Morgan Florida Real Estate Group
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March 11, 2007

Quote of the Week – I don’t think we need a full quote this week. This week we feature the word of the week – suck. Finally, a CEO that is not afraid to tell it like it is. You can drink Kool-Aid with Bob Toll, Dan Oppenheim and Stephen Kim, or you can belly up to the bar for a whiskey with Tomnitz.

Market Conditions – The Florida market increase in traffic during the last two weeks of February has come to a grinding halt. My conversations with buyers and other brokers attribute this to the negative press regarding the housing market, as well as growing concerns over the insurance and tax issues plaguing Florida. We see a further weakening in the Florida market as the selling season comes to a close. Our primary selling season is January, February and March, with snowbirds returning home to spend Easter in their other residences.

During the first 10 days of March we have seen an uncomfortable escalation of nervous sellers. Prices dropped significantly, and still there is no noticeable increase in buying. Simply put, too much inventory and not enough buyers. Basic Economics.

For the country in general we hear much of the same. The unusually warm winter season helped spike numbers in the Northern markets, but the South and West saw a gradually weakening market. Inventory is growing nationwide, as builders complete homes under construction, flippers walk from contracts, and traditional resales have slowed. I believe the unusually warm winter and mortgage tightening will cut into the Spring selling season numbers to some extent.

Other than inventory, financing is a black cloud plaguing the industry. The fed and banks have cracked down on lending practices, making it more difficult for buyers to qualify for mortgages. This results in a smaller pool of qualified buyers, and a pool that is qualified for homes at lower prices than a year or two ago. The result will be a continuation of inventory growth and price pressure.

Tomnitz said 2007 is going to suck. I am here to tell you that 2008 is not going to be a whole lot better, unless builders slow the building pace down to absorbable levels. It does not look that will happen until they feel a bit more pain.

Home Builders – I have nothing new to report on the bright side. They will continue to feel pressure on price and their inventories will continue to expand. More on the home builders in the Hovnanian call review below.

Mortgage Industry – No need to rehash the subprime issues. I advised clients a year ago that companies like NEW were going to implode. Despite news that this will not spillover, I’ve said for quite some time that the spillover will touch all lenders all the way up to the top, including companies like Wells Fargo, Washington Mutual, etc. MTG will be hard pressed to justify their numbers moving forward, as they will stand to bear the brunt of the spillover, as foreclosures surpass all current estimates. More on this in the Hovnanian review below.

Suppliers and Vendors – Even though these companies took somewhat of a hit during the last 6-8 months, it is hard to imagine they are immune to the spillover. We are already seeing permits and starts dropping, which will effect companies like SSD, EXP, BMHC, etc. For now, builders are still building backlog, and some of the more aggressive companies continue to build spec homes. But as the inventory grows, I expect permits and starts to crumble quickly. Even though there will be a delay in the spillover to the suppliers and vendors, they are going to see revenue and earnings slashed. They will feel it from both sides of the coin. First, they are already under pressure from companies to cut their costs. Lennar is a perfect example, asking for 20% cuts from subcontractors “on work already performed!” The second shoe will drop as starts fall and these companies are faced with less business and significantly lower margins.

Land – Even though Jack McCabe of McCabe Research was telling clients to start buying six months ago, he has a bit of mud on his face. We have not found any significant land deals where sellers are prepared to accept realistic prices. Even the national builders that come to us looking for buyers are still talking about unrealistic prices. Ara mentioned it on the HOV call, when he noted that sellers have yet to come down in price. We’ve looked at quite a few deals for clients, but have yet to find any seller that is ready to accept the inevitable. I expect to see land deals and deals on entire subdivisions in late 2007.

Hovnanian Call – I’ve always said the two most intelligent guys in the industry are Stuart Miller and Ara Hovnanian. I stand by that, although now the most honest guy is cleary Tomnitz.

The Friday call was full of tidbits, but little content for what is in the future, and how they are going to deal with the future. If we drove our cars only looking in the rear view mirror, we would not get very far. Most of the analysts asked the typical softball questions, and Stephen Kim actually got on four times. All of his questions were phrased to provide HOV with the opportunity to put forth a positive response, but nothing he said had any relevance or content. A perfect example was his last question. It was so confusing that Ara finally said, Uhhhhhhhh, I uhhhhhhhh guess that’s uhhhh correct, uhhhhhh. And then Larry confirmed with, Uhhhhhhh, I guess it could, but in this environment I would be cautious. All the usual villains were in attendance, but noticeably absent was my hero, Popeye with the punch, Ivy Zelman.

Most of the HOV call was spent talking about and deflecting to Ft. Myers. Enough already. It was the dumbest move I have seen in many years, with the one exception of Falcone’s deal with TOA. Ft. Myers was the most overpriced market full of flippers. Miami is the epicenter of the condo craze, but Ft. Myers was well known as the epicenter of the scattered lot, single family craze. Everyone knew that except the HOV team. Moreover, it was a scattered lot deal. Leave that stuff for the secondary builders. And you have to chuckle that one of Kim’s questions was asking for decimal places on the total number. Who cares whether it was $42M or $42.3 or $42.9 million? The bottom line is this. Ft. Myers was a perfect example of a national builder trying to play the flipper game. KB bailed out of this game earlier this year with a sale of it’s scattered lots to the infamous scattered lot, flipper builder Adams Homes.

