Astonishing Inventory in Palm Beach County

From the Palm Beach Post:

In Palm Beach County, the supply of unsold homes - called "inventory" in real estate-speak - has risen to astonishing levels as the housing boom continues to go bust.

"Fifty-five months!" McCabe said.

Actually, there's a 57-month supply - nearly five years - of single-family homes in Palm Beach County, based on the current pace of sales, according to Illustrated Properties Real Estate. The South Florida brokerage tracks listings in the Regional Multiple Listing Service.

Does anyone know what the record is for a market that size?

Corus Update

There was nothing languorous about the atmosphere of tropical Miami during that memorable summer and autumn of 1925. The whole city had become one frenzied real-estate exchange.

Yes, the public bought. By 1925 they were buying anything, anywhere, so long as it was in Florida. One had only to announce a new development, be it honest or fraudulent, be it on the Atlantic Ocean or deep in the wasteland of the interior, to set people scrambling for house lots.

A lot in the business center of Miami Beach had sold for $800 in the early days of the development and had resold for $150,000 in 1924. For a strip of land in Palm Beach a New York lawyer had been offered $240,000 some eight or ten years before the boom; in 1923 he finally accepted $800,000 for it...

It began obviously to collapse in the spring and summer of 1926...

By 1928 Henry S. Villard, writing in The Nation, thus described the approach to Miami by road: "Dead subdivisions line the highway, their pompous names half-obliterated on crumbling stucco gates. Lonely white-way lights stand guard over miles of cement side- walks, where grass and palmetto take the place of homes that were to be .... Whole sections of outlying subdivisions are composed of unoccupied houses, past which one speeds on broad thoroughfares as if traversing a city in the grip of death." In 1928 there were thirty-one bank failures in Florida; in 1929 there were fifty-seven...

By the middle of 1930, after the general business depression had set in, no less than twenty-six Florida cities had gone into default of principal or interest on their bonds...

The cheerful custom of incorporating real-estate developments as "cities" and financing the construction of all manner of improvements with "tax-free municipal bonds," as well as the custom on the part of development corporations of issuing real-estate bonds secured by new structures located in the boom territory, were showing weaknesses unimagined by the inspired dreamers of 1925.

That was from Only Yesterday: An Informal History of the 1920's, written by Frederick Lewis Allen in 1931.

Corus is the lender on 85 loans in the Southeastern U.S. for a total of 25,601 units. Of those deals, 68 are in Florida totaling 21,451 units.

Make sure you see these pictures of the Miami condo construction boom.

We had a debate going on in the comments section about CORS exposure to condos.

I prepared the following graphs regarding CORS deals in the SE region.

This is computed by calculating the average loan amount per unit for every CORS deal in the southwestern U.S. It would seem that the CORS loan size skews toward small amounts per unit.

The next graph illustrates that much of the skew comes from condo conversion loans. Excluding conversions, the average loan per unit is higher.




More bad news about the Miami condo glut:

"Boca Developers is considering a bulk sale of unsold units at three South Florida projects... New York-based Cabot Investment Properties has signed a letter of intent to pay $168 million for 236 units at Marina Grande in Riviera Beach, Peninsula II in Aventura and Oaks I at Biscayne Landing in North Miami.

Under the proposal, many of the units would be rented following the bulk sale with the idea of later trying to sell them when the residential market improves.

Cabot would purchase the units at a rate of $342 a square foot, which is much less than it would cost to build the same buildings at current construction prices, according to the documents outlining the proposal."

See the rest of this HBB post about Miami, which also says "Florida’s Miami Dade County has a 31-month supply of existing condos on the market."

Initiating Coverage on Corus (CORS): Part Two

This is the latest from Miami:

"...the most foreclosures at any condo development in [Miami-Dade county] this year."
"The 326-unit complex at 1331 Brickell Bay Drive had more foreclosures [17] than any other building in Miami-Dade and was second in South Florida..." That's 5.2% of the units, so far.
"Attempts to sell now are being compounded by falling appraisals and hesitant lenders. At least one has sworn off Jade already."
"Today, Miami-Dade has 28 months of existing inventory — without taking into account the new units that haven’t closed yet, said Ron Shuffield, president of [Esslinger Wooten Maxwell]." "In April 2005, there were 5,125 condos on the market. One year later, the number of available units spiked to 15,581, and the number rose to 22,924 in April, according to Multiple Listing Service research by EWM."
"Another problem for Jade owners trying to sell is that even willing buyers may have trouble finding a mortgage. Greenpointe Mortgage Funding stopped lending at Jade because of inflated appraisals and prior resale activity."

One of the themes of the nationwide condo bust is condo towers being converted to apartments, or condo conversions going back to apartments. From the Corus Q:
"An additional 3.8% of the loan portfolio ($147.5M) consists of one conversion loan and two construction loans that were previously classified as condominium loans. The borrowers ultimately failed to sell enough condominiums to make a condominium exit viable. For the conversion loan, the borrower has opted not to convert the property and will retain it as an apartment building. In the other two cases, the borrowers are negotiating the sale of the properties as apartment buildings."

Here's the two big pieces of bad news from the CORS Q:

• NPLs / Total Loans are 5.09% - up from 0.01% in 2006.
• "At this point, most of our problem loans are concentrated in the condominium conversion loan portfolio. We have a total of 48 condominium conversion loans totaling $1.0 billion, of which nine loans totaling $458 million are of particular concern."

