Market in Decline

Puerto Vallarta Speculative Boom Peaked in January, 2007

Using methodologies similar to the S&P/Case-Shiller® Home Price Indice published in the United States, HSC Financial is reporting that the Puerto Vallarta real estate market for recreational properties is officially in decline.

Prices are off by 5-20% since peaking in January, 2007, depending on location.

A number of projects have been pulled from the market including Monte Verde. Sales at major projects, such as Penninsula Tower III, have stalled. At least 3 years of supply of product is presently available.

The Puerto Vallarta market is following a very similar trend that we reviewed in Hong Kong SAR (1997-2003), Toronto, Canada (1989-1996) and Mont Tremblant, Quebec (1999-2007).

The absence of disclosure by developers and other stakeholders in Mexico make it very difficult to assess the potential downside in Puerto Vallarta presently nor the possible length of the decline.

Updates

Penninsula and Grand Venetian

The beaches of the Penninsula and Grand Venetian abut the Pitiall River. The Grand Venetian also abuts the beach of the Holiday Inn.

This weekend, about 40% of the Holiday Inn beach and waterfront collapsed into the Pacific Ocean. The collapse covers an area about 50 meters wide and 150 meters long. Initial assessment is that the collapse was due to the diversion of the Pitiall River recently completed in order to build the Grand Venetian and Penninsula projects. The river diversion resulted in a water table that was supporting the sand and rocks of the waterfront above it to dry up.

The collapse is yet another risk added to the Penninsula and Grand Venetian Projects.

Icon Vallarta

We were advised by Icon Vallarta that Tower 1 was sold out. We have now been advised that 36 prospective purchasers of the 112 units in Tower 1 have asked for their deposits back. We have also been advised that the sales contracts for Tower 1 were provided to purchasers with a condition that they be signed without a lawyer's review. And that the sales contract includes a provision allowing closings to be pushed out from the initial deadline of December 2009, for a full year without penalty to the developer.

We continue to recommend that any purchaser of Icon Vallarta request their deposit be returned.

Friday, November 16, 2007


Icon Vallarta

The marketing fact sheet reads "Icon Vallarta designed by Yoo by Stark another Related Group project co-developed with Grupo Chartwell."
If that marketing blurb wasn't confusing enough, so is trying to get discloure about prices, condominium budgets, delivery schedules and financing.

The Related Group is a Miami based, privately-owned, development company with several successful projects in Florida. Related has decided to expand in Latin America through Related International. Given the nature of the US housing market, particularly in Related's core market of South Florida, Related might benefit from focusing only on selling unsold inventory in South Florida.

Related's business model is to introduce a multi-phase project with low prices and low deposits on day 1, and then increase prices on a daily basis. Related keeps deposit requirements as low as their bank will allow in order encourage speculators and create the impression of selling out as fast as possible. The result is that Related is selling to clients for whom they know will lack the financial resources to close or simply have no intention of closing. This business model is precisely why the US housing market is now in so much trouble. Buying into a Related project is like buying a plane ticket. The guy beside you might have paid 50% what you paid, or 200%. And everyone paid with a credit card. But many of the buyers won't be able to make the monthly credit card payments. Related's target market in its key South Florida market are speculators. These are investors who hope to buy condos for as little down as possible and then sell them before they ever have to pay for closing. If prices go up, these guys flip and make money. If prices drop, they walk away from their deposit and the developer gets to sell into a declining market through an auction system. It is estimated that 50% of all condominiums in the Miami area that are completed within the next 18 months will be in Related projects. And many of these Florida condos will never be occupied. The problem is that Florida real estate prices are plummeting, down 30% in the past year in some markets. Related will be left with a large number of units where investors either walk away from their deposit or simply lack the financial resources to close. Related will have to sell those units via auction. And auction prices are typically 40% below original sale price.

Icon Vallarta was planned before the recent problems in US real estate surfaced. Icon is supposed to be a 3 tower, 336 unit project. Related used the same business model to "sell out" Phase 1 in Icon Vallarta as it used to sell its recent Florida projects. Published entry level prices were $240M to $300, but we are aware of buyers paying as little as $190M. Although Related claims to have sold out Tower 1, Related will not provide any information about the profile of the buyers or how many buyers purchased multiple units. We are of the opinion that some of the building contractors bidding on construction were required to buy units in Tower I to secure construction contracts. Usually the contractor is required only to place a small deposit and to defer all further payments until closing. This type of purchase does not have to be disclosed in Mexcio. It artificially creates demand and creates the false impression that there are many interested purchasers.

We have attempted to get full pricing disclosure from Related for Tower II. The best we can acheive is being told that buyers in Tower II will be offered units from $300,000 to $1.3 million. Related will not put anything in writing. Delivery of units in Towers I and II is expected sometime in late 2009 to middle 2010. No budgets have yet been developed. Related will say nothing about financing other than a $10,000 deposit is needed at the time a contract is signed. Related appears to require about 30% prepayment over the construction period, with 70% at closing.

Related's marketing material references a designer called Yoo by Starck who Related claims is world renowned. I asked my New York-based, self-described design-nerd expert about Yoo by Starck. He had no idea what I was talking about.

The project will likely be built, so construction risk is limited. But everyone will eventually be taking write downs on this project when it is completed in 2-3 years. Better to wait 3 years and buy for 30% less than existing rumoured prices today.

Even experienced speculators will be taking a hair cut on this project. US investors have bought into Tower I relying on their US experience as speculators They will eventually find out that when they flip/close, they are going to have to pay 8% in closing costs (compared to 3% in the US), as much as 8% in real estate sales commissions (compared to 4-6% in the US) and be liable for the new capital gains tax, only last year introduced to Mexico.

I have only ever reviewed two condominium projects more risky than Icon Vallarta. They are the Toronto Sliver project, now renamed 5 King Steet, which was built and is now under a complete financial restructuring, and the Toronto Sapphire Tower, which failed and will not be built.

Recommendations:

Existing Purchasers: Request initial deposit be returned

All Others: Pass

Sevla Romantica

Sevla Romantica is a 90 unit, series of low rise buildings in the heart of Old Town and Zona Romantica. The project can now be considered complete.

The project was pre-sold starting in 2004 with very attractive initial pricing. Studio units sold for about $109M and 1-bedroom units for $225M, unfurnished. By mid-2006, furnished studios were selling for $200M+ and 2-bedrooms for $240M. Prices have been stable for the past year, maybe up slightly for studios, down slightly for 2 bedrooms. Prices have remained high because this is a very attractive rental building. Very few listings and sales have been reported.

Since the project is complete, there is no delivery risk. We have no reports of any construction deficencies. However, the final building in the project is not brand new, it is a reconstruction of an existing building and requires its own inspection before an offer is made. Maintenance fees are about $250 monthly for 2-bedroom units. Operating risk (the risk of maintenance fees rising faster than inflation) is low. Almost all common elements are outside and require low maintenance. On-site staff requirements are very low.

There is a semi-formal rental program and rental opportunities are far higher than average. Two-bedroom units are, in some cases, generating over $20M net income per year.

Parking spots are deeded. We have a report of one owner selling with the claim that buying a parking spot is not necessary since there are many "empty" spots to use. These spots may be empty but they are owned, and simply owning a condo in the building does not allow an owner access to "empty" parking spaces. Parking in the area is very limited so if a parking spot is needed, insist on it being part of the purchase with a deed provided.

We are waiting for confirmation that condo deeds have been provided with no conditions, prior to issuing a recommendation.

We expect to recommend hold/buy with a requirement that the final building have specialized inspection.