DESERT LAW BLOG

JANUARY 2009 CASE-SHILLER NUMBERS SHOW ANOTHER RECORD DROP

The Case-Shiller home price index for January was released today showing January 2009 set another record for year over year home price decline.  The 20-city index showed a 19% year over year decline, edging out the previous record decline (set in December).  Phoenix was again the worse with a year over year 35% decline in prices...

He cited the numbers for Phoenix, the quintessential boomtown, as “gruesome.” Prices there fell 5.5 percent from December, and are now down 48.5 percent from its June 2006 peak.

Las Vegas, Miami, San Francisco and San Diego are not far behind. All have fallen more than 40 percent. The best performing city in the index is Dallas, down a mere 10.8 percent from its peak. Unlike the rest of the Sunbelt and the coasts, Dallas never had a boom, so it did not have as far to fall.

And, despite a rise in sales (primarily due to foreclosure sales), economists looking at the numbers sound gloomy.

Joshua Shapiro, chief United States economist for MFR Inc., said in a note to clients that “it is unlikely that we are anywhere near a bottom in nationwide home prices.” He estimated the index was perhaps two-thirds of the way through its ultimate total decline.

More from the WSJ here.  Press release with charts and graphs is here (pdf).

PHOENIX LIGHT RAIL RIDERSHIP UP AGAIN IN FEBRUARY

The Business Journal reports that light rail ridership increased from January, averaging over 35,000 per day, each weekday in February.  That is up from a weekday average of 30,600 in January.  The original estimates made by Valley Metro is that weekday ridership would average 26,000.  So far ridership is far outstripping that estimate - a good sign for the light rail.

I'm looking to see if ridership drops off somewhat after the initial curiousity factor wears off - as I suspect some people are riding just to see what it is like.  But so far, no drop off.  It will be interesting to see what effect warmer temperatures have on it in a couple of months.

FORECLOSED HOMES COMPETING WITH HOME BUILDERS IN ARIZONA

An article today in the WSJ points out what many first-time homebuyers in Phoenix already know - buying a bank owned (foreclosed) home is usually a better deal than buying a new home from the builder.  The article notes that often, foreclosed homes are priced 25% or more below what homebuilders are trying to sell their homes for in the same neighborhood.  

Apart from perhaps having to do some minor repair to the foreclosed home, I'm not sure why a homebuyer would purchase a brand new home priced 25% more - particularly in a market with housing prices that are still declining.  As the Phoenix area monthly sales figures rise, many agree this is the way to go.  Approximately 50% of sales in Phoenix metro are now foreclosed homes.  Savvy homebuyers can easily find a home that is only a year or two old that needs little to no repair and is ready to be moved into.  And they can choose their neighborhood in the Phoenix metro area as there are foreclosures in all areas. 

The net impact of this is that homebuilders are finding a tough time out there.  The Republic reported earlier this week that Chandler (formerly a top 10 fastest growing city in the nation) had only one new construction permit issued in February.   The WSJ sums up the reason for this:

Analysts question how low builders can go before building a house costs more than they can charge for it. In some markets in California and Florida, builders have reached that point and have stopped building.

I would guess we are at that point in many of the areas around Phoenix as well, leading to many builder failures already and lots of layoffs in the construction industry.  This is a big part of the reason that Arizona has had the second highest jump in unemployment numbers - next to Michigan.

TAX INCENTIVES APPROVED FOR GAYLORD HOTEL/RESORT IN MESA

Mesa voters approved a $51 million tax incentive yesterday for Gaylord Entertainment Co. to assist in developing a massive golf/hotel resort and convention center on the former GM testing grounds.  The convention center is expected to be more than double the size of the downtown Phoenix Convention Center when built.  It is the first step in owner and master developer DMB Associates' plans to develop the 5 square mile tract of land.  If you really have a lot of time on your hands, you can read the 289 page Development Agreement here (big pdf).

