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Morgan Florida Real Estate Group
3830 NW Royal Oak Drive, Jensen Beach, FL 34957
772-260-5448 – FAX 866-677-8624
Morgan@MorganFlorida.org
List of All Outlook Reports - Click Here
“[c]lose to break even, and maybe losing a little bit right now. ”
Stuart Miller – Lennar Corporation
June 30, 2007
Quote of the Week – Stuart made this comment on the conference call this week in response to a question from Dan Oppenheim about margins. A year ago I warned that builders would face negative margins by the end of this year. A lot of people laughed. It’s not so funny now. With markets still softening and mortgages still rising, it is only a matter of time before we see this in hard numbers. On the KB call, they admitted that they also saw a deterioration of margins in the latter half of Q2.
Seattle Market – We keep hearing that Seattle and Manhattan are different. I was in Seattle this past week, and it’s different, but they are facing some of the same problems . . . too much inventory and a glut of condos and office space. Manhattan is different, but it is the financial capital of the world. Seattle has the tech industry and Boeing. Unfortunately, that’s not enough . The construction cranes dot the skyline of Seattle, reminding me of Miami on a smaller scale. For Lease signs and empty office buildings are everywhere. There is no need to concentrate on this market as it is not relevant to the public builders. The Seattle market does not have the expanse of land the public builders need to build communities. I wanted to provide some color, as this market pops up in articles and reports about the housing industry. Other than Manhattan, I can’t find a single major market that is immune to the inventory and flipper issues.
Market Conditions – Affordability is the key here. We are not seeing or hearing about an increase in buyers in Florida or nationally. The buyers that are kicking the tires are looking for deals and/or lower priced homes than we saw 18 months ago. Two factors here. One, the buyers have been educated by the media. And two, qualifying for a mortgage has become much tougher.
Here are some Florida numbers for May. Single family sales down 34%. Condo sales down 28%. Single family median sales price down 5%. Condo median sales price 4%. What’s interesting about these numbers, is that they are down so hard against year ago numbers that were already coming down from the prior year. The Port St. Lucie MSA for sales of single family homes, which includes Indian River, St. Lucie and Martin counties, was down 39%, with prices tumbling 9%. In the West Palm – Boca market we saw a 25% drop in sales but just a 1% drop in prices. Prices here are at the high end for the state. Prices have held up a bit better in this market because it is a built out market with a lower number of new communities during the last few years. The pressure here will be primarily concentrated in the West Palm and Singer Island condos.
WCI – If you haven’t seen the Icahn interview on CNBC Plus, you need to watch it. Icahn made a fool of himself when asked about WCI. And I mean a complete fool. He started boasting about how smart he was to short the builders, but he dodged the question about why he wants WCI. Then he started talking about the second part of a cycle where “sooner or later they will start throwing that stuff on the market.” Here he was talking about buying distressed value. He wants you to believe he saw a differential in the asset value and the price of WCI, but he still didn’t answer the WCI question. In fact, he told the interviewer that he was NOT telling people to rush out and buy WCI. Clearly, and I mean very clearly, he made a huge mistake, he didn’t do his due diligence . . . and there is no hidden value.
Other than the hit to the stock price, there is little new to report. Sales are simply not happening. At Bal Harbour, there were three new listings this week, bringing the total to 72 of the 184 units.
By the way, even though WCI closed out The Resort at Singer Island, here is an ominous number. There are 49 condos listed at The Resort at Singer Island out of the 305 total units. Many of the non-listed unit owners are counting on earning a return on their units through the Starwood program. We’ll see a huge spike up in the For Sale units after we run through the 2008 winter vacation season. Next March these folks will realize how much trouble they are in. Why is this important? WCI has already told us that they have sold units to buyers in multiple buildings. If these owners are underwater in Singer Island, they will certainly not be able to close on Oceanside, Bal Harbour or any other projects.
And one final note here. There are seven units at One Singer Island on the market out of the 14 WCI sold. They still have not been able to sell the 15th unit. The list prices on these units range from $2.5M to $6.5M. So when you hear that flippers were not in the high end market, I say hogwash. Bal Harbour will be a major hit to WCI.
