pre-construction real estate - Posted by Mike

Posted by ray@lcorn on December 14, 2006 at 10:40:05:

Hi Carol,

I remember the guy. Met him at the St Louis convention in 2005 and he was “concerned”. By June at the LW concern had turned to being seriously worried aout losing his house. Ed G probably knows what happened post-hurricane but I haven’t heard.

For more info on the current status of condo markets nationally, the following is anecdotal, but as I read it I was led to consider the words of economist George Stigler, "The plural of anecdote is data?.

[Note: The letter below is from a newsletter I sometimes read, Whiskey & Gunpowder… I’m copying verbatim (ads deleted, contact info for the letter intact), and it pretty much describes what most of us here have been expecting for some time. The reference to an “unconditional” auction is also known as an “absolute” auction, which means the property is not subject to a minimum bid and will be sold regardless of price.]

Whiskey & Gunpowder

Greg?s Note: Mish called me today and shouted into the phone, ?Sold!? while banging a gavel on the phone. Dazed, and with bells ringing in my head, I somehow managed to calmly ask, ?Just what is that all about??

?Auctions,? said Mish, ?I am practicing my condo auction skills.?

?Are condo auctions really working,? I asked, ?and in comparison with what??

Mish responded with a tale of two cities, Tampa versus Key West. Read on and see if auctions are really a success or not, and, if so, how. Please send your thoughts (as well as eardrops) to your temporarily hearing-impaired editor right here:

P.S.: Please send Mish a note and tell him to stick to writing and leave auctioneering to the professionals. My hearing may depend on it.

Whiskey & Gunpowder
December 13, 2006
by Mike Shedlock ~ ?Mish?
Illinois, U.S.A.

Auctioneer’s Perspective

I spoke with Carl Carter, public relations manager for J.P. King, following the auction of 40 condos at The Hamptons at Tampa Palms. 171 bidders from 15 states arrived and 40 units were sold. The planned sale was 40 absolute with another 60 units with a minimum bid. In addition, there were another 160 the developer still owned and wanted to sell. The following are excerpts from that interview:

Mish: Can you describe the auction?

Carter: The auction was in a format called ?high bidder?s choice.? The winning bidder had a choice of condos in pools of similar picks, typically by unit size.

There were one-bedroom, two-bedroom, and three-bedroom pools being auctioned, and the high bidder had his choice of units remaining in the pool.

Mish: How many units of each type were sold?

Carter: 20 two-bedroom units, 15 three-bedroom units, and five one-bedroom units.

Mish: What was the price range on the units sold?

Carter: $130,000-200,000. Total auction proceeds were $5.9 million.

Mish: Does that include auction fees?

Carter: Yes.

Mish: What is the primary reason developers are resorting to auctions right now?

Carter: Condo sales by normal methods are practically dead and carrying costs are eroding the developers? anticipated profits. Sellers are looking for a way to preserve profits or minimize their losses.

Mish: What happened?

Carter: In short, developers overbuilt. The market was distorted by speculators who were flipping units for a quick profit, and that made it look like demand was higher than it was. When the speculators disappeared, reality set in. That reality is coming as a huge shock to many developers and flippers alike: Units are just not going to be sold for prices anywhere close to what was being offered a year ago – no matter what marketing method is used. In many instances, flippers are competing with developers to sell units. This is pushing prices down.

Mish: Is this a Florida thing only?

Carter: No, but Florida probably has the biggest oversupply. We are getting calls from developers every day, and several attended the Tampa auction just to see how it works. Some developers who last year had never even thought about an auction are seriously considering it. We have done condo auctions recently in Door County, Wis.; Austin, Texas; Florida; Alabama; and Michigan.

Mish: What about supply and demand issues?

Carter: Demand is still very weak, and supply is still increasing. From that perspective, it just seems very unlikely that we are close to a market bottom.

Mish: Are you speaking nationally or just about Florida?

Carter: I am speaking nationally, but when it comes to the oversupply, Florida?s the national situation on steroids.

Mish: Was the auction a success?

Carter: Definitely. We had 171 bidders from 15 states – more than four bidders there for every unit we sold. That?s a good turnout, which tells us we got the current market value. The developer would have offered 60 more units if the prices had been running higher. This is simply a weak market. Still, 40 units is a lot of units to move in a weekend, and the developer is happy to have reduced his carrying costs significantly. From the point of view of the buyers, many are pleased with the bargains they received.