The tax incentive had to be voted on by the residents of Mesa because their city charter requires a vote of residents for tax incentives higher than $1.5 million.  Under the deal, Gaylord gets to keep up to $51 million of "bed tax", but is required to spend most of it for tourism promotion.

The real question I have is whether the Goldwater Institute will challenge this tax incentive as unconstitutional under the Arizona Constitution like they did the Phoenix incentive for CityNorth.  The difference between the two seems to be that Gaylord is required to spend the tax incentive on promotion of tourism - something that benefits Gaylord, but also could be argued to benefit Mesa (the public) in general.  In the CityNorth deal, the public benefit seems a little more debatable.  After the CityNorth appeal is heard and decided upon by the Arizona Supreme Court, we may have a little more clarity about these types of tax incentive deals.  More details on the CityNorth case are here.

Timing of building the resort is up in the air because of the current economic environment.  With credit so tight and tourism/convention business way down in Phoenix, Gaylord will have to wait awhile before initiating the project.  The economic downturn has already claimed one other massive deal in Mesa that got taxpayer backing, the Waveyard project (delayed indefinitely according to reports).  The development agreement in this deal requires Gaylord to start construction on both phases of the resort project by the end of 2011.

More details from the Republic on the project and support and criticism of it can be read here.

1 IN 7 HOMES AND APARTMENTS NATIONWIDE VACANT

According to a NYTimes article today, nearly 1 out of 7 homes and apartments are now vacant - or about 19 million units.  And only 6 million of them are for sale or rent - leading one to believe there is still a massive bubble of inventory set to come on the market over the next year, further depressing prices and rents.  I wrote about the situation in Phoenix with for sale inventory a couple of week ago. 

Here's a nugget from the article:

Many of the vacant homes are concentrated in far-flung suburbs in the Southwest and in Florida, which means that prices there may not return to their highs for many years. It also suggests that much of the country does not have as large an oversupply of homes.

"Many years" in Phoenix metro likely means 10 to 15 years or more before many homes are again worth more than what their mortgage is worth.

ARIZONA SOLAR FALLING BEHIND

A very well written article in the Republic today highlights Arizona's continuing inability to attract solar manufacturing operations to the state.  The primary reason for this is that Arizona provides few, if any, incentives to manufacturing businesses to locate new plants here.  From the article:

But most solar panels, mirrors, frames and other equipment are made elsewhere. In case after case, the state has fallen short of the competition. At least 10 companies have looked at Arizona in the past two years but decided to move their factories and about 4,500 workers to other Western states.

Business experts say the state needs to use some of the tax credits and other tools used by those other states to diversify its housing-dependent economy and deliver the state high-paying manufacturing jobs.

Other, much less sunny states provide strong tax incentives and have been successful in growing a critical mass of solar manufacturing operations.

Oregon, for instance, offers a 50 percent tax credit to pay construction costs for renewable-energy equipment manufacturers. Development officials say it has helped them land seven international solar manufacturers in two years. Most of those companies had considered coming to Arizona.

And the fear is that once other cities get that critical mass, like Silicon Valley with tech, the momentum will build in those areas and new solar companies will generally locate in those hubs in order to take advantage of laborers and professionals there who are skilled in catering to the solar industry.

Economic development officials say the solar industry isn't likely to spread evenly over the country but grow around those cities established as hubs.

They say Arizona still has a narrowing chance at being one of those hubs.

"Right now, there are 11 companies looking to decide (on factory sites) this year," said Barry Broome, president of the Greater Phoenix Economic Council, a proponent of the incentive bill. "We may be in or out (of the industry) after two quarters."

So until the Arizona legislature gets its act together and realizes the opportunity they are missing to grow our economy, the following will continue to be the reality and we continue to rely more and more on construction and services here instead of well paying manufacturing jobs.

Arizona has strong selling points, such as its weather and a workforce with manufacturing skills. But factories require expensive buildings, lots of energy and hundreds of employees, making the economics much more important than, say, a corporate headquarters that simply needs office space for a few dozen employees.