Conference Calls – I did something a bit different this week. I listened to Lennar’s Q2 call from last year, and then this year’s Q2 call. Last year Lennar noted that there was a “reasonably mild overhang of inventory.” We now know the overhang is more like a really bad hangover. But you knew that a year ago if you were looking ahead, instead of listening to rear-view analysts that are often limited in just how negative they can be on a stock or a sector. When I asked one of the top analysts why he/she was not negative across the board, the answer was quite startling. I was told he/she could not downgrade all of the builders, as he/she had to maintain a balanced number of overall ratings.
A year ago Lennar talked about weakened demand, increase in cans and additional supply from investors. You could have listened to that segment of the 2006 call and never known it was 2006. It’s the same thing we are hearing now. A year ago we heard that margin erosion would follow through to future quarters. Well, a year ago gross margins were at 23.7%. Now they are at 13.6% but you must temper that with Stuart’s Quote of the Week . . . and we can see margins are close to zero or a “little” negative.
The only thing that stands out in the Lennar call from other calls is their Everything Included model. KB talked about offering 5,000 options, while Lennar discussed reducing options and eliminating design centers in all but 5% of their communities. Which one is right? Maybe both.
Everything Included will certainly bring down the cost of homes through bulk purchases of components. I believe Stuart said they offer just four types of faucets. That definitely gives Lennar buying power, but does it meet the demand of consumers? Buyers at the lower end of the market might be satisfied with just four choices, but buyers of higher priced homes want a wider choice. On the plus side, this provides Lennar with a distinct advantage in pricing homes with higher margins for a comparable home built by a competitor. In this market, the key is affordability and incentives. Lennar has the ability to offer both.
Right now Lennar is the only major builder concentrating on bringing down prices and increasing margins through component costs and vendor concessions. They’re creating their very own niche market and they will enjoy higher margins. The question is what happens when the current glut of inventory is absorbed.
To address the affordability and pricing issues, KB Homes is replacing 75% of their communities with lower priced product. I got a bit confused here, as the commentary was directed to simply building smaller homes. However, if KB has a 2,000 square foot home at $300,000 and Lennar has a 2,000 square foot home for $250,000, will the buyer really care that they only had four choices in faucets? Probably not.
What We Didn’t Hear – I didn’t hear much about future impairments. In fact, I didn’t hear much surprise about the size of current impairments. At Lennar, just 15% of the communities have been impaired, with 2/3 of this new AND 1/3 from previously impaired communities. At KB we didn’t hear much directly about impairments, but they did say they were buying land from banks that were stuck when builders either walked or were forced from land. That should be a huge signal to anyone that cares about future impairments. First, land prices are still coming down. Second, smaller builders are being forced to sell homes at highly competitive prices to stay alive. Land and sales prices down spells future impairments in my book. I don’t need rear view analysis of the numbers when I see horizontal development of new communities and little or no sales. I’m starting to see communities go horizontal, only to shut down sales offices and put the community on hold. This land is not appreciating. Moreover, this land is an expense to the builders for taxes, insurance on the improvements and debt.
What We Did Hear? - The builders are still building. Even flow production based on sales is misleading. If they are building a new home for every sale, how about cancellations that are running 25-40%? If you sell 10,000 homes and you have 3,000 cancellations, you really only have 7,000 homes sold. But if they are building 10,000, that means they are building 43% more inventory than they are selling. Stephen Kim started down this line of questioning when he asked about the can rate as a percent of backlog, but he didn’t get much color. It is a black and white issue, even though Stuart noted they have to give some thought to it.
The Numbers – One quick comment to follow through on my position that the reported numbers from NAR and the fed are not accurate. On the Lennar call, Stuart Miller noted that he was not sure existing home sales numbers were correctly reflected in national numbers. I’d take that a step further and say, I’m not sure the new homes numbers are correctly reflected in the national numbers either. But it’s good to hear one of the leaders in the industry commenting on something I have been talking about for quite some time.