In a response to a question as to ?developer interest,? Carl Carter informed me that approximately half a dozen developers showed up to witness the auction. Obviously, those developers wanted to see how things went.

Previous Listing Prices

Carter noted that previous asking prices on the condos were in the neighborhood of $181,000 for the one-bedroom units, $239,000-289,000 for the two-bedroom units,
and $309,000-340,000 for the three-bedroom units. He believed those to be average prices.

A link from NewCondoReality showed prices and numbers of units to be as follows:

1 Bedroom – from $169,000
2 Bedroom – from $220,000
3 Bedroom – from $299,000

As of Nov. 4, there are 70 units out of 300 units already under contract.

Let’s Do the Math

Giving everyone the benefit of the doubt, let’s assume the original prices offered/paid were at the low end of the range, as opposed to the average prices that Carter quoted:

5 one-bedrooms: $169,000 * 5 = $845,000
20 two-bedrooms: $220,000 * 20 = $4.4 million
15 three-bedrooms: $299,000 * 15 = $4.485 million

Total: $9.73 million

Auction total: $5.9 million

Subtracting a 10% auction fee, the revised auction total net $5.31 million to the seller.

Quick math shows that any investor who bought at last year’s prices is now 45% underwater on average, not counting maintenance fees, property taxes, insurance,
interest payments, etc. Note too that the developer is still holding 60 additional units he was hoping to unload at the auction, but failed to. The developer also has an additional 160 units waiting in the wings. Pent-up supply?

The only units sold at the auction were units offered on an unconditional basis (no minimum bid). Inquiring minds might be wondering if this auction was really a ?success.?

Shell-Shocked Comparison

Please consider ?Shell Shocked in Key West? for comparison purposes:

?Before the start of the auction, Slokumb had estimated 100 people would attend the event, but more than 200 showed up, with 58 registering to bid. Many chose to hang onto their bidding cards, and those who did bid were cautious. Absent were ?bidding wars? with people vying back and forth for the highest bid while the price climbs higher and higher. Instead, most were content to let the property go to someone else for a lesser ?bargain.?

?None of the asking prices was met. The closest bid fell $149,000 short, while bidding on the most expensive property, located at South Street, fell more than $2.5 million shy of the almost-$6 million asking price.?

Not a single home sold at that Key West auction. By comparison, the Tampa auction has to be considered a rousing success. How else can one look at it? What was the difference? The difference is “unconditional” versus “conditional.” There was no minimum bid required on the 40-unit J.P. King Tampa auction. There was a minimum bid on the Key West units.

Please note that I am not attempting to make a hero or a goat out of any auctioneer. Some of the terms and conditions of the auction are set by the sellers, not the auctioneer.

Pent-up Supply

Let’s now return to a question I asked Carter:

Mish: What about supply and demand issues?

Carter: Demand is still very weak, and supply is still increasing. From that perspective, it just seems very unlikely that we are close to a market bottom.

Can anyone doubt Carter’s reply? Indeed, 40 units sold, but how many of those were to the next flipper hoping to unload at a higher price? Did this auction, no matter how successful, reduce any supply? Even if it did (which is debatable), what about the condos still under construction in Miami, Tampa, Las Vegas, San Diego, Chicago, Boston, D.C., Seattle, and countless other places?

What have we learned from this?:

? Units will sell at an unconditional vs. a conditional auction
? Conditional sellers are still too stubborn about price
? Anyone “needing” a particular price likely cannot get it
? Condo prices have declined 40% in some locations, and we still are not at the bottom
? Carry costs are mounting
? There is still pent-up supply.

Final Thoughts

Panic has still not set in, but it will eventually. That event could be years off.

Mike Shedlock ~ ?Mish?

How to get your own shots of Whiskey:

Let the Whiskey flow!

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pre-construction real estate - Posted by Mike

Posted by Mike on December 11, 2006 at 01:08:10:

Just listened to J P Vaughan and Justin Ryans presentation on pre construction investing. Sounded interesting and was wondering if anyone here has any experience with or thoughts about what they are selling. Is this a valid means of investing or is it just another get rich quick scheme. (for them) They sell a tour for 4G where you look at properties not yet built, in emerging markets. Then buy a property for 10% down, no payments while being constructed with a supposed equity buildup during the building period. Any thoughts out there?

