excess of $100 million in asset dispositions were accomplished at values which generated overall profits rather than the losses which had been anticipated. Additionally, as all of the transactions were for cash to the company, they produced significant cash flows in excess of the debt directly associated with the assets being sold, permitting additional debt reduction to take place.
As part of this disposition effort, the company was able to extricate itself from all resort and club operations, resulting in reductions in annual payroll of more than $10 million and annual operating losses in excess of $4 million.
Standing inventories were reduced substantially as retail unit sales were increased by more than 50%, and retail sales volume increased by more than 60%. This was accomplished with a simultaneous reduction in overhead and selling costs of more than 33%.
New products received excellent market acceptance, with one project achieving sales of one unit per day until sold out. In addition to being profitable, this project, in the $200,000 to $300,000 price range, also received a national merit award in the production category from Builder Magazine.
Ultimately, the then remaining assets of the company were exchanged in satisfaction of most of the debt.