by Mike Morgan, J.D. of Morgan Florida Real Estate on 23 September 2007
” . . .we're in deep doodoo."
Robert Toll, CEO of Toll Brothers
Quote of the Week – Bob hit it on the head when talking about the Fed cut this week. And it really doesn’t matter what the Fed does at this point, because we are waist deep in doodoo. The only way out is through the doodoo, and it is going to get deeper and stinkier.
Market Conditions – I’ve received many phone calls and emails asking whether I prepared an Outlook last week. I did not because I have been on the road looking at communities and speaking with brokers, analysts, builders, etc. throughout the country. I am still on the road, so this week’s Outlook will be short and sweet. Strike that. Make it short and bitter. Very bitter.
I have decided to cut back on writing weekly updates. I might write one a month, but I might step back and not write publicly anymore. My clients are keeping me busy on specific projects, so I have little time to spend a full day putting together a weekly update for public consumption. Folks, we have reached a point in this cycle that is a surprise even to me. I will provide you with a brief recap.
When I first spoke about negative sales more than a year ago I was the butt of many jokes. I have the last laugh, and I am going to make it a full belly laugh. Analysts like Kim, Oppenheim, Whelan and Zelman refused to leave their plush offices and homes. They went on builder sponsored tours instead of ground zero tours in the trenches. They saw what they wanted to see. Many analysts had to balance banking relationships, and we know what that has led to. Now it
is very clear that most builders are experiencing negative sales in communities throughout the country. Negative sales are what you see when you have more cancellations than you have sales. But that is just one color of the nightmare I am going to paint . . . and have been painting for three years now.
The deterioration of the housing markets over the past six week has been devastating. I really don’t care what we hear on the conference calls this week, because I’m here to tell you from ground zero, it is much worse than anyone has discussed, and it is going to get far worse than any of the builders wants to admit.
Of the top five builders, maybe two will make it through this crash. But maybe just one. And here’s why.
Inventory – Nothing new here. These greedy pikers built more homes than the country needed . . . and they knew it. They were selling to anyone and everyone, even when they knew the buyers were not qualified and the buyers were lying on signed documents. The pikers sucked up bonuses in the hundreds of millions of dollars, all the while telling everyone that everything was fine. Now we have enough inventory for the builders
to totally stop building for 12-18 months. That’s what it would take to absorb the current inventory. We all know that’s not going to happen.
Prices – If you believe anyone telling you prices are stabilizing, or even showing signs of stabilizing, you are either on drugs or you have the IQ of a green mango. Prices are now in total free fall, with buyers and competing builders in complete control. The latter is more of the driving force in prices than buyers are now. Here’s a perfect example. We visited a Lennar community where prices for townhomes were
$215,000. But the sales person made it clear we should make an offer. In fact, he told us Lennar accepted an offer of $190,000 just a week ago. Lennar was willing to take a 10%+ haircut before we even saw the unit. But before you assume that is the negative to this story, read on. We left Lennar and drove to the front of the community where Prime Builders was developing a townhome section just outside the gated section where Lennar and Centex built.
Prices on Prime’s townhomes were in the $250,000 range . . . but Lennar’s townhomes were 2,200sf while Prime’s were in the 1,600sf range. So Lennar was willing to sell at $87 per square foot, while Prime is asking $156 per square foot. When I told the Prime sales agent that Lennar was selling at under $200,000, she winced and had a very interesting explanation to share with us. But the bottom line was clear. Builders are cutting each other’s
throats at this point of the cycle . . . and they have no choice. Darwin would tell you this is how the world works. We are going to see extinction with a lot of blood and guts.
The townhome example I just shared is not unique. I’ve seen and heard the same thing in other markets. In fact, I don’t think any markets are immune from the builder-on-builder fight to the death. We’re seeing builders slash prices and then before a buyer can even digest the price slash, the builder is throwing in incentives, additional price cuts . . . and telling you these prices are not real, because you can make an offer!
Psssttt . . . Don’t tell the builders, but not only are they competing with each other and the flippers they loaded up, but the banks are now a very, very, very reluctant competitor in the residential real estate market. Since banks are not in the business of owning, maintaining, renting and managing single family homes, they dump them. And I mean dump. More on this for my clients.
Sales – Ara has been filling your heads with “traffic” numbers. Sure, we saw traffic, but when I “ground-zero” this traffic, I get the real story. I’d say two thirds of the traffic is a false reading. Many of the folks I spoke with are neighbors that want a feel for what is happening to the price of homes in their back yards. Another segment of the traffic is people who have sipped the Kool-Aid. They think prices
have fallen far enough, and builders are making such great deals . . . that they can now afford a home. I have news for them, they can’t. Prices are still higher than five years ago and mortgage rates are not what they appear to be. Even with the 50bps cut, mortgages are tougher to get and with that comes higher rates for the folks that do qualify. Let’s face it, subprime deals and all of the creative financing we saw is gone. I’d say Ara’s
Deal of the Century will soon be known as Fake-Out of the Century, unless Hovnanian cuts prices further or buys down mortgages further. Personally, I don’t buy the numbers Hovnanian released. I was in the field during his Deal of the Century, and I didn’t see what his numbers portray. I challenge Ara and some of the others to spend a day in the field with me mystery shopping their communities and the communities of their competitors.
