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Real Estate and Housing Industry Outlook
August 4, 2007
Mike Morgan, J.D., CRS, GRI
Morgan@MorganFlorida.com - 772-260-5448

“I told you so."
Mike Morgan, Morgan Florida Real Estate Group

Quote of the Week – I couldn’t resist. More than a year ago, I commented that we were in for the worst Recession since the Depression. Everybody and their brother told me I was spending too much time in the sun.  Even though there are still some naysayers that don’t see it that way, it’s in the cards. I’ve got to take a jab at motor-mouth, Jim Cramer, who on-air read part of an email exchange we were having, in order to blast me, so he could pitch the builders a few months back. In his emails to me, he recited past housing problems and how far off the mark I was. He told me how he’s been through it all and this is no different. And he pontificated till I started laughing. Well Jim, you were looking in the rear-view mirror . . . and you were dead wrong.
    As you all know, I like to make people chuckle and laugh with my Outlooks.  I will do that with this piece, but nothing will make you laugh as hard as taking a minute and a half to watch this Jim Cramer piece on YouTube. It is the oracle, smashing the housing bears as recently as late October 2006 . . . and I mean smashing. Just make sure you have no liquids in your mouth when you watch this.  If there is anyone in the room, warn them that you will be laughing till you cry in a few seconds - http://www.youtube.com/watch?v=jmt5_T2WAQc 
    One more. If you missed Jim Cramer’s total meltdown on CNBC yesterday where he was  yelling and screaming "for real," here it is. He loses it at the 2 minute mark, but it is worth the wait - ­ http://www.cnbc.com/id/15840232?video=452808336 He actually thinks the Fed will lower rates bail out the current crisis.  Even if the Fed did lower rates, we are far beyond solving this with a rate fix. And he finally admits, “We have Armageddon.”  More on rates and bail outs below.

Story of the Week – Business Week’s Cover Story - Bonfire of the Builders http://www.businessweek.com/magazine/content/07_33/b4046601.htm?chan=top+news_top+news+index_top+story, as well as You Call This A Home? http://www.businessweek.com/magazine/content/07_33/b4046605.htm (Must Reads) These are just two of several articles in the August 13 issue and online.
    I spent quite a bit of time with the reporter, Mara DerHovanesian. She flew down and I took her out on a tour, and for the past few months I have provided her with a great deal of information and many contacts. I opted not to be quoted for the articles because of my ongoing litigation with Lennar over my website www.Defective-Homes.net   In all due fairness to Lennar, the problems are nationwide and involve just about every builder out there. Lennar is nowhere near the bottom of the pile on this one. The problems are due to building homes faster than local officials could inspect them, so just about every state did away with formal inspections. Making matters worse, will be homeowners that bought homes from builders that are out of business or are going out of business.
    The builders built their own bed, and it is not going to be comfortable for most. This will bring out the sharks and at some point we will see national reform. But the Business Week pieces go beyond defective homes. 
    For a moment, forget about the problems with no sales. Let’s talk about no mortgages. This week we saw an almost overnight evisceration of the mortgage markets for buyers. More on that below. As the Business Week article points out, builders will also be dealing with the sharks for the next few years. The sharks are ready to fire on all cylinders with lawsuits for predatory lending, mortgage fraud and defective homes.

Week in Review – I’m not going there this week. Not a chance. If you haven’t seen it heard it and felt it, you are dead. So I’m not going to talk about American Home Mortgage going bust or Bear Stearns announcing a third billion dollar bust or the fact that some people want you to believe it is only Bear Stearns. And I’m not going to remind you of the swings on Wall Street and the three minute 40% drop in Beazer Homes or MGIC and Radian’s billion dollar C-Bass bust (by the way you heard it here first almost a year ago and that’s not sea bass like you eat). 
    And I’m not going to send you back further in history to recall the initial ceiling of the S&L problem was $10 billion, but came in at $200 billion. Nor will I remind you of the footnote whispered this week that S&P listed 10 CDO’s for a “potential” downgrade (that’s like a potential sunburn from a nuclear explosion).
While I not talking about stuff, I’m not going to talk about S&P downgrading AHM after AHM announced they were in trouble, because then I would be talking about how far behind the Street is in recognizing just how bad things are because they are using rear-view mirror models. I’m not going to do that.
    Should I talk about the global problems, like the Australian hedge fund that suspended withdrawals because of CDO problems. Nah. This isn’t going to spillover globally, is it? The Chinese, Saudis and Singaporeans didn’t buy this debt, right? And its not going to effect global spending. (On your next trip to Florida, I’ll introduce you to the Tooth Fairy)

