Wednesday, 25 May 2011 16:56

Reggie Middleton's Real Estate Recap: As I Have Clearly Illustrated, It's a Real Estate Depression!!!

Summary: I called it the coming RE Depression in 2007! I put MY money where my mouth was and sold off all of my investment real estate. I put YOUR money where my mouth was and shorted all that had to do with real estate (REITs, banks, builders, insurers). I called almost every major bank collapse months in advance. I warned the .gov bubble blowing does not = organic economic recovery. Now I'm saying we need to, and will, continue what's left of the crash of 2009, with ample global company. There will be no RE recovery this year, and there will be a crash. OK, you heard it here!

First, let's go through the headlines for the day then proceed to breadcrumb trail that clearly led us to where we are now and where we will ultimately end (oh yeah, In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse Wednesday, February 23rd, 2011)


Commercial Real Estate

US Commercial Real Estate Prices Decline to Post-Crash Low ...‎ - Bloomberg

U.S. commercial property prices fell to a post-recession low in March as sales of financially distressed assets weighed on the market, according to Moody’s Investors Service.


The Moody’s/REAL Commercial Property Price Index dropped 4.2 percent from February and is now 47 percent below the peak of October 2007, Moody’s said in a statement today.


The national index has fallen for four straight months as sales of distressed properties hurt real estate values. Investor demand is strongest for well-leased buildings in such major markets as New York and Washington as vacancy rates decline and the economy grows.


The index “continues to bounce along the bottom as a large share of distressed transactions preclude a meaningful recovery of overall market prices,” Tad Philipp, Moody’s director of commercial real estate research, said in the statement. “Indeed, the post-peak low in price has been reached in the same period as a post-peak high in distressed transactions has been recorded.”


So-called trophy properties in New York, Washington, Boston, Chicago, Los Angeles and San Francisco are helping those markets avoid the drag caused by distressed asset sales nationwide, Moody’s reported. Prices of properties of $10 million or more have risen 23 percent since their July 2009 low, according to a separate report issued today.


No Recovery Signals


The overall index shows “no sign of recovery,” Moody’s said.


Almost a third of all March transactions measured by Moody’s were considered distressed, meaning the properties’ owners faced foreclosure, had difficulty covering their mortgage payments or experienced other financial problems. It was the largest proportion of distressed property sales in the history of the index, Moody’s said.

For all of those wondering how CRE can be doing so bad while REITs are doing so well, well I explained it in explicit detail several times in the past. Once we eliminate rampant fraud and bring back mark to market, all will be good again...

  1. The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?

  • Commercial Real Estate Continues to Dropped into Foreclosure as the Landlords of Said Properties Enjoy Skyrocketing Share Prices? Yep, Makes Plenty of Sense Friday, August 6th, 2010

  • Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees! Thursday, April 15th, 2010

  • Was this hard to see coming? Of course not - at least if you were looking! For those that may doubt that I have my finger on the real asset pulse of the markets, I practically wrote today's headlines 5 years ago! Let's jump into our time machine, shall we


    September 1st, 2007: The very first post on BoomBustBlog tells the whole story for the next 6 years!

    Thoughts on the US Publicly Traded HomebuildersBoomBustBlog

    I noticed that many pundits are focusing on single family residential market, most likely because it is in the news so often. It is bad, very bad. I am an ex-residential real estate investor who sold off in 2005 due to fundamentals that were totally out of whack. It appears that many do not see how precarious the commercial sector has become, with many deals being done at 2-5% cap rates (net profit yields) in Manhattan and many major metro areas, which is absolutely ridiculous considering the risk and illiquidity of these deals. The compensation for these deals are coming no where near justifying the risk. I am sure the excessive liquidity coupled with significant demand caused the cap rate compression, but the buyers fell for it assuming liquidity and demand would continue for some time. Well, corporate liquidity has just dried up, and many are stuck holding the bag with buildings that are yielding as low as half that of treasuries, yet easily quadrupling the risk. Some are even selling at lower cap rates in successful flips (reference the Blackstone purchase of Sam Zell's portfolio, which was totally overpriced, yet Blackstone managed to flip much of the portfolio over to speculators, some of which actually flipped it over to someone else at a profit – ALL in a period of a few months). This has now become nigh in impossible, but in an attempt to raise the cap rates, commercial rents have skyrocketed to all time highs in the major metro areas, causing significant pressure on corporate profits (I have inside knowledge of this affecting MAJOR public and private firms who are looking to expand and are getting squeezed).
    And now, on to small residential (single family and 1-4 family residential)…