New Home Sales – The Commerce Department reported a decline of 1.6 percent to an annual rate of 915,000 units, but they also reported a downwardly revised number for April of 930,000. And that was not a small revision. It was from 981,000 to 930,000. If we see a similar revision for May, we’re looking at 869,000.
Existing Home Sales – Another decline of 0.3 percent to an annual rate of 5.99 million, as well as a downwardly revised April number of 6.01. This represents a 15.26% drop from 2005 and a 10.3% drop from 2006. NAR also reported the supply is now at 8.9 months, and prices fell again. In Florida, we have markets with 30-50 month supplies of inventory. Even though these numbers are based on current sales levels, even if sales increase 100%, we still have markets here with 2+ year supplies of inventory . . . and you guessed it, these are the markets where the public builders are present.
Spillover – An interesting comment from the Joint Center for Housing Studies at Harvard. Housing accounts for about 23 percent of the U.S. economy, when taking into account purchases of furniture, appliances and items for new homes. All we need to do now is figure in the loss of the housing ATM machines and the loss of jobs for real estate agents, real estate attorneys, mortgage brokers, etc. That 23% number is probably closer to 40% when you look at the full picture . . . in color.
Legal Woes – We have not seen the tip of the iceberg here, from class actions and SEC investigations into the builders and their mortgage practices, to the defective homes issues.
Beazer - They fired their chief accounting officer for attempting to destroy documents related to the mortgage issues they are facing. Even though they released a statement saying he was fired because of the “in-house” probe, there is an SEC investigation and a class action lawsuit out there. They either conveniently forgot to mention those “probes” or Reid destroyed those documents. By the way, you generally don’t destroy documents unless you’re trying to hide something.
Lennar – The EPA visited Lennar built homes in South Carolina this week. But the bigger news is a visit from Erin Brockovich at the same time the EPA was in town. Erin was there representing her firm, Masry & Vitote. I was told there were two other prominent firms looking into the issues as well. The Charleston Post & Courier ran a piece on the visit, and the NBC affiliate ran a piece on the evening news.
Articles – There are two significant articles in the works on the legal issues facing the builders. We should see one late this week or early next week, and the second one the following week. I will email you links when the articles run. Both articles are being prepared by very prominent international publications.
In General – Here’s a nice summary from the Daily Business Review, which is the paper for South Florida attorneys - “With the expansion of the condo market, you’re getting all kinds of construction-related lawsuits and will continue to,” said Bruce Charles King, a shareholder at Carlton Fields in Miami. “There will continue to be more claims due to the sheer number of projects out there. I see 30 cranes from my window.”
Many South Florida projects, both residential and commercial, have been delayed or plagued with defects. The shortage of qualified construction workers is part of the problem.
“You have job superintendents now acting as construction managers,” said Michael Kreitzer, a partner at Bilzin Sumberg Baena Price & Axelrod in Miami. “They have never done that before. There simply isn’t the talent out there to handle these jobs. So there are delays, and the quality is not there.”
Bill McCormick, a partner at Ruden McCloskey in Fort Lauderdale, said his firm has gotten numerous calls from condo speculators who bought their units strictly to flip them, and are looking to find “interesting ways to get out of their contracts” as they near their closing dates. The most common reasons cited for trying to get out are construction delays and defects. Ruden, which only represents developers and contractors, turns away such clients.
McCormick said he has heard of speculators who are determined to get out of their contracts forming groups that pool their money to hire lawyers.
NOTE: The quote from Mr. Kreitzer – “the quality is not there” – is amusing, since he is one of the attorneys Lennar has hired to sue me for our public service website about the quality of these homes www.Defective-Homes.net He basically made my case in one sentence.
Subprime – The SEC has opened an “informal” investigation into the problems at the Bear Stearns funds. And on Tuesday, SEC chairman Christopher Cox told a House committee that the SEC has launched a dozen formal inquiries into "complex bundled financial products" linked to the subprime lending sector. As more of these portfolios are marked to market, we will see more exposure and lawsuits. The buyers of these pools and investors in these funds will be stoked along by the attorneys looking at fat class action settlements. It’s just a matter of time. And the collapse of this market is, without question, effecting Alt-A and prime. In turn, that means fewer qualified buyers at lower prices . . . and lower sales and margins for the builders.