Re: pre-construction real estate - Posted by ray@lcorn

Posted by ray@lcorn on December 11, 2006 at 16:58:26:


First, I am not familiar with any of the the specifics of the Pre-Construction presentation you mentioned. My comments are about the concept in general.

Pre-Construction Sales is first and always a marketing program for developers. It’s a way to spread the risk of funding, construction and sales of the project among additional parties (i.e. the buyers) that insulates the primary lender and the developer from the consequences of the project failing to perform as projected.

That said, the ultimate success or failure of any real estate project depends entirely on the realized market support vs. the projections. It’s the nature of the game that some will succeed, and some won’t.

In addition to the above development risks, the Pre-Construction buyer takes on the added risk of choosing which projects have the best chance of succeeding, often between competing projects in the same market. It’s not unlike a wholesale buyer of retail products deciding which of many new offerings will fly off the shelves and which will gather dust.

As with any investment, and similar to syndicated partnerships such as LPs or TICs, extensive independent due diligence should be performed on both the promoter and the market before deciding to participate in a particular Pre-Construction Sales project.

Assuming one has a comfort level with the promoter’s competence and capacity, and since the return is dependent solely upon price appreciation, the market factors double in importance.

Among those factors are sub-market location dynamics, competitive properties, market-specific demographic trends and overall economic health. These factors, along with availibility of take-out financing for retail buyers, will control the absorption rate (i.e. sales) and the natural appreciation rate. The combination of the two will ultimately determine realized vs. projected profits.

Again, my comments are directed toward the sales strategy in general, not a specific project.


Re: pre-construction real estate - Posted by Mike

Posted by Mike on December 11, 2006 at 23:00:31:

Thank you Ray for your response. This presentation was linked through the creonline website and deals with the Biloxi Mississippi market which they claim is a emerging (recovering) market. Sounds like a lot of cash is flowing in to the area with some nice tax incentives for stimulation. I wasn’t familiar with this type of investing untill this web seminar so just looking for feedback. Would you, Ray, as a seasoned pro ever invest your dollars this way (if all due diligence looked good) or is it too hands off. Thanks again. Mike

One investor’s experience - Posted by CarolFL

Posted by CarolFL on December 12, 2006 at 20:34:30:

Not mine - but that of a participant in Ed and Terry’s Lender’s seminar 18 months ago - as concerned condos in Biloxi - was devastating. The guys had mortgaged his home in order to do a cple of deals in Biloxi, after having had some success in S. Florida, if I remember correctly. I’ve often wondered if he pulled it off … he was in a world of hurt at the time.
Something to consider.

Re: pre-construction real estate - Posted by ray@lcorn

Posted by ray@lcorn on December 12, 2006 at 16:29:38:


No, that’s not the type of thing that I would buy. Too many things I can’t control, all of which are between me and the money!

As to the GO Zone tax incentives, that’s something I was interested in for obvious reasons. I did a bit of research, and there are three issues that gave me pause.

First, there is some confusion as to the definition definition of “active trade or business” in respect to the GO Zone enabling legislation. According to the IRS and legal writers, it is not certain that property held “merely” for the production of income (i.e. rental units) qualifies. According to the IRS they are seeking guidance on this. (There is an ancillary issue about the limit on passive losses for non-real estate professionals, but it didn’t affect me so I didn’t run it down. See article below)

Second, the issue of bonus depreciation recapture on sale is murky as well. The last IRS bulletin I could find was dated August 14 '06 and states clearly that the GO Zone legislation includes a recapture provision. The direct URL for the IRS memo is,,id=156144,00.html

Last, the easiest way around the recapture provision is a 1031 exchange. But in addressing that issue the answers are also not clear. Specifically, there is a “gray area” (imagine that, the IRS not specific? who knew…) in whether qualified GO Zone property would be subject to depreciation recapture if exchanged for non-qualifying GO Zone property. For more on that issue, see this article from a gulf coast law firm:

Please note: I am not a lawyer or a tax professional nor do I play one on the internet. Consult both if you plan to act on anything mentioned here. My comments should not be taken as an endorsement or non-endorsement of any specific venture or enterprise. These are issues and questions that arose as I considered the GO Zone when enacted earlier this year. I decided against the investment based on my personal criteria, which always includes market factors, tax attributes and competing opportunities.