"If you're comparing Portland, Albuquerque and Phoenix, I know I can get real estate, labor, transportation, they're all within one or two points of each other," Colson said. "Then I overlay the incentives on top of that. Albuquerque jumps up, Portland jumps up and Phoenix actually goes down.

"That's why the Greater Phoenix region is not winning these projects."

I encourage everyone to read the whole article as it does a good job laying out how a state that has 320 days of sunshine a year can have an almost non-existent solar manufacturing industry.

ARIZONA AND THE NEW FEDERAL MORTGAGE MODIFICATION GUIDELINES

Much has already been written in the last day about the new guidelines for mortgage refinance and modifications released yesterday by the Obama administration (dubbed "Making Home Affordable").  The Summary of Guidelines can be read here (pdf).  The full Modification Guidelines can be read here (pdf).  A Q&A for loan refinance and modification counselors can be read here (pdf). And a fact sheet on the programs can be found here (pdf).  All this is from the financialstability.gov page.  The Counselor Q&A is the most helpful if you don't have a lot of time to read - skip down to #10 in the Q&A for the loan modification portions.  Then read the Summary more carefully if you think you may qualify.

Essentially, the program has two pieces - helping homeowners refinance and helping homeowners get up to five years of reduced payments through loan modification.  The refinancing part of it, while important, will help very few people in Arizona.  It is meant to assist refinancing for homeowners who have less than 20% equity remaining in their home or who are up to 5% underwater on their mortgage.  Arizona has such a high number of people who are drastically underwater that this will help relatively few people in the state.  Most are just too far underwater to qualify.

The loan modification program, on the other hand, will be able to help many Arizonans.  The program essentially incentivizes servicers and lenders/investors (through payments) to modify loans so that monthly mortgage payments end up being only 31% of a borrower's total income.  In order to qualify, borrowers must show financial hardship, but must be able to document their income showing that they will be able to continue to make payments - thus keeping people from participating who are unable to continue own a home.  If borrowers continue to pay on time over 5 years, they will be eligible for up to $5,000 in principal reduction under the loan modification. The modification program is for mortgages originated before January 1, 2009 and runs until the end of 2012.

So if you are a homeowners, you should check first to see if your monthly mortgage payment (the full PITI) is greater than 31% of all of your sources of income.  And if so, you should read the full qualifications for homeowners summarized in the above links to see if you are eligible.

Read more important details after the jump....

RECORD 12% OF HOMEOWNERS WITH MORTGAGES IN DEFAULT NATIONWIDE

The WSJ reported today that a record 5.4 million U.S. homeowners with a mortgage are behind in payments (i.e., in default) or somewhere further along in the foreclosure process by the end of the 4th quarter.  That's 12% of mortgage loans in the U.S., an incredibly high number.  Here is the press release for the study from the Mortgage Bankers Association.

This number is a leading indicator for a continuing rise in foreclosed homes taken back by banks and then eventually dumped on the market - and highlights how important loan modification efforts are to slowing down the real estate crash.  The press release from the MBA notes that delinquencies from the actual mortgage structure (subprime, alt-A, negative amortization, etc.) is starting to dissipate, while foreclosures are expected to remain high due to job losses and other economic hardships.  In Arizona, I expect it to come from people who are very far underwater on their homes and feel like they have no hope for their home to ever be worth what the loan is worth again - i.e., people who simply decide to walk away.

Interestingly, one of the reasons cited in the article for the increase is that borrowers are deliberately stopping payment on their loans in order to qualify for loan modifications - even if they can pay.  This is because banks refuse to even talk to a borrower about a loan modification unless they are seriously delinquent.  So if a homeowner is diligently making payments, but is barely scraping by due to job loss or other financial hardship, they must intentionally default in order to get the bank's attention.

President Obama's new mortgage modification program guidelines released yesterday attempt to mitigate that problem by incentivizing servicers and lenders/investors to modify loans for people who are in trouble, but who are still current on their payments.   I will write a bit more about the new program later.

