Waiting for Bubble to Burst

By Kenneth R. Harney
Saturday, June 4, 2005

Growing expectations of price slowdowns -- or even significant drops in values -- in hot real estate markets are stimulating a new sub-industry: entrepreneurs who are preparing investment funds and businesses to snap up bargains after the bubbles burst.

Yale economist Robert J. Shiller, who forecast the stock market decline and the dot-com implosion in the 2000 edition of his book "Irrational Exuberance," says that significant corrections in housing prices in some of the fastest-appreciating markets are now almost inevitable.

Double-digit, multiyear run-ups in prices in dozens of markets in California, Florida, Nevada and along the Atlantic Coast are "much the same phenomena" as the tech stock market bubble of the late 1990s. Schiller, who recently published a new edition of his book, isn't making specific predictions about when or how severe the corrections will be in these areas. He is, however, convinced the speculative excesses in at least some of them will trigger downturns in real property valuations.

In Deerfield Beach, Fla., Jack McCabe of McCabe Research & Consulting, a project feasibility adviser to large residential developers and apartment owners, shares Shiller's bearish views. But he's getting ready to pick up the pieces after the storm. He is putting together a series of what he calls "opportunity funds" -- pools of investor capital -- to acquire new and converted condominium units purchased by speculators.

Some condo projects in the Miami-Dade County area have sold "70 to 80 percent" of their units to speculators, "who think they're getting into a gold rush and expect to flip" the units within the year. In reality, McCabe believes, many of these investors will lose their shirts trying to resell at ever-inflating prices.

It's the 2005 real estate version of the "greater fool" theory, he argues. "At some point there just aren't enough people who will buy" your overpriced condo unit, "and you can't afford to carry it any more."

McCabe says a lot of sophisticated, experienced investors appear to agree with his scenario. He says he now has commitments for more than $10 million in capital from investors -- large and small -- who expect to acquire individual units and entire projects at deflated prices during 2006 and 2007.

McCabe is putting together limited-liability companies (LLCs) for small groups of up to 25 investors to buy new units, some of which are at the pre-construction stage today. The LLCs have varying minimum share requirements -- anywhere from $30,000 to $50,000 at the low end to $1 million at the top. Their acquisition strategies and financing will depend upon the specific opportunities available, but will include holding and managing properties for extended periods, or shorter-term ownership followed by profitable resales when the market begins to recover. The LLCs expect to buy for all cash or use financing to increase leverage.

"We think there will be very attractive opportunities" beginning in the first quarter of 2006, he says. Even now there are signs that the speculative bubble may be in its final phase. Developers in the Miami area are beginning to limit the number of investors they will sell to in certain projects. Lenders are cutting back on higher-risk loans for speculators, especially low-down-payment, interest-only and "payment option" plans that allow substantial negative amortization (rising principal balances).

McCabe believes that speculation-driven price excesses -- Federal Reserve Chairman Alan Greenspan called it "froth" in a recent speech -- can be found in dozens of other markets besides Miami.

"The dynamics are similar" in the Washington area, California, the west coast of Florida and other high-fizz areas where speculators are active, McCabe says.

In Denver, Tom DiMercurio, a veteran specialist in defaulted properties taken back by banks, also sees a rising tide of distressed property opportunities ahead. He has just launched a new, multi-city firm, the Mercury Alliance, to work with lenders "in the 15 hottest markets" around the country to dispose of homes, condos and other properties that go sour.

DiMercurio thinks that any significant increase in interest rates will cut short the boom psychology puffing up many markets. That, in turn, "will trigger a substantial increase" in lender-owned property available for resale or for management on behalf of lenders. Even in cities such as Denver, where recent price gains have been modest, DiMercurio says an oversupply of loft and condominium projects is likely to trigger property devaluations and a decrease in willing purchasers.

DiMercurio attributes a major part of the problem to mortgage lenders themselves. Too many of them have come up with programs that allow unsophisticated borrowers to take out loans larger than even the inflated appraisals on the properties they are financing.

"People think they can only make money and there's no risk" when they invest in real estate, he said. "That is ridiculous."

Kenneth R. Harney's e-mail address isKenHarney@earthlink.net.


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