    For those who really have a life and do not have the time to read building company annual reports, here is a bullet list of tidbits that all will find interesting, particularly in light of today's mortgage environment (pardon if their is info that you are already privy to, this is a comprehensive summary, but I am sure everybody is to find something that is of illuminating):

    1. Joint venture debt and depreciating inventory held off balance sheet, so you and I can't see it.
    2. A significant amount of the non-conforming market has all but seized up, which will significantly reduce the demand for housing, in an environment where the supply demand ratio was totally out of whack to begin with. I know you think you already know this, but wait…
    3. Large public home builders are some of the largest non-conforming mortgage originators, funded by warehouse credit lines that have been the source of unprecedented margin calls throughout the non-bank mortgage industry (which the homebuilders are a member). Banks have internal financing such as deposit accounts to fund mortgages, but non-bank entities must rely on credit lines to fund loans. Significant non-conforming mortgage operations that have already been put out to pasture amount to about 60 mortgage companies – totally out of business, and the secondary market has effectively frozen. Reference LEND, American Home Mortgage, New Castle, most recently LUM to see how quickly this can bankrupt a company. These are entities that do not have to deal with the cash burn and depreciating assets of the homebuilders as well. In just a few months, American went from the 10th largest lender, to bankruptcy. In just one week, LUM went from rosy management pronouncements to postponing earnings and halting trading, stating that their business model has simply been locked up (this is what American did the week it declared bankruptcy). All of these non-bank lenders had margin calls on their credit lines combined with an inability to sell their product. The builders use the EXACT same business model to fund much of their sales, and in some cases the vast majority of their sales. Some builders (such as Centex) named the mortgage subsidiary as one of the significant contributors to their bottom line, performing much better than home building. Think about it.
    4. From the 2006 HOV annual report: 9.5% of our home buyers paid in cash and 62.9% of our non-cash home buyers obtained mortgages from one of our mortgage banking subsidiaries. Mortgages originated by our mortgage banking subsidiaries are sold in the secondary market within a short period of time. (Tell that to LUM, LEND, AHM, New Century, etc.) Even those buyers who do not need mortgages will be hurt if they cannot sell their existing properties (to those who need mortgages) to move up to their newer purchase (this is how most pay cash for the 9.5% referenced earlier). Thus the backlog that is stated in the builder's financial statements will not, and cannot, be fully realized, and thus is overstated.
    5. From the LEN 2006 annual report: "We provide a full spectrum of conventional, FHA-insured and VA-guaranteed, first and second lien residential mortgage loan products to our home buyers and others through our financial services subsidiaries, Universal American Mortgage Company, LLC and Eagle Home Mortgage, LLC, located generally in the same states as our homebuilding segments and Homebuilding Other, as well as other states. In 2006, our financial services subsidiaries provided loans to 66% of our home buyers who obtained mortgage financing in areas where we offered services. Because of the availability of mortgage loans from our financial services subsidiaries, as well as independent mortgage lenders, we believe access to financing has not been, and is not, a significant
    obstacle for most purchasers of our homes." For the record, second lien loans are not being bought in any volume for the week ending the day of this writing. It is the second lien loan that is used to get cash strapped buyers into homes. This is a problem for LEN, if it accounts for up to 66% of their sales. They say they issue FHA and VA loans, but fail to break out a granular analysis. "
    "During 2006, we originated approximately 41,800 mortgage loans totaling $10.5 billion. Substantially all of those loans were sold within a short period in the secondary mortgage market on a servicing released, non-recourse basis; however, we remain liable for certain limited representations and warranties related to loan sales."
    Can a company that is losing money at the rate of Lennar afford to buy back or get stuck with unwanted assets that have extremely wide spreads such as the $10.5 billion (41,800 actually mortgages) that they quoted here?
    "Increasing interest rates could cause defaults for home buyers who financed homes using non-traditional financing products, which could increase the number of homes available for resale.
    During the recent time of high demand in the homebuilding industry, many home buyers financed their
    purchases using non-traditional adjustable rate or interest only mortgages or other mortgages, including sub-prime mortgages, that involve significantly lower initial monthly payments. As a result, new homes have been more affordable in recent years. However, as monthly payments for these homes increase either as a result of increasing adjustable interest rates or as a result of principal payments coming due, some of these home buyers could default on their payments and have their homes foreclosed, which would increase the inventory of homes available for resale.
