Entrepreneurs are banking on bursting of realty bubble


GROWING expectations of price slowdowns - or even significant drops in values - in hot real estate markets are stimulating a new sub-industry: entrepreneurs preparing investment funds and businesses to snap up bargains if the bubble bursts.

Yale economist Robert J. Shiller, who forecast the stock market decline and the dot-com implosion in his book Irrational Exuberance, says significant downturns in housing prices in some of the fastest-appreciating markets are virtually inevitable.

Double-digit, multiyear increases 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 isn't making specific predictions about when or how severe the slowdowns will be in these areas, but he is convinced that 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 and is 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 condominium projects in the Miami-Dade County area have sold 70 percent 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, he says. McCabe thinks 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 many sophisticated, experienced investors apparently agree with the prospect he sees. He says he 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 in 2006 and 2007.

McCabe is putting together limited-liability companies for small groups of up to 25 investors to buy new units, some of which haven't been constructed.

The LLCs have minimum share requirements of $30,000 to $50,000 at the low end to $1 million at the top. Their acquisition strategies and financing will depend on the opportunities available but will include holding and managing properties for extended periods or shorter-term ownership followed by profitable resales if the market begins to recover.

The LLCs expect to pay cash in some cases 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 might 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 thinks 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 California, the Washington area, the west coast of Florida and other areas where speculators are active.

In Denver, Tom DiMercurio, a veteran specialist in real estate owned or defaulted properties taken back by banks, also sees a rising tide of distressed property opportunities ahead.

He has started a multicity 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 any significant increase in interest rates will cut short the boom psychology puffing up many markets. That, in turn, he says, "will trigger a substantial increase in REO" available for resale to distressed property buyers 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 much of the problem to mortgage lenders, too many of whom, he says, have come up with what he calls "hairball programs" that allow unsophisticated borrowers to take out loans larger than 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. "That is ridiculous," says DiMercurio.

Ken Harney's e-mail address is KenHarney@earthlink.net.

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