Condo Futures

By Hannah Wallace August 31, 2006

Within just four years, Jack McCabe's McCabe Research Inc. has established itself as one of the leading condo-construction and conversion consulting firms in the Southeast. McCabe got even greater notice last year when he announced the creation of an investment fund that plans to snap up distressed condo units around the state, thus gambling on a crash and subsequent recovery of the Florida condo market. We caught up with McCabe at his Deerfield Beach office for an update on the Sarasota-Bradenton market and his perceptions of the Florida condo crisis.

One of my hobbies during high season is driving by new condo high-rises at night to count how many lights are on. There are very few. Is it naive to think that condos should actually be used, not just bought and sold? It's a sign of the excess of the building and housing boom. This is an artificial boom.

Why artificial? Because condo construction projects were not driven by real demand. They were driven by speculative purchases—short-term investors seeking high profits in a quick flip.

Last year you started a fund that seeks wealthy investors to snap up distressed condos. What can you tell us about it? I can't identify the fund, because it is a private company that has expressed its desire to remain private. At this point, I have contracted with a large pool of money, about $4 billion. They have expressed their desire to acquire, in particular, condo conversion units geographically specific to Florida. It's estimated they have an available pool for these acquisitions in the $600 million to $700 million range.

How long do you think it will take the market to recover from a price drop? In condo acquisitions we expect the turnaround to vary in different markets. In Miami-Dade County, we expect it could take five to seven years until the demand-supply ratio comes into equilibrium. In markets like Sarasota or Fort Myers, we expect the turnaround within a three-year time frame.

What makes you think the market could recover so quickly? Technology. Previously, information about falling sales prices was controlled by realtors and lenders. In this correction cycle, 70 percent of buyers do Internet research prior to their purchases. We have Web sites where people can list their properties for sale. Some have been set up strictly to handle condo sales in a very similar fashion to eBay. Speculators and potential purchasers can see prices immediately online, 24 hours a day, seven days a week. You can go to a Web site and see how a speculator who owns units in your condo has just lowered his price by $20,000 to get under your price for the one end-user that's out there.

So there's a commoditization of the condo market. Real estate is being traded more like commodities than like real property.

Who are these condo commodity traders? The vast majority of speculators fall into two categories. The first one is the previous stock speculator. The other is people who have actually never bought any property as an investment before. Now we have taxi drivers and dentists investing in condos. Many own portfolios of condo units.

How many buyers these days are short-term speculators, how many are well-endowed and sophisticated long-term investors, and how many are actual users? A lot of it is very anecdotal. Most developers don't like to reveal the percentage of potential speculator-buyers. We've sent our researchers to grand opening events, doing straw polls of the potential buyers. We also check the school enrollment in different counties. And we check with Florida Power & Light to see if their hookups are increasing at a correlative rate with condo sales.

What did you find? In all cases, we've been able to determine that not only are school populations not increasing, they're actually decreasing. FPL hookups have increased at a steady pace. But it hasn't been any different in the last three years compared to what it was in the previous 10. So it's our best opinion that 70 percent to 80 percent of condo sales have been made to speculators planning on quick flips. Only 20 percent to 30 percent of sales were to buyers whom we would consider primary or secondary homeowners. The vast majority of condo investors haven't been active in the past year and a half because prices have gone so high there was no way to rent the properties out for a break-even or positive cash flow. Of the new condo towers that are being completed, 50 percent or more of the units are immediately being listed on the MLS.

Where and how do condo flippers get their funds? Until about six months ago, almost anyone who could fog a mirror could get a loan. We had different pools of capital, some from well-known lenders like Countrywide, Wells Fargo and Washington Mutual. But there was also a lot of private capital and a lot of secondary capital that was made available to people who would ordinarily not have been able to qualify for loans. Additionally, [some] companies offered investor financing. In previous years they required 25 or 30 percent down from an investor. But in recent times, we've seen investor financing with no money down. Interest rates last year started as low as 1.25 percent, first-year rate. We've been in an over-exuberant period driven by greed. We're going to see a historically high foreclosure rate in Florida over the next three years.

What do you think about and similar undertakings that bring a day trading mentality to the condo business? has gotten a lot of publicity over the last year, probably due more to its name than anything. The more pre-eminent Web site at this point is [U.S. Condo Exchange]. They have spent millions of dollars on their platform, and I expect them to be the leader in future sales, not only in the United States but internationally. They've been set up under the assumption that there is a huge oversupply of condos, that there are speculators with thousands of units and that they are going to need a platform to sell these units. They've been set up to not only handle retail sales, but also distressed property sales.

