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Real Estate and Housing Industry Outlook
July 22, 2007
Morgan@MorganFlorida.org

Prior Weeks Outlook Reports - Click Here

“I do not view this as a Bear Stearns problem,
but a systematic one. This opens investors to sizable losses
which, at this moment, simply cannot be calculated . . ."
Dick Bove, Analyst with Punk Ziegel

Quote of the Week – Mr. Bove’s comments were in response to the meltdown of two of Bear Stearns credit funds. His fear factor reached a peak when he advised selling the brokers at once. As I have noted for several weeks, no one knows the extent of the meltdown, and by the time these funds realize the true value of their portfolios (or admit the true value). . . its too late.

Hard Landing Quote – Bernanke finally admitted a hard landing in the housing market is a risk. During this week’s Q&A after his testimony, he was asked if there was a risk of a “hard fall” in housing. He responded that it remains a risk. Then he added, “we have an inventory problem.” Talk about rear-view mirror guidance. Bernanke also commented that our housing problems “could spread to other parts of the economy.” Let’s face it, the key word here is not “could” but WILL. Unfortunately, there is nothing the Fed can do at this point, and as long as the builders keep building inventory . . . the problems get worse.

Spillover Quote of the Week – “. . . U.S. housing slump that looks to be significantly deeper and longer than we or most others thought even six months ago . . ." Gregory Hayes, vice president of accounting and control at United Technologies. Mr. Hayes joins the growing list of executives finally starting to acknowledge the housing market is in for tough times. Spillover will eventually catch up to our economic growth. It is hard to imagine we are not in for a very serious recession, when you look at housing, the dollar, metals, oil and corn. Corn? Yeah. The farmers love it, as the market buys up as much corn as they can get for expensive (subsidized) ethanol, but it’s having an effect on everything from your Wheaties and milk, to the steak on the grill. I hate to use the Perfect Storm analogy, but it is the best fit for what lies ahead
.
Downgrades – No longer is this an area limited to builders, even though we’ve yet to see any serious downgrades in the housing sector. This week we saw downgrades of the brokerage firms and the country’s largest banks.

Warren Buffet and Hovnanian – I noted when the rumor hit that it was unlikely Buffet was in anyway interested in Hovnanian. Since the rumor there has been no new news. In fact, HOV closed at 16.43 on Friday, below the 18.53 close the day the rumor hit. HOV, just like all of the other builders, will be announcing further impairments, as well as negative margins moving forward. No need to bottom fish now, when the bottom is still months away.

Bottom Fishing – There are two areas of bottom fishing in the housing markets. One, where do you buy the builders. I’m not an analyst, so I try to refrain from commenting on stock prices. My commentary and information is from ground zero looking at what is actually happening in the housing markets. And from what I see, the builders have failed to properly impair their land and communities. So there is still a lot of bad news coming. Whether that means the stock prices of these companies continues to drop is anyone’s guess. I remember some of the comments of hedge fund managers on my real estate tours last year. When I asked them why they still owned the builders, they said they were going to hold their positions because the market will correct and the stocks will rebound. Since then, stock prices of builders has fallen 30-50%, so you’ve got to wonder if they are still holding like the guys getting caught in the subprime mess. Then again, at some point, the buyers for these stocks will step up to the plate, believing the bad news is behind us. But we’re not there yet.
The second area of bottom fishing is when to start buying real estate. Not yet. I’m still looking at properties for clients, but sellers are not desperate enough yet. They will be. I believe condos in Miami will sell for as little 30 cents on the dollar of original sales prices. For the financial institutions hiding behind a 65% loan cushion, they are in for a rude awakening. But that’s the extreme. In other markets prices are still under pressure for individual units and entire projects. While I am seeing a few deals being made, I believe the buyers are premature. Just like Icahn tried to call it with WCI, the buyers of towers and office buildings have not taken into consideration the severity of what’s ahead. There is a trickle of blood in the streets. Just a trickle.