    In addition, if lenders perceive deterioration in credit quality among home buyers, lenders may eliminate some of the available non-traditional and sub-prime financing products or increase the qualifications needed for mortgages or adjust their terms to address any increased credit risk. In general, if mortgage rates increase or lenders make it more difficult for prospective buyers to finance home purchases, it could become more difficult or costly for customers to purchase our homes, which would have an adverse affect on our sales volume.
    We sell substantially all of the loans we originate within a short period in the secondary mortgage market on a servicing released, non-recourse basis; however, we remain liable for certain limited representations and warranties related to loan sales and certain limited repurchase obligations in the event of early borrower default."
    6. Additionally from LEN 2006 report: "Our Financial Services segment could have difficulty financing its activities. Our Financial Services segment has warehouse lines of credit totaling $1.4 billion. It uses those lines to finance its lending activities until it accumulates sufficient mortgage loans to be able to sell them into the capital markets. These warehouse lines of credit mature in September 2007 ($700 million) and in April 2008 ($670 million). If we are unable to renew or extend these debt arrangements when they mature, our Financial Services segment’s mortgage lending activities may be adversely affected."
    7. Pulte relies on internal mortgage financing for nearly 100% of their home sales. This is a serious problem in the current environment. From the Pulte Annual Report: "In originating mortgage loans, we initially use our own funds and borrowings made available to us through various credit arrangements. Subsequently, we sell such mortgage loans and mortgage-backed securities to outside investors. Our capture rate for the years ended December 31, 2006, 2005, and 2004 was approximately 91%, 89%, and 88%, respectively. Our capture rate represents loan originations from our homebuilding business as a percent of total loan opportunities, excluding cash settlements, from our homebuilding business. During the years ended December 31, 2006, 2005, and 2004, we originated mortgage loans for approximately 77%, 75%, and 72%, respectively, of the homes we sold. Such originations represented nearly 100%, 98%, and 92%, respectively, of our total originations. During 2006, 21% of total origination dollars were from brokered loans, which are less profitable to us, compared with 26% and 36% in 2005 and 2004, respectively. The decrease in brokered loans can be attributed to a shift in product mix towards funded production."
    8. HOV, as I am sure other builders, have not only SEVERAL mortgage subsidiaries, but off balance sheet mortgage joint ventures that have the potential to add untold amounts of additional liability and exposure to what has put so many non-bank lenders out of business.
    9. The homebuilders, due to their negative cash flow, have either violated or come close to violating their loan covenants. Some have renegotiated them, but have done so with terms that they are not likely to be able to comply with. DHOM has already defaulted on their loans, just to have them bought out by a hedge fund that is charging them 15% interest, up from 9% that the bank charged them for non-investment grade paper. This is a true junk rate that DHOM just can't afford. Look at their numbers… They are losing money hand over fist, and the market is getting worse, not better.
    10. Some of builders use special purpose (financing shell) companies that banks fund and the builder repays the bank via swaps to fund their mortgage arms (ex. Centex). Most banks require investment grade swap partners, which most builders will find hard to be identified as.
    11. Rating agencies have downgraded most builders to junk status
    12. Credit swap spreads are as high as 450 basis points (cost to insure builder debt)
    13. Banks have been lenient thus far, but all you need is one to decide that the risk is too great and it will create a run on the builders. The first creditor to move will most likely be the one to get back the most of its lunch money. No one wants to be left holding the bag.
    14. Finally, the real estate market, as we all know by now, is entering into a bust, which is most likely to protract into 2 to 3 year range. Do the homebuilders have the cash to last that long, writing down billions of dollars of asset value per year and half of them operating at negative operating earnings (Sans write downs). Will the banks, who have literally ran from non-conforming (loans that cannot be sold to government sponsored entities such as FNMA, Freddie MAC), ALT A, and sub-prime loans be willing to fund these money losing business that rely on these very loans to unload depreciating inventory for another 2 to three years? It appears that many of the banks have real estate related issues of their own, and cannot prudently afford to baby sit the homebuilder.
    Needless to say, I am short the entire housing and soon commercial industry – that is not just homebuilders, but insurers, suppliers, mortgage bankers, etc. The spillover into the broader economy is undeniable – construction, brokerage, ancillary services, finance (American Home and Bear Stearns alone have let go 7,000 employees, and over 60 non-bank lenders have been driven out of business in the last 6 months).