WCI and Icahn – Happy days for my clients that held strong and very sad days for the folks that followed Icahn off the cliff. Someone commented that for $3,500 Mr. Ichan could have avoided the blues he must be feeling about WCI. I charge $3,500 for a day of my time, and that’s all it would have taken on a Florida tour to demonstrate the problems with WCI. Three other parties interested in WCI avoided disaster after I spent a bit of time with them. 
    For those that think WCI is a buy in here . . . think again. A few months back I might have agreed with you, but not after seeing how fast things are falling apart. Watch for WCI to throw in the towel within the next 60 days. Bal Harbour is a $400 million dead weight for WCI. More on that below. For those still waiting for Jack McCabe’s “done deal” buyer of WCI, do you want me to open the window or hand you a gun?
    How about the debt? Well, S&P was late to the party (again) and downgraded the debt three notches to “CCC-plus.” If anyone thinks they can buy the debt at these prices and make a go of it, they will be in the same boat with Icahn and all of the sharp guys that followed him over the cliff. WCI simply has too many problem communities in some of the worst markets possible. The equity will be wiped out and the debt holders will take a 35-50% haircut when its all over. That’s being conservative!

Warren Buffet and Hovnanian – Maybe now Buffet could step up to the plate, but I doubt he’s ever going to buy a home builder. The day of the rumor, HOV closed at $18.53. It traded under $11 this week, and now sits at $12. Where’s the bottom? Not here. I believe the Street will overdo it and take the builders to levels where you can buy them and sock them away. It’s not going to be a short trade, since the builders have several years of problems ahead of them.

Beazer and the Sharks – You heard this one hear first as well, when I announced the first lawsuit filed by The Jackson Law Group. Gary Jackson was on my legal team, and he’s also got one going against Ryland in a 6,000 home class action. The SEC investigation has been upgraded from informal to formal. That’s not a good sign either. And I believe what you are seeing Beazer deal with will be the same thing the other builders will eventually be up against.