Once again, we don’t need full quotes from this call, as the operative word here was IF. Ara said he sees stabilizing trends, but followed this with cautious optimism IF IF IF. The IF word was used to qualify all comments by Ara and Larry.

Points of interest include lower margins in backlog and projected deliveries, along with uncertainty about inventories. HOV is projecting a 15-20% drop in total deliveries. Unfortunately, this projection is made at a time when inventory levels are still growing. It is easy to see that this number will not be met as inventory pressure continues to increase. The 1% increase in traffic that Ara spoke about was nothing more than a blip. It was attributable to the warmest early winter on records, as well as a curious buyers that wanted to hear about the price drops, concessions and incentives. Bob Toll made similar reference to traffic, but I can assure you, as we say in the hospitality industry, lookers are not bookers. I’ve seen the same increase in lookers here in Florida, and I hear the same thing from brokers throughout the country.

The false positive in the traffic numbers has lead builders like HOV to make statements similar to Ara’s, when he said, “no longer a monsoon, but downgraded to scattered showers.” It is strange that he admitted we were in a monsoon, but he failed to talk about the devastation a monsoon leaves in its wake.

Ara did come clean on his optimistic views with the IF factors. He did not come out and say we are at the bottom, nor did he say things will return to 2004 or 2003 levels. He did say, he is optimistic things are stabilizing, BUT then we will remain in a pattern of absorption. Ara said we are not going to see a U or V patter recover. I agree. He said it will be more like the keel of a boat moving from the transom to the bow. But my question to him would have been, are we at the top, middle or bottom of the transom. I submit we are in the middle, with more to go till we even hit the waterline. Ara also analogized the cycle with a question about whether the boat was an 18 foot Whaler or a yacht. I can assure you this cycle is not an 18 foot Whaler. Just take a look at HOV’s 400% increase backlog from 2002 to 2006.

It was interesting to hear Ara finally talk about MLS listing numbers, and how they should be modeling these in the future. Duhhh? While that is a given, and it is almost unbelievable that builders ignored this number, it can be a misleading number for two key reasons. One, builders don’t put their inventory on the MLS. Two, many flippers have decided to rent and eat negative cash flow, but that inventory still must be sold eventually.

Consumer sentiment numbers came up on the call, with Ara relying on an improvement as a precursor of good things to come. I disagree. And Ara should as well. A little later in the call Ara admitted to shaving his employee count by 20%. Does he think he is the only one doing that? Then we have Larry’s comment that they have renegotiated savings of 5-8% from their vendors and subs, and Lennar demanding 20% cuts from their subs. The spillover effect will touch all areas of the economy from sales associates, to real estate agents, mortgage companies, title companies, subcontractors, vendors, architects, attorneys, insurance agents, newspaper ad revenue, marketing companies, etc. Just think about how many of the nation’s jobs were admittedly created in the construction industry during the last four years, and you have a major spillover with the end result of lower consumer sentiment numbers. So far, the biggest impact of the spillover has been on illegal immigrants. Once they are eliminated, the numbers will start to show up.

Larry noted that we must see inventory drop, even though he admitted their inventory grew by 2%. Unfortunately, inventory continues to rise. Builders have still not realized they sold most of their homes to flippers during the last two years. Moreover, we see builders still selling to investors, but now they are selling blocks of units. All they did was move their inventory from their sales offices to the flippers. The builders created their biggest group of competition. This is a group with weak hands that are unable to carry the inventory with negative cash flow. And that is exactly what we are seeing now. Price drops are stumbling over price drops. Sellers are becoming desperate, and we still have not seen the wave of foreclosures that will flood the market in Q3 and Q4. Personally, I have new clients coming to me that are now willing to sell at a loss . . . and they still cannot find buyers.

The IF word popped up again when Larry noted that he does not see any further impairments for 2007 . . . IF the market holds up. Then he noted that he would not be surprised to see additional impairments. Which is it Larry? And does HOV expect us to believe they only have three communities in MN and NJ that will be impaired? I’d need an entire jar of cod liver oil to swallow that one.

Dan Oppenheim asked about inventory concerns, and that is when we saw a bit of dancing and back pedaling. Ara finally said, it is probably not the time to open up the Champagne. Larry noted that the industry average of spec homes is 5.7 months, even though HOV was at 2.2 months. It doesn’t really matter if HOV is the only one cutting back inventory. One national builder has the objective of continuing to build in order to keep the marketing machine going and come out on top when other builders fail. I guess that’s similar to the retail industry when they carve each other’s hearts out with loss leaders that fail to generate overall profits.

To sum it up, with a quote from the most honest guy in the industry, all of 2007 is going to suck. Inventory, inventory, inventory. Economics 101.

2008 – There is no question in my mind that this cycle carries into 2008, as flipper inventory is unloaded at bargain basement prices, foreclosures are unloaded at bargain basement prices, and builders continue to build inventory that they will be forced to sell at bargain basement prices with NO margins if they want to sell anything. I think we will see the real color start to paint the picture beginning in early June as the Spring selling season fails to materialize in numbers or margins.

Mish's Blog: If you haven't been following Mike Shedlock on Global Economic Analysis, here is a link to his blog - http://globaleconomicanalysis.blogspot.com/ It is a great read on a macro level where Mish (Mike Shedlock) zooms in on micro issues as well.

Mike Morgan, J.D., CRS, GRI
Morgan Florida Real Estate
Morgan@MorganFlorida.org
772-260-5448

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