This nationwide number comes against the backdrop of the following state by state graphic looking at concentration of foreclosures in the U.S.  Not surprisingly, California, Arizona, Nevada and Florida are all above the national average, while much of the rest of the country is below the national average.  Of course, because the national average is rising rapidly, this doesn't mean there isn't a foreclosure problem in states besides those four.  Nevertheless, the bulk of the problem is concentrated in a few states - Arizona among them.

(click for larger image)

Update:  As I indicated above, the continuing problem in Arizona is that massive devaluation (around 50% in many areas) has caused many borrowers to be way underwater on their loans (i.e., house is worth less than the mortgage) and they are simply walking away.  HousingWire reported yesterday that new data shows 20% of all homes with mortgages nationwide were underwater in December.  And of course that number will rapidly increase as prices decline further as expected.  Noted in the Housingwire article is the same concentration in the four states mentioned above.

SMALL BUSINESSES TURNING TO CREDIT UNIONS FOR LOANS

The WSJ has a good article about how start-up companies and existing small businesses are increasingly turning to credit unions for business loans. 

Many regional banks avoided much of the fall-out from the consumer mortgage market - as they sold their mortgages to the big investment and commercial banks or were never really in the business because they couldn't compete with mortgage brokers.  But they did instead do a lot of lending to local real estate developers, who are now defaulting on their loans at increasingly high rates.  This leaves the regional banks with mounting losses and a decreasing ability to provide loans to small businesses.

Credit unions, on the other hand, largely avoided most types of real estate lending according to the article - leaving them in good shape to take up some of the lending slack.  Consumers are increasing their savings rates and are trusting the local credit unions more to handle their money.  So these credit unions are seeing their deposits rise and are able to comfortably lend to small businesses - ranging in amounts from only a few tens of thousands up to $750,000 or more per loan.

So if you are a small business in Arizona with a good track record that has been having trouble securing loans from your usual sources, try calling several of your local credit unions to see if they can provide financing.  And if you need an attorney to help review loan documentation, I'd be happy to help.

BETHANY GROUP APARTMENT COMPLEXES REPORTEDLY IN RECEIVERSHIP

The Republic is reporting tonight that Bethany Group, one of the largest apartment complex owners in Phoenix metro, is losing ownership of all of its 13 local apartment complexes to lenders - affecting over 5,500 apartment units in the Valley.  According to the story, managers at the complexes haven't been paid in weeks, utility bills for complexes have gone unpaid and basic services, like trash collection and landscaping, aren't getting done.  Sources tell the Republic that all employees at Bethany Group's headquarters in Irvine, CA were fired last Friday.

It's hard not to know someone in the Valley who lives in one of these complexes.  In fact, a good friend of mine lives in Scottsdale Springs in Old Town.  Over the last several months, it became very clear that basic services were falling apart - as the weed to rock ratio skyrocketed in the complex.  The managers also seemed at the point of desperation in getting vacant units rented, offering the same rental rate for your choice of size of apartment (1, 2 or 3 bedroom) at prices 20% less than only 6 months ago.  

Rents have been dropping rather rapidly all around Phoenix and this is a prime example of the fallout of that.  Many companies who bought apartment complexes (and other commercial properties) over the past several years did so with fairly high leverage at inflated valuations.  Typically, that lending has certain debt coverage ratio covenants, requiring income at the property to be anywhere from 1.1 to 1.5 times the debt payment.   As rents drop, the income at the property falls to a point where that debt service coverage covenant is breached and the credit facility is in default, allowing lenders to foreclose on the loan. 

The story on the Bethany Group doesn't specify the exact trigger, but in order to take over the complexes it is likely that not only was the DSCR breached, but that Bethany Group was way behind in payments.  Lender typically don't want to be taking back these types of large properties in this real estate environment unless it is the last option.  The end result of this is likely foreclosure by the lenders on the properties and then a sale to a third party.  More details to come, I'm sure, on the identities of the lender(s), clarification on status of the properties, etc.