Who Survives – Maybe I should save this for the end of this week’s Outlook, but let’s wing-it. This week several clients asked me if it was time to buy. Since I’m not an analyst, I try to stay away from those questions . . . but they don’t let me. So I gave in and said, buy Lennar and short more WCI, Beazer, Brookfield, Standard Pacific or Technical Olympic. Personally, I think they all go lower, as does the entire market. But for those that must buy, I think you buy the best and short the worst. We are not at the point where we start crawling back out of the pit.
    Lennar will most likely be at the top of the pile when it’s all over, if the JV and off balance sheet "options" can work their way through. Stuart Miller is sharp. Very sharp, and he’s built a team that knows how to wade through the bodies, picking up the juicy parts along the way. I believe Lennar will be in the position to scoop up bargains from those that are simply not going to make it. Do they have debt? You betchya. Just like all the rest of the group. But renegotiating that debt will be an art. The debt holders will make deals with the best of the group, and will pull in their money from the guys that still don’t realize, the light at end of the tunnel is a freight train. 
    Beazer, Brookfield, Standard Pacific and Technical Olympic are most likely the first to go. But here’s the catch. At what price? With land prices already off by 25-40% from the peak and margins at or below zero, book values are nothing more than misleading numbers. So all this talk about how builders are selling at discounts to book is nothing but Kaka dePoop. Add to those problems, the fact that we have a HUGE inventory problem, and you have a recipe for disaster. I don’t know what prices some of these companies go out at. In fact, I am pretty sure a few companies can’t deal with their debt.  If you think the Wall Street analysts know, think again. Look at the track records of this group. I will not name names, but if you’ve followed the market behind this group of knuckleheads, you’ve lost a bundle. The sad part, is that they were paid huge salaries and bonuses for sitting in their offices, talking to Investor Relations and grinding numbers. I actually asked one analyst why they always seemed to upgrade one builder and downgrade another. The response was startling. Because the company (one of the big ones) required an overall neutral rating! So you had to read between the lines . . . but that was not always easy to do. 
    With all of that said, there is one analyst that has been right on the money and asking the right questions on conference calls. Alex Barron, now with Agency Trading, first called me in October 2005 after TheStreet.com ran a piece about me. After speaking with Alex, it was clear he didn’t buy a single word I was saying. But he got on a plane and spent a few days with me. We toured communities and spoke with a lot of people. Alex still does more ground zero work than anyone I know. He started asking about impairments before it became the subject du jour on conference calls. And his reports and models include ground zero data.
    “Liars can figure, but figures don’t lie.” This axiom has one fault. Figures don’t lie, but when the figures are in fact a lie . . . you have a double lie. We’ve seen numbers from NAR for the last few years that are pure nonsense. We’re seeing numbers that exclude entire sectors of the market. More on this below. The problems we are seeing are all due to the numbers, and if you can’t swallow that, think about the hedge fund and mortgage company failures we’ve just started to see. They had no idea what their portfolios were worth, and by the time they found out, it was too late. By the way, if you think we’ve seen the worst, I’m here to tell you the light at the end of the tunnel is, in fact, a freight train.

Market Conditions – We’re in the summer doldrums. But even if were in the peak season, there is simply too much inventory and affordability is becoming a huge problem. Buyers that find the house they want, can’t qualify. So they go back out and look again. And again. And again. I’m making this point, because NAR’s pending sales numbers must be dissected carefully (read: they are worthless in this market). We are seeing more buyers fail to qualify, so when they go back out again and try, they are actually being double counted. NAR’s pending sales numbers represent contracts, not closed sales. Anyone betting on this number is going to lose. This number was a proper gauge to use three years ago when anyone that could fog a mirror could qualify, but not anymore. 
    Here’s a perfect example of what I am talking about. A headline in one paper read “Home Contract Numbers Rise Unexpectedly” and the article quoted a bunch of upbeat real estate brokers. The number of contracts is up, but closed sales are NOT. That tells us less people are qualifying, so how can this be good news?
    On a ground zero level, let me share a couple of experiences. I’ve had a couple of clients that wanted to buy million dollar plus condos for more than a year. Every time they called me, I would tell them to rent . . . wait, prices are coming down. Sometimes they were quite frustrated with me, because everyone was calling the bottom . . . and they didn’t want to miss it. So this week I found an auction condo in Sailfish Point. Very prestigious, private address in Stuart, Florida on the water. The condo is a penthouse unit and it is an absolute auction in the middle of August. The seller could not have picked a worse time to go to auction. 
    I send the information to my clients. One client calls to tell me his wife made him buy a condo in May. When I heard the details, all I could say was, enjoy it. He spent $1.6 million on a unit he can buy today for $1.4 million, and if he waited, even less. For the $200,000 he just lost, he could have rented the unit for the next two years, and probably still buy it for $1.4 million, without paying $40,000 a year in taxes, insurance, condo fees and maintenance. 
    Another client told me they changed their mind, and they were looking at North Carolina instead. This is a big problem for Florida. Three years ago, North Carolina was not on the radar screen for the Baby Boomers. It is now, and it does not have the property insurance and tax problems we have in Florida.
    A third client is going to bid at the auction. I have yet to hear from the fourth client, even though he has been anxiously emailing me for more than a year. I’m afraid he may have bought something.