Here’s another problem with sales. Builders are actually killing the sales they already have on the books. As builders cut prices and pile on the incentives, folks that purchased homes a year ago are canceling contracts . . . or the builders are forced to honor the current slashed prices and increased discounts. Did I say a year ago? While that is true, even sales made 2-3 months ago are no moot. If you signed a contract two months ago with a $5,000 deposit,
and the builders have dropped prices $20,000, you do the math.
That means the sales we saw a year ago or even a few months ago with healthy margins, will actually be closed at low or no margins. From here on out, the majority of sales for all builders will be no and negative margins. Maybe I should color that a bit. Builders are telling you they are still at decent margins . . . exclusive of impairments. Think about that, but not too hard if you’re in the mango category. This one’s not that difficult. More on just
how bad this problem is for clients, including land and spec issues that compound the sales problems.
Who Survives – I’m not sure anymore. I thought I knew based on what I see at ground zero and the numbers in the models, but now I am turning over rocks and finding slimy, stinky stuff that is going to feed the slide to the sewer. There will be three groups of survivors.
Smart Guys – These are the guys that have managed and continue to manage down inventory, and are shutting down operations like a frog shuts down during the dry season. The faster these guys can get out of sight into the soft mud, the healthier they will be when the rains return. From what I see now, there are only a handful of these frogs out there right now.
Bullies – These guys have the arrogant attitude that they can build their competitors out of business. They may have Einstein IQs but there super-egos smush out any clear thinking of what is best for the company. These blockheads announced plans to build and compete aggressively on pricing. They thought they could continue building and dropping prices to force the competition out of business. Some of these knuckleheads still believe this. But
the bullies never left their comfy offices and the comfort of their boats, beach/mountain homes and vacations. They just didn’t get it. I’m not saying that sarcastically. These CEOs and other execs were (and are) so full of themselves, that they missed the heart of the problem, and instead of taking their foot off the gas pedal, they pushed it to the floor. They felt they could go through the wall with more speed. If they had bothered to take a ground
zero look before heading for the wall, they would have seen two things. The wall is not two feet thick. It is twenty-two feet thick and it is reinforced with rebar.
There might be one or two bullies that survive. They will not make it through the wall. They will come out the side, in pain, with broken bones and a big hurtin’ to their vain pride.
Crippled Fools – This will be the largest group. There are builders out there with no cohesive plan for sales, marketing, customer service or how to navigate the mines. They've grown too big and swallowed up the good and the bad. They now have severe indigestion and they are so fat and sloppy, they can barely move. It will be hit or miss for these fools, since they have not taken the time to sit down and formulate a plan.
There is a big difference between being “reactive” and “proactive.” The first two groups are being proactive, even if the brains of the bullies have the density and contents of a coconut. The crippled fools will come limping out of this two ways. If they lose a leg or two, they will come out with a partner or two who may have only lost and eye or an arm. The second group will come out, but will probably shrivel up and die.
Who and What to Buy – No one, yet. The big boys can’t buy any of the builders, since the Street has not priced in the reality of the twenty-two foot, reinforced wall. The big boys can’t buy the debt, because the debt is also overpriced. I’ve had several calls from deep pockets that want to step in with a checkbook. My advice is simple. Wait. Look, touch, smell, don’t taste, squeeze, poke . . .
giggle and wait. More specifics on who survives and who to watch for clients.
image above: aerial view of a plaza development by Ross Reality Investments in South Florida
Florida – I have been on the road in Florida since my return from New Jersey. Let me cut to the chase. Bad. Ugly. And getting worse. Much worse. I hope that is enough color, because if you don’t get it, you never will. If you are a Stephen Kim or Dan Oppenheim follower, and you think the bad is getting better, you need a good smack up the side of the head and a kick in the pants. And as Forrest would say, “And
that’s all I have to say about that.”
WCI – You’ve got to see Bal Harbour to believe it. The CO promised for the end of August is nowhere in sight. The building is still under construction. Prices continue to drop. I’m here to tell you this one doesn’t close this year and the can-rate is going to be ugly. I also hear the attorneys grumbling, so for the bankers expecting cash this year, think again. In fact, you guys might need a couple mangos,
a couple coconuts, some ice, and a bottle of vodka. Throw these in a blender and suck it up boys. If you’re on Oceanside too, you might want to go to the top of the building and open a window.
New Jersey – I visited the Mid-Atlantic this week to look at a few areas. Let’s start with the Jersey Shore and Asbury Park. I actually grew up on the Jersey Shore and attended Asbury Park High School. It’s the home of Bruce Springsteen and it was a jewel back in the 20’s. Just one hour from New York by train and with a mile of beautiful beaches, you’d think this area would have sprung back to
life.