WCI and Icahn – The light at the end of the tunnel for WCI appears to be the freight train. Friday the stock traded about 3.5 times average volume with a 6% drop in price, trading below 14 before recovering a bit. Far cry from Icahn’s $22. Obviously, the guys stuck in this stock are starting to unwind. I will be making a trip to several WCI properties this week. Bal Harbour is key to the survival of WCI, and it is hardly likely this will work out. There were eight new listings from Bal Harbour this week, and one real estate broker’s website shows 109 listings. Still no pending sales for the flippers, and prices are still falling. If there are no buyers for these flippers, and prices continue to drop below initial sales price, you can expect a very high default rate.
I received a few more calls from folks still looking at WCI for the pieces and for the entire company. But how do you justify almost $2 billion in debt? You can’t. As for buying the pieces, I doubt WCI can carve off assets at this point. It’s only a matter of time before the debt holders cut the strings and demand accountability.

Market Conditions – Last week I reported that weekly reporting of market conditions is becoming less significant. However, this past week I noticed a spike in Internet traffic related to searches for homes, and an increase in the number of inquiries I received. I am hearing the same thing from other brokers and agents. Most of the inquiries were for homes under $300,000, and these were renters that want to own. Unfortunately, affordability is still a problem, and renting still makes more sense than owning. With the huge overhang of inventory, there are tremendous opportunities for renters. Flippers that can’t sell are still dropping rental prices in hopes of generating some revenue from their properties. But here’s the catch. Rents do not cover carrying costs. In most cases rents do not even cover mortgage payments for the flippers. Now add in taxes, insurance and maintenance. Worse yet, at the end of the rental period they have the additional cost of repairs. For a growing number of flippers, nonpayment of rents and costly evictions are also in the cards. Simply put, in the hot markets, we are seeing a total collapse of both the rental and sales markets. Orlando is a perfect example with a vacancy rate north of 5%. It wasn’t too long ago that the experts were talking about a tight rental market. I have no clue what market they were looking at.

Inventory – Still growing, but I am seeing more sales offices closing and deposits being returned. For the most part, it is the non-public builders that are shutting down. It is still mind boggling that the public builders continue to build. As Bernanke finally admitted, we have an inventory problem.

Impairments – Pulte is going to take $740-770 million in impairments. Not enough, even though it represents an after-tax hit to book value of 8%. The pain will not end until builders impair up to 70% (or more) of their communities . . . and at numbers that represent what is truly going on at ground zero. You can’t sit in an office and read reports in this market. By the time you read the report, the market has taken another notch out of margins. Strike that. There are no margins in most communities . . . and that’ why “real” impairments are critical to putting the paper side of the housing disaster behind us. For those builders hoping things were going to stabilize or get better . . . all hope is lost for the next 12 months.

Mortgage Numbers Disconnect – For the last couple of years, it has become painfully clear that the numbers we are being fed from the National Association of Realtors (NAR), the Fed and the Mortgage Bankers Association (MBA) are misleading, at best. This week Bloomberg News came out with a piece suggesting the MBA numbers are pointing to the bottom of the housing woes. This was based on MBA’s report that purchase applications rose 3.8% and refinance applications fell 36.2%. I simply don’t buy it.
First, refinancing is on the increase, no matter what the MBA numbers say. We’re seeing tens of thousands of zero down, teaser rates, and adjustable rate mortgages resetting from the Wild West days of the last 2-3 years. A 36.2% drop in refinancing? Not a chance. Unless, these folks are simply being forced into foreclosure. In that case, there would be no need to refinance.
As for mortgage applications being up 3.8%, it depends on how you analyze that number. As the senior economist at Wachovia noted, this could be due to buyers previously rejected, now re-applying for mortgages. One big problem here. It has become tougher to qualify for a mortgage, not easier. And rates are rising, not falling. So the folks that were rejected last month or the month before, are going to be rejected again. Moreover, mortgage applications don’t translate into actual sales.