SSI Index Hits New Low – This has proven to be the most accurate predictor of the housing market. Forget about housing starts, debt ratios, jobs to permits, equity inverted capital differentials, and all of the other mumbo-jumbo. If you had followed the SSI (Sign Spinners Index) you would have seen it all coming. Two years ago, this index was at 100. Now follow me here. An index reading of 100 means “no sign twirlers on the streets.” One year ago, the index was at 72, which translates into a physical count divided by pie (apple crumb preferably), multiplied by the difference between the conditionally convergent physical count and the inverse derivative of “e” to the “x” power. I kid you not! Do you have any idea how NAR or the Fed produce there numbers? I didn’t think so.
    Six months ago, the index fell to 53.48, and now stands at minus (yes minus) 28.97. You might be wondering how we get to a minus. Very easy. Prior to 2007, sign twirlers were only found twirling signs for builders hawking houses, high school car washes, and in April for income tax services. But now, we have sign twirlers for mattresses, cars, $5 pizzas, office supplies, dry cleaning . . . and the list goes on. So once these new industries are factored in, we go negative. Taking out the ancillary (read: housing spillover) industries, we are still at a dismal 2.10. 
    To prove the importance of the SSI, the Palm Beach Post ran a feature piece on La Danyin “Day Day” Jordan, a professional sign spinner from Las Vegas. Was he in Las Vegas spinning for a $2.00 steak dinner at an off the strip casino? No. He was in Florida, spinning for a builder. And this guy can spin. If you think this is a joke, take a peak at the picture below and check out this guy’s website at www.aarrowads.com The Shadow never kids around.

Mortgages – I was going to leave this section blank, because it will take a few weeks for the buyers to adjust to the shock. Wells Fargo raised their “prime” jumbo mortgages from 6 7/8% to 8% overnight. Other lenders have announced – no more liar loans. These are stated income loans, where a buyer would state his income and assets, and the lender would accept it as the gospel. It doesn’t end there, we’re hearing . . . again . . . no more 100% loans, and no more low interest teasers, and no more inside-out, double-wrap, left-side flip loans. I don’t know what these are either. I’m just trying to make a point. The lenders are telling us . . . no more creative financing. But they said the same thing a few months back, and the loans are still out there. The freight train is getting closer and these folks still have their dark glasses on. We hear all the talk about “color” on these conference calls, but if you’re wearing dark rose colored glasses, why even ask?
    Much more to come on mortgage fallout. It’s impossible for banks like Wachovia, Wells Fargo, Washington Mutual, etc. to avoid this one. If you think so, think about American Home Mortgage calling it quits this week. They didn’t do subprime. AHM was an Alt-A lender. 
    If you go back a few months in my Outlook Reports, you’ll see where I noted that this crisis (and it is a crisis) will absolutely hit Alt-A and Prime. For those folks buying the banks now for their 5-6% yields, what happens to that yield when the dividend is cut in half? Well the easy answer is the yield gets cut in half, but the value of that stock will also drop as buyers that bought for the yield look to treasuries or bonds. Just like the builders failed to own up to the problem, the banks are following along on the same tracks.
    One final note. There is another side to this box. Tighter mortgages and affordability issues which mean lower prices on homes and lower sales. By now you must realize, we are in the tunnel . . . and the light at the end is the freight train . . . but so is the light in back of us!

