Sunday, December 13, 2015
Hope, Greed and Bad Advice.
It's the year 2005 and it seems almost everyone is making money hand over fist speculating in real estate. Keanu's neighbor, Nigel, refinanced his house and has been using the cash-out money to reserve pre-construction condos for 10% down and then flipping the contracts prior to closing for several times his investment. He made over a hundred thousand bucks on just two contracts at Portside Villas and is currently sitting on contracts at Solana on the River, Somerset in Titusville and Island Pointe in Merritt Island. These contracts look to profit several hundred thousand by the time he flips them next year.
Nigel calls Keanu one afternoon with the news that his cracker-jack young agent has somehow scored a pre-construction list for a just approved riverfront project in south Cocoa Beach. If Keanu wants in, 10% will reserve one of these to-be-built units starting at $549,900. The price only has to move to $600,000 to double the investment and a triple or more is possible depending on where the market is by the time the contract is flipped to another buyer. Both of them decide to go for one of the $549,900 units and plop down $54,900 each for the reservations.
As the buildings go up, things are looking good. Nigel flips one of his other contracts for a tidy profit but decides to sit tight on the remaining ones for more money. Both list their pre-construction units summer of 2006 for mid-$600s and mentally begin counting the profits. One little snag, the developer hasn't been able to sell all the units and is still offering identical units for $549,900. A few months later the notice of impending completion goes out and closings are set for early in 2007. It is now time to come up with the remaining $500,000 and close on the unit or, gulp, default on the contract and lose the $54,900 deposit. Nigel has a slick mortgage guy who will finance the entire remaining balance with a no documentation, interest-only jumbo mortgage at 6.5%. That's his plan as he expects to resell the unit for much more after the developer unloads his remaining units. After much thought and with much regret Keanu makes the very difficult decision to walk away from the $54,900 deposit. Nigel closes and mortgage, fees, taxes and insurance on his unit run just over $3900 a month.
Something feels different going into 2007. The optimism has evaporated almost overnight. The developer hasn't sold another unit and only closes eleven units that year. Nigel's cracker-jack agent suggests renting his unit while waiting for the market turnaround and is able to get a tenant for $1350 a month. After bleeding money every month for two years Nigel lists his unit for sale for $398,500. No takers and he rents again for $1350. Fast forward to summer 2014 and the unit is listed again sans tenant for $410,000. Unfortunately, the developer still has unsold units and is offering an identical unit for under $400,000. Nigel's unit sits empty until this week when it finally closes for $346,500. That's over $200,000 less than paid in 2007 and after almost eight years of over $2500 a month negative cash flow. For all Keanu knows, Nigel may have stuck the lender and association for a good portion of the losses and is vacationing in Cannes. For Keanu the evidence suggests that the decision eight years ago to walk away from the $54,900 deposit may have saved him more than a quarter million dollars. He has no idea how Nigel's contracts at the other complexes played out. Nigel hasn't mentioned them since 2007. The cracker-jack agent is still around, older and, hopefully, wiser and still closing a couple of deals a year. His star faded significantly after evaporating over a million dollars of client money with ill-timed pre-construction recommendations. I have a fond memory of the developer asking me after giving me the same list of available pre-construction units "Why aren't you selling any of these units to your clients? Cracker Jack is on fire." Really? Less than a year later the National Association of Realtors launched their ill-advised $40 million "Now Is a Great Time to Buy or Sell" campaign. They were half right.
“We are ripping you off like no one has ever ripped anyone off as a per-unit basis,” but ”We are also building a time bomb that’s going to flatten us forever.” Sasha Frere-Jones talking about the music industry's shift in the 90s to CDs selling at higher prices than albums but, in the process, setting up the apparatus for music pirating with digital copies in the hands of the now-pissed-off consumer.