Talking about—a year ago, they had a slogan that read, "Bubbles are for bathtubs." Now you go to this Web site, and it's got a special place called "The Panic Button." This is a great analogy of how rapidly this market has changed, particularly over the last six months.

Could any condos in Sarasota-Bradenton end up in your fund's basket? They very possibly could. We're going to look at the best available opportunities all around Florida, from Miami-Dade to Panama Beach. Right now, because of the volume of supply that is under construction, we feel that some of the most immediate opportunities are in Miami-Dade. But other markets have seen sharp downturns, in particular Fort Myers, Sarasota and Orlando.

You're talking about price drops? Yes, price downturns, and also skyrocketing inventory and diminishing sales. When you try to figure out when prices are going to fall, it's when you see this big discrepancy between inventory and sales velocity. Just a year ago in Sarasota, according to the Multiple Listing Service, the average time a property spent on the market was one to two months. In many cases they sold within a day or week of being listed. Now the average time on the market is 11 to 12 months. For $1 million-and-higher properties, it's more than one year.

So are we seeing price drops here? In Sarasota, you have a huge oversupply of single-family homes. Lakewood Ranch is a great example of that. In the last few months, both [homebuilders] Centex and Lennar have offered $60,000 in buyer's incentives, to use any way you want—take it off the price, use it for points in closing costs, use it for additional free options. They basically lowered their prices by $60,000 or more, and I believe they're even doing better than that when you're sitting down privately at the negotiation table. The areas that have seen the highest rise in what I consider artificial appreciation are also prone to the biggest downturns. Sarasota during the last three or four years was in the top three metropolitan statistical areas in the nation for appreciation. It's one of the most volatile MSAs.

Is it time to buy? The deals are already starting to happen. For individual buyers, if you're planning to hold on for five years or longer, now is probably the best time to buy for several years. What I'm doing with my group of investors is looking to find properties where I think the market is going to wind up. If we can buy those right now, if you have your pick of the litter, you take it. If you can buy at the right price, it makes more sense to pick the best units, as opposed to later times where you have greater competition.

You are in the consulting business for major builders. Are there any demographic indicators or a ratio that still triggers your green light for condo construction? When I look at what makes for a successful condominium project, I look for a very unique location and for a skilled, successful developer with a track record. That would either be waterfront [or] it would be an area that does have demand for units that isn't being met. Unfortunately, in Florida there aren't many at this point.

How does Sarasota-Bradenton compare with other markets in Florida? Miami-Dade is the poster child for the real estate bubble. Miami-Dade has by far the most condominiums under construction, in the pipeline and announced, for any market in the United States. In Fort Myers, there are eight luxury condominium towers going up along the Intracoastal, where there had never been a single luxury high-rise built before. The same thing is true for Sarasota. We haven't seen any historical demand that would justify this amount of construction. That's why we're now seeing projects that are getting canceled and delayed. We're going to see other sites that were previously announced for condo development that will become office buildings, condo hotels or some other type of product. We're already seeing in the condo conversion market that they're going back to apartment rentals—we've tracked 15 of them in Southeast Florida just in the last four months.

Who is lending the money for condo developers in Florida? There were pools of money available from all four points of the compass, both from institutional lenders here in the United States, but also private pools of lenders that came from Europe. That has dried up now. It's become very, very difficult for a condominium developer to get a loan for a new project. The ones that have been active in recent months have been very aggressive during this cycle, in particular companies like Corus Bancshares out of Chicago, First National Bank of Puerto Rico, or Banco Popular, another Puerto Rican bank. We are seeing some of the mainstay institutionals offer some loans, but it's maybe one-tenth of what it was just 12 months ago. The spigot has really been shut off for condo development in Florida, at least on a temporary basis.

What percentage of condo construction loans are defaulting these days in Florida? We're going to see a tremendous number of developers defaulting projects back to the lender. In Florida, we have the potential over the next three years to see corrections that are similar to the downturn in the 1970s. But once we get though this temporary correction cycle, we're not only going to see prices appreciate again in Florida, but they're going to skyrocket five years down the line. At this point in time, we'll see real estate prices that are becoming equivalent to what we see in California and in New York. The important thing is to be solvent enough to get through this downturn.

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