Unfortunately, ever since 1969, Asbury Park has been on a slow and steady decline. The shops closed and moved to the regional malls. The old hotels of the 20’s became less and less attractive to summer vacationers. And the state started dumping mental health patients in the rooming houses and old hotels.
Johnny Cash and many others sunk money into projects to revitalize the beach district of Asbury Park. They all flopped. How can you expect buyers to return, when seedy hotels, boarded up buildings and worse, are just a block from the planned condos and hotels.
So a few years ago at the height of the housing bubble, a new group stepped in with big dreams and bigger promises. I drove past newly constructed town home projects that were totally empty. I drove past several mid-rise condos that are going up on Ocean Avenue, and right across the street it looks like a war zone with dilapidated buildings. The boardwalk has been repaired, but without the shops of the 60’s and 70’s, it is nothing more than a hang out
for bums and kids with nowhere else to go. It’s sad. Very sad.
For my clients, the photos speak for themselves. For the good folks reading this piece, I have included a photo of what the buyers of the condos are looking at, if they close and move in. I doubt anyone will move into some of these towers. And just like other projects in Asbury Park, they will either eventually be torn down or filled with welfare and displaced mental health tenants. Unfortunately, that’s just the way it is in Asbury Park. |
Whenever I return to the Jersey Shore, it’s great to see all of the great things happening. It’s sad, but never unexpected, to see failure after failure in Asbury Park.
At the other end of the State, we have Atlantic City. Several clients have asked me for information on what it looks like at ground zero and what’s ahead. It’s quite simple - Atlantic City has seen better days. AC saw better days in the 20’s just like Asbury Park. But AC got another shot in the arm with gambling. As many of you know, I was an executive with the Trump Organization in Atlantic City in the 90’s. Even then, if you walked one
block away from the casinos, you were in another world. One of desperation, cheap hookers, street vendors (drugs) and run down buildings. Not much has changed, and any hope of Atlantic City turning things around has disappeared. Gambling in Pennsylvania has already hit Atlantic City hard, and PA is just getting it together. I don’t expect any new casinos in Atlantic City, nor do I see the potential of any new investments that will help the industry or the
surrounding communities.
Blowing Smoke Article of the Week – The Wall Street Journal’s Mike Corkery does it again, as he touts the virtues of the return of Ivy Zelman. The title of his article is fitting, “Expert on Housing Has Her own Nest.” More on the nest in a moment. Corkery makes it sound as if Ivy led the way when it comes to the housing issues. Well . . . before you run out and plunk money down on Ivy, I can assure you she came to the party reluctantly and
very late. She also had a rather sloppy track record for quite a few years prior to leaving Credit Suisse.
Analysts like Ivy and the giant financial institutions these analysts worked for, may have played a larger role in the housing issues than one might think. While analysts were touting the virtures of the builders and bankers were putting together CDOs, SIVs and other packages, there were very few voices talking about the clouds forming. Personally, I can't seem to balance how the analysts refuse to paint the true picture, while the banking side continues to fund
the problem. And isn't it funny how Credit Suisse just put on a housing conference, providing the builders with a global forum to sing their song . . . without anyone to ask the hard questions.
As for the ground zero issues brewing over the last few years, Ivy tapped into me for quite a bit of information about the housing industry late in the game, but she never left the “nest” to come out and see ground zero. Ivy ran around on the guided tours offered by the builders, but that’s like asking a bank robber for a tour of the crime scene. With her team of cracker jack research analysts, she had massive amounts of data she could pump out.
But having rear-view mirror data, and not being able to marry it to what is coming down the road is a major problem.
Ivy was socked away in her “nest” with her three pre-school children, while her research team was in New York and the builders were building in Florida, California, Arizona, Nevada, etc. And as Quirky Corkery points out, she will continue to work from her home in Cleveland, while her team remains in New York. The problem is . . . there’s not much going on with housing in Cleveland or New York, and using your kids as an excuse for not being able
to get out in the field may have worked with Credit Suisse, but might not cut it in the real world.
Let’s forget about Ivy coming to the party late and failing to get out in the field at ground zero. Let’s look at the record. I asked Ivy why she didn’t come out and simply downgrade builders across the board. I asked why it seemed like she would downgrade one and upgrade another, and why she seemed to be almost neutral in her ratings. For those of you that know the game, her response will come as no surprise. Ivy told me she Credit Suisse required
her to maintain an overall rating on the builders and she couldn’t simply downgrade them across the board. Maybe banking relationships are more important that coming out with what’s really happening and what the real long term fall out will be.
Analysts that sit in their offices (or at home with the kids) and think they can provide relevant information, are kidding themselves and their clients. Ivy comes across great on conference calls and she pumps out a lot of information. She’s a tough cookie, and I was always a bit shocked at her truck driver language on the phone, but her rear view analysis was not much different from the rest of the group. Coming across tough and pumping out volumes of data
is not a replacement for field research and counter balancing what the builders tell you with what is happening – real-time in the real world.
Disclosure: Of the stocks referenced today, I have a short positions in Lennar and Toll Brothers positions.
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