Tuesday, August 01, 2006

Florida and Wall Street

We recently had two more of Wall Street's finest out on a tour of Florida real estate markets. After the first day, these guys needed diapers. They've been listening to the garbage from home building company management teams and what dribble they hear on the conference calls. I showed them reality, and it hit them like a ton of bricks. Here's a review of reality.

Inventory -- Our current levels are all time highs. We've never seen anything like this. If you want to believe the NAR numbers, so be it. In the previously hot markets, inventory levels are well beyond a year, and in some markets 2-4 years. You have hundreds of thousands of homes in the hands of flippers, not to mention all of the unsold inventory the builders are sitting on, and you still have the normal market of people selling for reasons like death, new job, etc..

Ghost Market -- Why so much inventory? The Ghost Market of so called "investors." These people were not investors. Maybe speculators, but even that is too kind. They were uninformed gamblers. For the last two years, you had better odds at the Big Six Wheel in Vegas. And the builders knew it. The builders saw buyers flipping contracts before closing a few years back. There response was to include a contract provision that you could not assign the contract, and you must close with the builder. They told the Street they were doing this to control investors. Well, that's pure nonsense. If they wanted to keep investors out, they could have demanded sworn affidavits. They could have put deed restrictions in regarding sale and rental of the home. But there logic was not to eliminate investors from the market, but rather to capitalize on them. So with assignments prohibited, the new wave of lemmings had to buy from the builders. And away we go! So now we have a market flooded with people that had no intention of living in the home. When, in the history of the world, have you seen millions of people buying multiple homes like a box of donuts? Like donuts, the value of these homes is dropping as they sit on the market.

Quality - Builders have been selling the vast majority of their homes to flippers. Flippers don't care about quality. Rarely does a flipper order a competent home inspection. Rarely does a flipper even do a walk through. They are only concerned with flipping the contract as soon as they close. The builders did not let this opportunity go unnoticed. They built lower and lower quality homes, often ignoring building codes. How? In many markets the pace of construction has outpaced the ability of the local authorities to inspect homes, so these markets allow the builder to hire their very own private inspectors. Now if you hired an inspector that flagged your homes, how long do you think you would keep that inspector? So the builders find inspectors that are willing to look the other way. Many of the homes on the market today do not meet building codes. We are seeing an escalation of defective roofs, defective trusses, defective stucco and the list goes on. We actually set up a website to help home buyers with information. I'd like to report on all of the home builders, but for now our site is focused on just one builder www.Lennar-Homes.info. We'll be adding new sites over the next few months.

Location - Once again, builders realized they could sell anything as long as they pegged it as "pre-construction." Building next to dumps, rail lines and depressed areas became the norm. Flippers never bothered to visit the sites. Let's look at Miami. Out of area flippers just hear two things. "Miami" and "pre-construction." Our trips through Miami reveal that many of the construction zones are in depressed areas full of crack houses, empty warehouses and worse. The flippers didn't care, and neither did the builders. But the "real" buyers that might live in these condos and homes care. And they are not going to buy these projects.

Cancellations - If you think the cancellation rate is less than 50%, I've got a bridge for sale. Flippers are dumb, but they are not going to wipe themselves out. If they bought a property for $500,000 and it is now selling for $400,000, why would they close? They will simply walk away from their contract, leaving the builder with more unsold inventory. Here's one example to drive this point home. An investor client of ours was recently released from his contract price of $490,000. The builder just resold it for $315,000. That's a "real life" example. That's a 36% haircut for the builder. Margins? There are none at these prices. P/E ratio low? How about no P/E ratios? One final note: The flippers have about 3% in closing costs with the builder. Then they have about 10% with the new buyer. So they need a 13% increase in price to break even. What would you do if prices have already fallen by 20%? Lose another 7% or walk away from the contract?

Affordability - Prices skyrocketed artificially because flippers did not care about price. They only cared about one thing . . . We're they getting pre-construction pricing? Now we have a flood of inventory on the market that buyers cannot afford. First time buyers generally need homes under $300,000. Even in previously hot markets like Port St. Lucie, we saw average home prices rise above $300,000 for pre-construction homes. And the high end market is not immune to this problem either. Buyers that purchase million dollar plus homes are far more astute then the first time buyer. The high end buyers read the Wall Street Journal and follow the numbers. They see the massive build up of inventory, and they all tell me the same thing. "We're looking, but we're going to wait till prices come down." And with that kind of logic, prices will continue to drop.

Interest Rates - Compounding the affordability problem are interest rates. A little over a year ago a buyer could secure a $300,000 mortgage for $1,250 a month (less if they used an ARM). Now the same buyer is looking at a $1,750 mortgage or $6,000 a year more in mortgage payments.


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