As for renters, I don't expect them to be affected much, other than perhaps having to deal with a slowdown in property management services for a period of time.  Unlike a foreclosure on a single family home where tenants are typically kicked out, in this case, the lender wants to keep as many tenants in the complex as possible to make the sale to a third party attractive.

ILX RESORTS FILES FOR CHAPTER 11 BANKRUPTCY

Phoenix-based ILX Resorts, a timeshare resorts owner and operator and real estate development company, filed for voluntary Chapter 11 bankruptcy protection today - seeking to reorganize and continue operations. 

From ILX's website:

ILX Resorts acquires, develops, and operates premier timeshare resorts primarily in the western United States that provide its owners with extraordinary vacation experiences. ILX's portfolio of world-class properties includes eight resorts in Arizona, one in Indiana, one in Colorado, one in San Carlos, Mexico and land in Puerto Peñasco (Rocky Point), Mexico and Sedona, Arizona, both of which are in the final planning stages. It also, through Premiere Vacation Club, has acquired, and continues to acquire, inventory at the Carriage House in Las Vegas and in addition has acquired inventory at the Scottsdale Camelback Resort in Scottsdale, Arizona.

No doubt the falling occupancy rate of Arizona's hotels and resorts due to the recession has taken its toll on the company.  From their press release, it sounds like they were also having trouble with their outstanding credit facility - although it doesn't specific what.

VENTURE CAPITAL INVESTMENT DEAL TERMS GETTING TOUGHER

Businessweek in an article this past week documents some of the changes that the pain in the venture capital and start-up company sector are bringing about - particularly in investment terms being imposed on start-ups.  As the economy gets worse and young companies struggle, more investments are down-rounds - or investments at lower company valuations than previous investments.  And the deal terms are getting tougher.  The article shows results from a survey done by Silicon Valley law firm Fenwick & West.  Among the findings:

As venture capital firms retreat and finance fewer deals, the financiers that do move forward are continuing to extract tough terms from the entrepreneurs they go into business with. Of the companies that received financing, 41% of the deals contained "liquidation preferences," or provisions obligating that the most recent investors get their money back first if the company is sold or acquired. That's about the same rate as the previous two quarters.

However, many more firms that do receive liquidation preference are getting "multiple liquidation" preferences, which state that a venture firm will get back as much as two or three times the amount of capital it invested. In the fourth quarter, 23% of the companies that secured preferences negotiated a multiple preference, up from 16% in the third quarter.

Multiple liquidations preferences mean that, for example, a venture capital firm investment $1 million would get paid a multiple of their $1 million investment (up to $3 million according to the study) prior to anyone else getting paid following a sale of the company.  This is a mechanism that venture capital firms use to elevate their return on investment above what they can normally earn simply from dividends on their preferred stock.  It's also a safety mechanism to make sure they get paid whatever money is left if the company liquidates.

Another feature increasingly being used are "pay to play" terms:

When companies can't find new investors to bring into a company, they sometimes will try to corral a new round of financing from existing investors. Some may balk. To force all of the current investors to pony up the money, venture capitalists who are willing to play will create a provision stipulating that if others don't participate, their existing equity, which is usually in preferred stock, will convert into common stock.

So in a given venture investment, there are often several different venture groups that will fund a round of investment (say VC A, B and C).  A "pay to play" provision means that if the company needs funding down the road to continue, can't find new investors and only current investor A wants to fund another round, B and C will have their preferred stock from the initial round converted into common stock and A will end up being the only holder of preferred stock - with its rights, preferences and dividends.  B and C are relegated to the last-in-line status of common stockholder in the case of a sale or liquidation of the company - essentially a punishment for not participating in the latter financing round.

As 2009 drags on, we are no doubt going to see investment terms continue to tighten as venture capital firms use the downturn as an opportunity to extract additional terms and conditions that mitigate their risk and help to safeguard their investments.  Start-ups will have to decide whether to try to tough it out without taking additional funding and its concomitant loss of valuation and control.  In this down economy, however, they may have no choice but to accept the tougher terms in order to just survive.