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Thursday, July 20, 2006 9:50 AM

Ghost Housing Market

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Following is an update from Mike Morgan at Morgan Florida.
This entire post is from Morgan so I will skip my normal procedure of indenting.
It is about the "Ghost Market" in Florida.

Mike Morgan:

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. If they could only afford $1,250, they can now only afford $215,000 mortgage. That represents a 28% drop in affordability. Margins? Not with 28% affordability drops.

ARMS - Ouch. What more can you say. With a trillion dollars in debt a year coming due for refinancing, what’s going to happen to people when their mortgaged go up 40%? They’re going to put their homes on the market. The same market that is already flooded with inventory from flippers, builders and the normal sellers. The result will be more inventory and prices dropping further as sellers scramble to sell.

ATM - Add to the problems, all of those home owners that used their homes like ATM machines to buy cars, boats, skiddos and vacations. The counted on ever increasing home prices and low interest rates to keep them afloat. What do they do now? Put their homes on the market in hopes of cashing in and downsizing. More inventory!

Costs/Margins - Take a look at the main components in a home - copper, cement and lumber. Now look at how high these prices have skyrocketed during the last three years. Once again, ask yourself where the margins are.

Jobs - Now we’re getting to the heart of the problem moving forward. The housing boom has accounted for more jobs during the last few years, than any other sector. Think about this: real estate agents, builders’ sales agents, mortgage brokers, title companies, subcontractors, suppliers, vendors, attorneys, insurance agents, and the list goes on and on. We’re going to see a dramatic drop in jobs, an increase in unemployment and fewer people able to buy the homes that are flooding the market. By the way, as these people lose their jobs, they lose their homes! More inventory.

Foreign Investors - Here’s something we’ve heard about but could not verify until this last trip. Builders are targeting oversees investors. We visited a couple of developments that are targeting investors from South America and Puerto Rico. There are companies that put on road shows overseas targeting these investors. They require larger deposits, so the builders can pay the commissions up front. These sales teams don’t care about closings, since they get most, if not all, of their commissions up front. The builders get to book a sale, even if it doesn’t close a year from now. The angle used by these teams is that the flipper can either flip the home, or rent it out. I’ve got news for you. Drive through any of these communities and you’ll see dozens of For Sale and For Rent signs. These unwitting flippers can’t sell and they can’t rent. They have massive carrying costs and prices on the homes are dropping fast. Eventually, these homes go back to the banks.

“We Don’t Sell to Investors” - I wish I had a dollar for every time I’ve heard this line. We visited one national builder that proclaims they don’t want investors, but the sales agent told us they just sold a block of 30 town homes to one investor and another block of 8 to another investor.

“We Don’t Use Incentives” - Another line we’ve heard for the last six months. Incentives are rampant. We did not find a single builder that did not offer an incentive. And these incentives are getting larger and more creative. Some builders simply told us to make an offer! One national builder told us to make an offer, and then knock another $100,000 off of a $1.8M condo that has been on the market for more than a year, and originally had a price tag of $2.4M. How does this effect margins? What margins?

“We Don’t Build Spec Homes” - Yeah, right. On this trip we saw the worst of the worst. We saw entire developments under construction on spec. No buyers. “Make us an offer.” The logic the builders use for building spec homes is simple. Component prices or homes are going up, so if we don’t build now, it will cost us more a year from now. The problem with this logic is just as simple. If no one is going to buy these homes, the builders have two choices. One, slash prices. Two, carry the homes and pay the taxes, insurance and maintenance. Neither option is sound business. The other thing we hear from builders is this. “If we don’t build spec homes, we have nothing to sell, and our competitors will have inventory to sell.” Once again, bad logic. The builders would be better off with no inventory, versus inventory they will be forced to sell at a loss or carry at a loss. But the titans of the home building industry realize they need to produce numbers now, even if it means a lot of pain a year from now. Their only concern is near term so they can capitalize on their bonuses.

Our Economy - If all of this is not enough to drive the point home that the home building market is going to crush this economy, consider this. We are sending most of our manufacturing jobs to China. GM and Ford are near bankruptcy. We don’t even answer our own phones anymore with giant call centers in India. We hire nurses from all over the world and we even have an association called Visiting Nurse Association. Take a look at any of these new developments being built. Who do you see? Who’s cutting your lawn? The Florida orange juice association just announced that six million boxes of oranges are going to be left on the trees this year, because we don’t have the immigrant labor to pick the oranges. Many of those pickers are now building the homes for flippers. What kind of quality can we expect out of that? A recession is coming and lenders simply are not prepared for the defaults we are going to see. Banks are going to be flooded with REOs (Real Estate Owned) properties and that too is going to add to supply. It’s not pretty no matter how you look at it.

Mike Morgan, Broker-Owner, REALTOR®, J.D., GRI, e-PRO
Morgan Florida Real Estate Group

Mish Comments:

I have little to add to that update other than to be completely prepared for the consumer/housing led recession of 2007. It is coming.

Mike Shedlock / Mish

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