Subprime Unravels – I’m still a bit amused that we haven’t seen a wholesale announcement of failures in this market. The latest fund to collapse was Caliber Global Investment Ltd., a London-listed fund that controlled almost $1 billion of mortgage assets. And the worst is yet to come. Just wait till the ARMs start resetting in bulk. Here’s an interesting email I received from someone with a friend in the business.
Subprime Unravels – (email received)
A friend of mine works as a Portfolio Manager for a $2.2B CDO pool of subprime loans. I spoke to him on Friday for an hour. Asked how he is doing, he says "nothing." I ask what do you mean nothing, I hear all these stories about CDO's and losses (Bear Stearns for example), he shrugs and says nothing will happen until the Rating agencies do something. Asked about losses, he says they are there but he doesn't have to mark to market his portfolio until someone discovers it or the Rating agencies force his hand. So his plan is to lie low and collect the management fees (and bonus) and pretend as if there are no losses. Asked about management fees, he laughs and says it's a low 50 bips. WOW! On $2.2B, that's a cool $10M yearly which he and his four colleagues have to split up at the end of the year. He says he has the best job in the world and says there is really no work to do every day. Just wait and hope that the rating agencies don't downgrade his CDO pool and voila, at the end of the year, he and his partners can split the $10M spoils (minus the expenses for one Park Avenue office, and a secretary). I am amazed that no body (regulators, investors, the public) has beseeched the Rating agencies to review all the Subprime CDO's by now given the headlines and the incredible losses hidden there. There is literally no one regulating these CDO's and hence it allows a neophyte finance guy like this idiot to pocket $2M in salary this year while his investors are facing certain losses (of about 20% at least since he told me he holds the riskiest tranches). This is a slap in the face of John Doe who is working hard on his daily job and will be happy with a $10K bonus.
Florida Condo Failures – A condo conversion company in South Florida filed for bankruptcy. I believe this is the largest bankruptcy case we’ve seen yet, but not the last. PUIG, a private condo conversion company has filed for bankruptcy protection involving nearly $120 million. And a Miami bank, Ocean Bank, filed a $50 million foreclosure action against developers of a Boca Raton condo project.
But this is just a sampling of what is to come. The Urban Land Institute and Miami law firm Bilzin Sumberg each hosted panel discussions on what to do when condo projects go bad. A Coral Gables law firm, hosted a ''Distressed Property'' happy hour recently. And a partner in one of Florida’s top firms noted that “the ball is just beginning to roll.” Bowman Brown of Shutts & Bowen also said, ``This is probably not going to be the only major bankruptcy in this area.''
Florida Insurance Problems – “This is scary,” said Bob Hartwig, senior economist at the Insurance Information Institute. “Citizens is the most overexposed insurer in the world.” He was speaking about Citizens, the state run insurance of last resort. The St. Petersburg Times reported that more than half of the insurable residential property in Florida will be with Citizens by the end of this year. That represents about $500 billion under Citizens.
A spokesman for Citizens recently commented, “We take the policies that nobody wants.” I’m here to tell you, there’s a reason nobody wants them. If, not strike that, when we see a repeat of 2004, Citizens will not be able to cope with the liability. This means floating a bond or increased taxes. One more startling statistic. 81% of the homes with Citizens are more than 20 years old. And 46% are more than 40 years old!
Wrap Up Quote - "As we look to our third quarter and the remainder of 2007, we continue to see weak, and perhaps deteriorating, market conditions. Given uncertain market conditions, we continue to lack visibility as to future results, but we currently expect to be in a loss position in our third quarter." Stuart Miller, Lennar Corporation.
Disclosure: Of the stocks referenced today, I have no positions but I am involved in two lawsuits with Lennar. I am the defendant.
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