    Reggie's grassroots analysis:

    The S&P index severely understates the glut in housing and the downward pressure on pricing. It uses the repeat sales methodology which only includes houses have that have been sold at least twice, which excludes all new construction. So the homebuilder’s product which is being slashed in price with butcher knives and cleavers don’t even show up in the index, and these homes must be slashed enough to sell in a slow market that no longer has cheap credit, has much competition in excess supply, and no longer has the phantom appraisal pricing which helped sustain the bubble in the first place (more on this later).


    The index also fails to include anything but single family detached and semi-detached housing, so coops and condos aren’t included in the mix. This means that areas like Manhattan and Brooklyn, South Miami and Las Vegas, DC and Cally are severely under counted. The mere act of excluding condos (the worst victim of boom time speculation) instantaneously makes things look a lot better than they are.


    Also excluded are properties who experienced larger than median jumps in pricing, which where considered to be investor properties (benefiting from significant renovation in anticipation of resale). Investor properties constitute a very significant amount of the current prime and sub-prime defaults now.


    Mentioned earlier was the push from appraisers eager to win new business. In the residential investment game, you (as in bank, mortgage banker, mortgage broker, real estate broker, investor, seller, and everyone in between) push the appraiser to come in with the highest value possible to allow you to a.) get the biggest loan possible, b.) obtain the most preferential pricing/terms (lower LTV) possible, c.) get as much from the sale as possible, or d.) all of the above. In the comparable valuation game, you pick comparables and adjust them for particulars to come up with a valuation. Once that inflated value is actually recorded in the city register, it's inflated value is used to further hyper-inflate other deals, and the upward spiral continues. The appraiser, in the boom times, picked the highest prices (which were inflated) to get a highest price (which itself was inflated) that is added into the records to make (guess what???) higher prices. Throw the petrochemical fuel of very cheap money and easy credit NINJA loans and it is easy to see how this housing boom was more than a boom, it was a speculative explosion in real asset prices that usually average 1%-3% a year in appreciation doing about 12%-100% in many places.


    The caveat is, this works both ways. When the appraisers get busted for being too aggressive (and threatened with litigation and discipline - if you read the articles, they have been passing the buck saying they were pressured into inflating numbers) they start getting overly conservative and do the opposite. The banks also stop looking the other way since they may actually have to use their own money to fund/keep these loans instead of the OPM method of MBS/CDO fame. So now, the guys are looking for the lowest average prices in an attempt to be conservative, and the process reverses itself.


    Now, we haven't even gotten to the commercial sector yet, where the real money is thrown around. Speculation and credit underwriting lite is coming home to roost in a sector near you.