Foreclosures – Maybe you’ve heard enough about foreclosures as well. But it’s not just Florida, California, Arizona and other previously hot bubble markets. How about the heartbeat of America, Fairfax County Virginia, where the Washington crowd lives? How about a 500% increase YOY from 190 to 987 foreclosures for the first six months. You’ve got to keep foreclosure numbers in perspective, and you must understand you are only seeing the tip of the problem. Banks are doing everything they can to avoid putting homes into foreclosure. It looks bad for them and it makes everyone more nervous, which multiplies the problems. 
    So banks are using short sales, where they take less than they are owed prior to foreclosure to settle the debt. And banks are getting into the real estate business to sell foreclosure properties prior to stamping them with the foreclosure insignia. Banks are also using their own version of creative financing to renegotiate interest rates, terms and balances! All of these tricks are used to delay or prevent foreclosure, but the key word here is delay. So the numbers we are seeing are not historically accurate. If the banks were doing business as usual, they toss these homeowners into foreclosure as soon as the grace period allowed. C’est la vie. Or is it?
    For those of you that want numbers. How about one out of every 81 homes in Florida were sent foreclosure notices in the first six months of this year. Just think for a moment. Many Florida communities are upscale and immune to foreclosure. NOT. But I will give you this one. In some areas the number is more like one out of every 30 homes. So if you’re still walking towards the light at the end of the tunnel, this freight train is coming soon to a city near you . . . FREE . . . but small popcorn and a small soda an extra $11.00.

Inventory – Do you remember back in the Spring when Ivy Zelman was telling us there would be 2 million foreclosures? I thought that was a reasonable number. And she was the best. But since then things have gotten even worse than even this bearer of bad news thought. RealtyTrac now admits 2 million is in the cards, but I think it will be north of 2.5 million. But why am I talking about foreclosures in the Inventory section? Because the foreclosures are inventory, but most of these never show up in NAR numbers. So when NAR tells you we have an 8.8 month supply, add another 2-4 months for foreclosure inventory and then add another 2-4 months for builder inventory. Very little builder inventory shows up in MLS listings. You might also want to add a month or two to the inventory for the folks that have pulled homes off the market, and are renting or the homes are sitting empty.
    Florida now has a three year supply of inventory . . . and more on the way. What’s most disturbing about Florida’s inventory is two fold. First, it represented the most lucrative market for many of the publicly traded builders. Second, Florida has some huge headaches to deal with. Two of these are skyrocketing homeowner’s insurance and property taxes that have nowhere to go but up. Well . . . there is a third problem. You see, Florida was like a heroin addict. We sucked up the taxes and fees from the housing rush, and now it is gone. It hurts, and it is going to hurt a heck of a lot more when already steep taxes must go up further to pay for the shortfall. More on this below.

Florida Woes Are Your Woes – Florida led us into the housing bubble, and it is a great barometer to watch for what’s coming your way. This week Florida’s Consumer Confidence Index slipped again to 81, while the national Consumer Confidence Index hit a six-year high of 112.6. And as Forrest Gump would say, “that’s all I have to say about that.”
    Governor Crist has all but admitted his attempt to control skyrocketing homeowners’ insurance has failed. In a headline this week, he threatened to sue the insurance companies. Now I’m no business wizard, but it would seem to me that threatening to sue an industry might piss them off. You see, Citizens Insurance is the State run insurance company. And we all know how poorly government runs when it comes to business. Florida created Citizens Insurance, but now that they realize they are in a money losing business, they want the insurance companies to take back the policies and lose money. This week USAA asked for a 54% rate hike!
    As for Florida property taxes. Up, up and away. As I noted above, Florida is going to have a huge shortfall due to the housing crash. Local governments are already trying to cut funds from budgets that were unrealistic. The new property tax proposal comes up for a vote in January. Unfortunately, the new proposal is so convoluted that it might not pass. Even if it does, I think it means less revenue to the State of Florida in the initial phases!
This might explain why the moving van lines are reporting more moves out of Florida than in.

