Credit Crunch Impact on the Miami Condo Market

August 4, 2007

Many of you have probably already heard about what happened on Wall Street on Friday. For those of you who didn’t, the Dow Jones Industrial Average posted its third-biggest drop of 2007. Much of the drop occurred in the final two hours of trading. The Blue Chip index dropped 281.42 points. Much of the sell-off was attributed to the credit squeeze that Wall Street is feeling as a direct result of lousy lending practices in the housing market that occurred in recent years.

There were 3 major stories that unraveled throughout the day on Wall Street. The primary story in the morning was that of Bear Stearns. The S&P downgraded Bear Stearns’ rating from stable to negative. That sent shares of Bear Stearns plummeting. It recovered by mid-afternoon but once again sold off as a Bear Stearns conference call began. The CFO of Bear Stearns, Sam Molinaro, was quoted as saying “It’s (speaking of the recent credit crunch) been as bad as I’ve seen it in 22 years. The fixed-income market environment we’ve seen in the last eight weeks has been pretty extreme”. Shares of BSC once again sold off.

The second story to emerge was the reduction of Alt-A loans by major lenders. For those of you who don’t know what Alt-A is, it is a category of lending that resides between prime and subprime lending. Wells Fargo announced on Friday that they would curtail Alt-A lending. Other large banks followed suit. Wachovia announced that it would discontinue Alt-A loans altogether.

A large portion of mortgage loans are categorized as Alt-A. The suspension of Alt-A loans by major lenders means that a bulk of the demand for housing could become nonexistent. A hedge fund representative in New York told me on Friday that subprime and Alt-A represented 40% of the loans in 2006. A local, reputable mortgage broker feels that this number could be as high as 60% in South Florida. The following chart from Credit Suisse illustrates the growth in Alt-A and subprime lending from 2002 to 2006. In 2002, Alt-A represented 5% of loan originations while sub-prime represented 6%. By 2006, Alt-A and subprime loans each represented 20% of the overall loan originations.

The third major story to hit PR newswires was that Wells Fargo would increase their prime 30-year Jumbo rate to 8 percent. Other major lenders followed suit. Last week, a 30-year Jumbo rate could be acquired for 6.875%. That’s a huge increase. Potential home buyers could be priced out of the market.

So why am I reporting this you may wonder. The impact on the Miami condo market is inevitable. Many of the speculators who acquired preconstruction condos 2-3 years ago fall into the Alt-A category. Even if these speculators plan to close on their preconstruction condo units, they may not be afforded that opportunity. Major banks have begun to shut off the valve to extend credit to even the most credit-worthy. If this happens then the fall-out on Miami condos could be grim at best. These practices, however, will return full circle to the banks who loaned money to developers. If banks shut off Alt-A loans then investors will be unable to close on condo units which will mean that developers will get back a larger percentage of the total units in the building. Developers will then be unable to make payments on the loan and they’ll eventually go bust. Banks who shut off the valves will push the pain onto the banks who made these loans. I know that Corus Bank, a publicly traded company, was a major lender to condo developers in Miami. (You’re welcome for that information).

The good news is that smaller banks will fill in the gap to lend money to Alt-A borrowers. The bad news is that interest rates quoted to home buyers will be higher. The higher rates will price out potential condo contracts holders who plan to close or will lead to higher foreclosure rates down the road. If I were closing on a condo within the next 60 days then I would definitely contact a reputable mortgage broker ASAP to have them lock you in at a good rate. Who knows where rates will be in upcoming weeks. I can definitely point you in the right direction if anyone needs guidance in this matter.

Many feel that a rate cut by the Fed is inevitable. We should see one very soon.

Follow-up: A late story emerged on Friday, after the markets closed, that Option One Mortgage Corporation is ceasing all loans “secured by condos in Florida”. Option One is a top-10 non-prime lender and subsidiary of H&R Block. I don’t even want to think about what will happen to the Miami condo market if other major lenders follow their lead. I’ll leave it at that.