    October 2007

    Straight Talk From the Homebuilder CFO: The Coming Land Recession, Pt IThursday, October 11th, 2007

    December 2007

    Do you remember when I said Commercial Real Estate was sure to fall?Thursday, December 20th, 2007 by Reggie Middleton

    My first post on my blog in September warned about the coming drop in real estate prices. I revisited the topic a couple of weeks ago, as I prepared the research of a short position in the sector. Well, we are almost done with the research and the position and I will release a summary of the research and the performance (expected and actual) of the position after Christmas.

    Check this out from January 2008

    The Commercial Real Estate Crash Cometh, and I know ... - BoomBustBlog

    A couple of weeks ago I informed readers that I was working on a big project concerning commercial real estate short candidates. I stated last year that I was sure CRE was headed down, hard. Well, I am now ready to start releasing the results of my research over the next week or so. Unfortunately, the market has moved against the subject of my research fiercely as I was completing it, but it appears to be far from over. Who is the subject of that research, you ask? General Growth Properties (GGP).  I have actually seen this company pop up in the media and a few discussion groups from time to time, but they have no idea what the management of this company has been up to. First, a little background on how I got here. Those who are not versed in commercial real estate valuation are urged to read my quick and dirty primer on CRE valuation .

    I told members of my analytical team to screen the commercial real estate trust, service, and development sector for the usual suspects, starting with the the guys that purchased Sam Zell’s flipped properties from Blackstone. I made some of the companies available via blog post and download: icon Commercial Real Estate Cos. (43 kB)icon Forest City Enterprise Peer Comparison (198.98 kB), icon Vonardo Realty Trust (146.49 kB). After and exhaustive screen and resultant short list, we chose GGP. I then instructed the team to canvass local and national brokers (4), databases (5) and data aggregators (several) to get the most precise localized rental and expenses figures possible. This data, as well as purchase dates, prices, management actions, capital improvements, etc. were used to plug into models such as this 33 page illustrative example, icon GGPs Woodlands Village (612.34 kB), to ascertain the true value of GGP’s portfolio. We also measured and valued their development operations, joint ventures, CMBS financing, off balance sheet vehicles and master planned communities. Sum total, I now have roughly 2 gigabytes of “REAL” valuation data on my servers covering 260 properties owned or partly owned by GGP. A this point, I may know more about their operations than they do.

    What is more telling is the window of understanding this opens into the commercial real estate space in the US. It is my opinion that most are extremely over-optimistic regarding the prospects for this space.

    And here we are Now, in 2011...

    The “American Realist” Says: Past as Prologue – Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!! Wednesday, May 18th, 2011

    In the post that followed said appearance, Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate, I ran down what I perceived to be the major risks of real estate in the states today, and that is a departure from the fundamentals and bleak macro outlook. During the Q&A at Roubini's crib, where I was actually guilty of accusing Nouriel of being too optimistic (I know, that's probably a first - but if anyone were to do such it would probably end up being me), participants were suggesting in a rather optimistic fashion that if a hard landing or recessionary environment were to come it would presage a time to buy assets at value prices. Of course, that is assuming those assets that you got very cheap didn't then proceed to get much cheaper. Nouriel replied exactly as I would have (and have in the past, particularly during my Keynote at the ING Valuation Conference in Amsterdam), and that was that it simply cannot taken as a given that assets prices will cyclically snap back in a year or even two. Now, I do have an investment strategy that I plan to pursue in regards to real estate, but it is quite different from what I see being bandied about today and over the last 8 years or so. To wit (as excerpted from the link directly above):

    ... It is the reporting company’s responsibility to report, not to obfuscate. The big problem with this “hide the market marks” thing is that markets tend to revert to mean. Unless said market values fundamentally catch up with said market prices, you will get a snapback. That is what is happening in residential real estate now. That is what happened in Japan over the last 21 years!!! That’s right, it wasn’t a lost decade in Japan, it was a lost 2.1 decades!