Bottom Fishing – Not yet. I know that is tough for some people to accept, but not yet. For single family residential maybe next spring or summer, but if the builders keep building, it will be 2009. I’ve heard the reports of 2011 for a turnaround, and just like everything else, that’s overdone . . . unless the builders keep pumping out inventory at current levels. 
    For Miami condos, the bottom is probably spring or summer of 2009. By then most of the projects under construction will have been completed. The inventory will be at the peak, and it will be a very ugly picture. With more than 100,000 units under construction in just Dade, Broward and Palm Beach counties, you can expect some tower prices to fall 70% from original sales prices. You can also expect complete collapse for many towers that should have never been built. Once again, if you haven’t seen where some of these towers are, there is no way to describe it in print. Let me just say, some of these areas were (and still are) slums. Can you imagine buying a million dollar condo, and not being able to take a walk without a security guard? Even if you had the security guard, do you really want to see boarded up storefronts, soup kitchen lines, pawn shops, etc.?
    A final thought on the towers. We have a thing called concurrency in Florida. This means you can’t build a tower or community, unless the roads, schools, etc. are concurrently developed or already in place. If all of the Miami Beach condos were to fill up with residents, and these residents had cars, we would have total gridlock for miles. Once again, you’ve got to see it to believe it.

Impairments – M/I Homes announced impairments of 40% of their communities. I think this might be the highest number I’ve heard yet, with most builders under 25%. Here’s why it gets worse. Home prices are still falling. Incentives are still rising. Margins are at or below zero. Nobody wants to own land, when they can buy it for less a year from now. In this market, builders should be impairing 80-90% of their communities. I realize there are accounting standards to follow, but from what I am hearing on conference calls, everyone has their own formula to determine when they should book an impairment. For those guys using smoke and mirrors, you’ve got 7 years bad luck coming and smoking kills.
    I’ve been talking about impairments for more than a year. And even though we saw some huge impairments recently, we’ve seen less than half. According to the STB Index, more impairments means lower Book Value. (STB – Stop The Bull%$#@)
    You might think that’s funny, but consider this. Brookfield Homes took no impairments . . . even though one of their JVs lost $41.7 million. I heard the conference call, and I still don’t get it. At first I thought it was the accent, but when I read the transcript, I still didn’t get it. Brookfield’s STB Index rating is zero.

Interest Rates – I’m wearing my economist hat right now. It’s down over my eyes, but that’s standard for these guys. Lower rates? I can do that with my eyes closed. Not a chance. Our economy is in the tank and the dollar is on par with the loonie. As loonie as that sounds, we all know the loonie is a nickname for the Canadian dollar. And the last time our dollar was on par with the loonie was way back in 1976! The other major currencies are kicking our butt as well, and that means higher prices on imported goods, which means higher inflation, which means higher interest rates. There you have it, with my eyes closed.
    So when Cramer and the other talking heads, start flapping their jaws about lower rates to bail out the housing problem, that’s nonsense. Not to mention the oil factor. If we lower rates, and the dollar goes lower, the countries with the oil are going to hike the price of oil to compensate for the falling dollar. Off with the hat.

Bail Out – Two comments you’ve been hearing all week. If we bail out idiots that sucked up ridiculous mortgages and the party hounds that used the housing ATM for four wheelers, jet skis, boats and other bon-bons, how about credit card debt and losses in the stock market? I’m only including these topics in this week’s Outlook to demonstrate that this is not going to be a soft landing and the hangover is going to linger.

Rental Markets – To round it all out, I will address some of questions about why the rental market is not booming. Traditionally, when housing affordability is squeezed, rents go up, as more people realize they cannot buy a house. But when you have more houses than you have people to live in them, both rents and sales prices go down. Despite the rosy picture painted for the rental market a few months back, I’ve said all along it is in the tank. I’ve had dozens of people call me that own more than 10 flip properties. One guy actually bought 70. These people are in deep trouble. They can’t sell ‘em and they can’t rent ‘em. Even if they could rent them, it would not cover their carrying costs . . . and then they would have to deal with the damages to the units . . . not to mention the difference in selling a used house versus a new one.

The Numbers – For my clients that want regional numbers for June in Florida or Virginia, please email me. The same for foreclosures by region.

WCI – Bal Harbour – I almost forgot. 12 new listings and asking prices coming down. An interesting note is the drop of more than 20 listings on one of the large broker’s websites. I suspect these folks tried to arrange for a mortgage, and learned the hard way that you can’t get a mortgage if your property is listed. With some banks it is 30 days prior to closing, and with some it is up to six months. It is even tougher on pre-construction.

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