Starts and Permits Disconnect – This week the Commerce Department is telling us starts rose by 2.3% and permits fell by 7.5%. Starts being up is not good news for inventory. Permits off by 7.5% is good news . . . but that still puts us on pace for 1.406 million new homes. Let’s face it, if the builders stopped building today, it would take at least 8-12 months for the nation’s inventory to moderate to acceptable levels.

Builder Confidence Numbers - Who cares? But let’s look at it for a moment. The number dropped to 28, the lowest level in more than 16 years. But we really don’t even know what this number means. Here is a quote from the NAHB website making a convoluted attempt to explain the number:

Derived from a monthly survey that NAHB has been conducting for more than 20 years, the NAHB/Wells Fargo HMI gauges builder perceptions of current single-family home sales and sales expectations for the next six months as either “good,” “fair” or “poor.” The survey also asks builders to rate traffic of prospective buyers as either “high to very high,” “average” or “low to very low.” Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view sales conditions as good than poor.

Only the geeks at NAHB know how the criteria are weighted and what (if any) significance the number has for us. What we do know, is builder confidence continues to drop, even though a few Kool-Aid kings were calling for the bottom a few months ago.

No Confidence – We’re seeing an increase of private builders going belly up and banks calling in loans on land and communities. Just this past week in Florida there were two reports of builders failing. Sullivan Homes and Merit Homes have all but closed up shop, leaving thousands of homeowners and subcontractors in the dust. More than 80% of the buyers with Sullivan Homes waived escrow, allowing their deposit funds to go into the general operating
account of Sullivan Homes. That’s pretty standard with most builders. Needless to say, there is nothing left for the buyers that waived escrow.
At Merit Homes the problem gets a little worse. There are 350 homes in some stage of construction . . . with more than 500 mechanics’ liens against them. And in some cases, buyers are making interest payments on construction loans they can’t close!

Job Numbers - Up, down, up, down, up down. Down. Yes, down, not matter what you see week to week or month to month. We’re adding about 150,000 jobs a month in 2007 compared to closer to 200,000 last year. We’re already hearing about recession economies in the hot housing markets. As construction continues to slow, the spillover in the jobs market increases. Just think about South Florida and the condo market. There are more than 100 tower projects under construction, with no new projects being started. As projects are completed, construction jobs are eliminated . . . and not replaced. Up to this point, the biggest hit in construction related employment has been in the undocumented and illegal alien segment. Once they are gone, it spills over to the documented segment and all of the places these guys spend money.
If you ever wished for a crystal ball, you’ve got it. Just take a look at the previously hot housing markets. For the past two years, these markets have been your crystal ball into the future. What we thought was isolated to these markets, has proven an accurate predictor for the country. So as these markets suffer continuing job erosion and significant drops in consumer spending, you can expect the same from the rest of the country.

Subprime - Bernanke offered Washington assurances this week that regulators are taking steps to protect homeowners from abusive mortgage practices. A little late Ben.

Florida Woes – State Farm is dropping another 50,000 homeowner policies. The State of Florida will be blessed with these policies. Insurance and property taxes in Florida continue to plague the future of the Florida housing industry.

On the Bright Side – FPL Energy, the nonregulated unit of FPL Group Inc. announced plans to convert citrus peels into fuel ethanol. I don’t think there is a better run power company in the country. FPL is Number 1 in wind energy in the country, and they are now focusing on expanding existing nuclear and building new nuclear plants. Even after the hurricanes in 2004, when the Street was talking about the hit FPL would take, the company managed the problems without so much as a hiccup.

Virginia Numbers – Last week I promised Virginia numbers, but the VAR has not released them yet. As we have seen in other areas, Realtor Boards are showing more hesitation to release these numbers and to share them with the National Association of Realtors.

Disclosure: Of the stocks referenced today, I have no positions.

Prior Weeks Outlook Reports - Click Here

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