Corus has an unusual loan officer compensation program:
"A significant portion of commercial loan officer compensation is ... the CLO Program... [which] generally holds back much of their commissions for up to nine years, during which time it is at risk of loss in the event the Company suffers a loss on the loans. Management believes the program motivates officers to make safe loans and aligns the officers’ goals with the Company’s interests."

This is admirable, but probably not enough because it gives the loan officers the same free option on the loan portfolio and they still don't have any skin in the game.

There's been an ongoing discussion in the comments section of the last CORS post that is worthy of publication.

Matt suggests that CORS will be able to take any foreclosed projects, sell them to REITs at a 5% cap rate, and break even.

There is a glut of condos for rent and for sale in Miami, for example. We could be very generous and assume that some REIT would be able to take a building and rent all the units for $2500/mo. We will assume that they can do this when 20,000 units are on the market simultaneously.

A cap rate of 5% would value one of these hypothetical units at (2500*12*60%profitmargin)/(.05) = $360,000.

Of course, if spreads widen to reasonable levels and condo rentals are yielding 8%, the value would be slashed by 38% to $225k.

If caps were at 8% and rents were only $1500 because of the inventory glut, the unit would be valued at $135,000.

Initiating Coverage on Corus (CORS): Part One

Corus Bankshares Inc. (CORS) is the holding company for Corus Bank, N.A., the Chicago bank that is a pure play on condo loans in bubble markets. Corus’ lending focuses almost exclusively on condominium projects including both construction of new buildings and conversion of existing apartments.

As of March 31, 2007, their $3.85B loan portfolio was 64% condo construction ($2.46B) and 25% condo conversion ($0.98B) loans.

To fully understand the CORS story, you need to be familiar with the adverse cyclical events that are affecting condo towers and conversions and will be persisting for several years.

Just as with single family residential construction, an astonishing proportion of people signing condo purchase contracts were speculators. Because there is such a long lead time before the closing of condo purchases, speculators can make highly leveraged bets on real estate prices far in the future.

After the last real estate crash in the U.S., and after the 1990's crashes in Asian markets, economics and finance researchers began modelling these purchase contracts as call options. This is strictly accurate only if the developer has no specific performance remedy for buyers who back out of the purchase (e.g. when the market crashes).

However, that is a common circumstance: the contracts usually call for the deposit to be the liquidated damages, and specific performance is difficult even when your counterparty is not an overleveraged amateur speculator. (See also: As Condos Rise in South Florida, Nervous Investors Try to Flee)

Further, many of these contracts are contingent upon buyers being able to finance the purchases. But if there is a credit tightening associated with a real estate bust, then the speculators lose their financing and thereby have an assured "out" from any performance obligations.

(A related wrinkle occurs when buyers who want to close on their units can't, because the units no longer appraise for the sale price and the buyers can't get financing. This is an easy way for a tower project to fall into a death spiral.)

Anyway, under the "presale" model that developers use, the speculators get a call option (often underpriced), and the developer gets a unit "sold," which brings them closer to the threshold of sold units needed to close construction financing.

The 25% y/o/y real estate price increases combined with the high leverage of these implicit call options attracted legions of speculators. This led to increased development activity, and a positive-feedback loop was born.

Unfortunately, there is hardly any actual demand to live in these units at any price that will allow the developers - and possibly Corus - to be made whole.

Therefore, we find ourselves back in 1983, when the New York Times wrote "AUCTIONEER'S GAVEL FINALLY MOVES LUXURY CONDOMINIUMS IN MIAMI." That year, Miami condos sold at auction for "30 to 45 cents on the dollar."

As a percentage of funded balances of Corus' commercial real estate loans: Florida is 38% (Miami/SE FL is 22%), California is 16% and Las Vegas is 10%.

Which means that Corus' lending is concentrated in the most overbuilt bubble markets. In Miami-Dade County alone, 8,000 new condo units will be completed this year and nearly 12,000 more in 2008.

In Las Vegas, there are "4,214 existing [condo] units with another 13,409 under construction. Las Vegas also has a 16.5 month supply of residential inventory.

Jack McCabe talking about Miami condos: “When you drive by in the daytime, they are gorgeous, but when you drive by at night, there’s no furniture on the patios and only one light on out of 10.”

Stay tuned for the next post about Corus' portfolio, already showing signs of trouble.

Incentive Incompatibility at Mortgage Brokers

From a recent Washington Post:

"Maggie Hardiman cringed as she heard the salesmen knocking the sides of desks with a baseball bat as they walked through her office. Bang! Bang!

'You cut my [expletive] deal!' she recalls one man yelling at her. 'You can't do that.' Bang! The bat whacked the top of her desk. As an appraiser for a company called New Century Financial, Hardiman was supposed to weed out bad mortgage applications. Most of the mortgage applications Hardiman reviewed had problems, she said.

But 'you didn't want to turn away a loan because all hell would break loose,' she recounted in interviews. When she did, her bosses often overruled her and found another appraiser to sign off on it.

'There was instant notification to everyone as soon as you rejected a loan. And you dreaded doing it because you paid for it. Two guys would come with a bat, and they were all [ticked] off because you cut their deals.'

This sounds like something out of The Sopranos, except it was happening at the nation's third largest subprime lender, which wrote tens of billions in loans.

It's really not that surprising. This story could have come from a book about S&L Crisis I.