    This has been the first balance sheet recession that the US has ever had, but there is precedence to follow. Japan had a balance sheet recession following their gigantic real asset bust. They made a slew of fiscal and policy errors, which essentially prolonged their real asset recession (now officially a depression) for T-W-E-N-T-Y  O-N-E long years! For those that may have  a problem reading that, it is 21 long years. What did the Japanese do wrong?


    • They refused to mark assets to market
    • They attempted to prop up zombie banks
    • They failed to promptly clean up NPAs in the banking system
    • They looked the other way in regards to real estate value shenanigans

    Residential Real Estate

    Bloomberg: US Home Prices Fell 5.5% in 1st Quarter, The Most Since The Hear Of The Crash! Doesn't that indicate to you that the crash is not over, and is not only ongoing but actually accelerating?

    U.S. home prices dropped 5.5 percent in the first quarter from a year earlier, the biggest decline in almost two years, as sales of discounted foreclosures undermined real estate values.


    Prices fell 2.5 percent from the fourth quarter, the Washington-based Federal Housing Finance Agency said today in a report. Economists projected a 1.2 percent drop from the previous three months, according to the median of five estimates in a Bloomberg survey.


    The FHFA’s measure, based on properties with loans backed by mortgage financiers Fannie Mae or Freddie Mac, has fallen for 15 straight quarters as lenders seize homes and sell them at cut-rate prices that drag down overall values. Foreclosures and short sales, in which banks agree to let properties sell for less than their loan balances, have accounted for about 38 percent of transactions this year, based on the monthly average of data from the National Association of Realtors.


    “Dumping foreclosures on the market and selling them at distressed prices affects the whole real estate market,” said Richard DeKaser, an economist at Parthenon Group in Boston. “It puts downward pressure on prices, even for homes that aren’t in foreclosure.”

    From and editorial perspective, we have been here before: The Residential Real Estate Week in Review, or I Told You We’re In A Real Estate Depression! The MSM is Just Catching Up Thursday, May 12th, 2011

    I'd like to make it perfectly clear that we have a very long ways to go in regard to residential housing price collapse. I have been 100% on point regarding this topic since 2000, it is now 2011 and I have never been more confident.

    Reggie Middleton on Bloomberg TV's Fast Forward

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    Bloomberg TV: "The risk/reward ratio in commercial real estate does not look good!"

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    Bloomberg TV & Reggie Middleton on the Flawed Case Shiller Index: "That's what they said in Japan about 12 years ago, look where they are now!"

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    1. Less Than 24 Hours After My Warning Of Extensive Legal Risk In The Banking Industry, The Massachusetts Supreme Court Drops THE BOMB! Monday, January 10th, 2011
    2. JP Morgan Purposely Downplayed Litigation Risk That Spiked 5,000% Last Year & Is Still Severely Under Reserved By Over $4 Billion!!! Shareholder Lawyers Should Be Scrambling Now Wednesday, March 2nd, 2011

    Bloomberg reports that Foreclosures Prompt Four U.S. Cities to Sue Banks for Mowing, Home Repairs. I discussed this in detail both on Boombustblog and on the Max Keiser show: Reggie Middleton On Max Keiser Discussing Tradable Fraud, Goldman’s Facebook Deal & Phantom Bank Earnings

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    For more detail, reference I Warned That Banks Will Soon Be Forced To Walk Away From Homes… Guess What! Monday, January 17th, 2011. You would be shocked at the amount of so-called professionals and experts who told me this could never happen! I pushed further, with articles that expanded on the topic last year as well:

    Now, in May, my proclamations from last year and the first quarter look prophetic. They are not, they are the result of objective analysis. Either way, In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse.

    In There’s Stinky Gas Inside Of This Mini-Housing Bubble, You Don’t Want To Be Around When It Pops! I illustrated the poor macro and fundamental conditions that made it impossible for a housing recovery to occur in the near term.

    Nobody wants to admit it, but the 2008 never finished - The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance.

    Last modified on Friday, 26 August 2011 13:17