Ground Under Repair–Florida’s CDD Comeuppance
As often we do, we start here with a dream. In this case, the dream was of 1,750 acres near the West Coast, the Gulf side of Florida, north of Fort Myers, south of Port Charlotte, i.e. arguably, the middle of nowhere. Starting out as raw dirt in late 2005, it would in the next half-dozen years become a thriving place for 738 garden condos, 504 mid-rise condos, 208 coach homes, 360 single-family homes, a golf course, fitness center, a 60-room hotel, as well as 85 units of commercial office space.
To jumpstart the dream–known as the Tern Bay Country Club Resort–developers set up a local quasi-government that Florida statutes allow to create special purpose districts. This entity, called a Community Development District, has the financial and operational clout to move a project from being mere dream on paper to reality, where real people buy the 1,810 or so homes, and live the American Dream–owning a home in one of Florida’s brand new communities.
To do that, the CDD gets power to collect tax payments from the property owner or property owners—first, the developer, and then, progressively, the home buyers. Other states have an equivalent; California has its Mellow-Roos Community Facilities Districts that act the same way. Texas has them too.
The kicker is this: just like a shark has to move constantly and eat often, a new CDD has to be propelled forward by demand for new homes to live. When growth stops, the youngest of these things die of asphyxiation.
With the tax payments assured of coming in from property owners, developers and, one believed, a seemingly endless flow of new homeowners, CDDs also have the power to issue bond debt on those present and future payments. In 2005, Tern Bay’s CDD issued $58 million in bond debt to fund infrastructure like roads, water supply, sewers, amenities, and to “put down the lots.” The principal contractor to buy the lots and build was Lennar Homes. In addition to the almost $60 million in bond debt, Ocean Bank also fronted $61 million for the project as the first mortgage holder.
Fast-forward two years, to 2007. More than $33 million in development costs later, Lennar cuts loose from the project. Developer Priority Developers walks as well, apparently forgetting to tell the golf course lawn mower service to stop cutting the grass. The CDD starts missing its payment obligations on operations and management, and the project tailspins into default. Said golf course lawn mower service, Hawkins Environmental, Inc., winds up at an advertised foreclosure sale on June 29, 2007, and walks away with title to the entire tract for $100.
Wait a minute. Weren’t we just tallying total debt—bond and bank mortgage–on Tern Bay at more than $120 million? Yes. What happens, then, when a lawn mowing company picks up title to 1,750 acres for $100? Well, now he owes bond holders a lot of money, is what. Clearly, it’s a mess.
“Prior to May 2008, we had exactly one default in all the years we’ve been doing this, and now we’ve got 90-plus that are in various stages of distress,” says Ed Bulleit, a managing director at Prager, Sealy & Co., which has underwritten the lion’s share of CDD bond issuances since their 1990s creation. “When CDDs were set up in the 1990s, they represented a small component of the capital stack available to the developer. Like everything else, they overgrew during the 2004 to 2007 period because of the intense demand for instruments for liquidity.”
For more than a year, Tern Bay has been slogging through foreclosure proceedings, and the legal complexities are too numerous to go into. Now, multiply the Tern Bay case by say 120 or 130 times, with upwards of $2 billion in bond debt at risk, collateralizing land that may be worthless or at least far less than the face-value of the bonds outstanding.
In round figures, estimates of 100 to 150 are number of CDDs set up in Florida during the go-go years 2003 to 2007 that are either already in distress or are likely headed for default and foreclosure. All told, there are just under 400 Florida CDDs, with about $8 billion in bond debt outstanding.
The highest casualty rate is for CDDs that cropped up as scores of new dots up and down both coasts of Florida’s map during the great real estate surge. Billions of dollars in bond money has been spent on vast tracts with roads, sewer and water, parks, golf courses, etc., with tens of thousands of finished lots ready to go, and going no where. The means for bond holders to get their money back has evaporated as paths of growth morphed into trails to real estate paralysis–and as values of everything have plummeted–the land itself is worth a fraction of the money spent on horizontal development.
Tern Bay is viewed by many Florida real estate pros as the poster child of CDDs gone bad. Since reality has scrunched everyone’s rose-colored eyeglasses to a thousand pieces, the dream is now seen for what it was—a pipedream—and what it is—a nightmare. Other CDDs that have hit the wall in Florida include Cordoba Ranch in Hillsborough County, Southern Hills in Hernando, Grand Hampton in Hillsborough, River Hill in Lee County, Bridgewater in Polk County.
Ironically, though. Some of the hugeness of the CDD problem in Florida may be the precise measure of its solution, as the massive de-leveraging of the economy and resetting of asset values grinds its way toward a solution. Take the toxicity out of the asset and you’ve got an asset of some value or other. That’s where the big question is: Is an asset that was worth a dollar in 2006 worth a dime today? Or 40 cents? Or 85 cents?
- The markets haven’t decided on the new value base
- Large bondholders are weighing their options—owning land or cashing out for pennies
- Bank lenders are likely to be wiped out since their debt is junior to bondholders
- Cash vulture investors are circling, awaiting blood
- Mitigation of off-site expenditures need resolving
Mayday Mayday
Mayday comes from the French “m’aidez,” and is globally understood as code for “We’re in big, big trouble here, so help now!” That’s precisely what May Day has come to mean in the world of Florida’s CDDs. Like so many of real estate’s pretty good ideas-gone-terribly-wrong, CDDs’ immediate past has been caught up in a billion-dollar vortex where easy money instantly swung to rack and ruin.
As it turns out, a CDD’s interest and principal payments on bonds come due twice a year, May 1 and November 1, with May 1 being the more important. When things go right, CDD’s collect assessments as property taxes and make payments vs. “A Bonds” from homeowners’ property taxes over an extended period, and “B Bonds” from assessments to developers and builders who are phasing through their plan, usually within seven years.
Last year, things started not to go right, and this year they went wrong. Around May 1 of this year, 80-plus CDDs defaulted on payments they needed to make to fulfill obligations to bondholders who invested upfront dollars so that developers and builders could put in infrastructure.
CDD distress has its phases. When money stops coming in via the tax assessments to businesses and homeowners, the district may no longer be able to pay operations and management fees first. That’s a no-no that trips covenants. Depending on how bad things get quickly, a CDD may not be able to make its interest and principal payment on May 1. They tap their emergency reserve fund so that bondholders get paid, but then they’re technically in default.
The CDD, working in the fiduciary interest of the bondholders as senior to all other debt—including first mortgage bank debt—can decide to proceed toward foreclosure.
What’s likely in at least some of the cases is that the CDD will go from being a paper asset to a real estate asset. Bondholders will need to decide whether to take a little cash and run far away from the instrument, or to take the land just like a bank takes land back as real estate owned, and possibly hold it until volume comes back to normal and it may regain a value.
“There’s no single solution for all of these districts. It depends where they are; how far along in development they are, what the disposition of the bondholder to wait or not is, many, many factors that make each one different when you approach restructuring,” says William Rizzetta, president of Rizzetta & Co., which performs financial and operational management more than 100 CDDs, and is the largest company of its kind.
Still, their future as a sensible financial building block for planned residential development is in question. Who gets burned and how much will no doubt reset risk and reward levels around their use.
Part of the ironic so what for home builders is this: If they could get their hands on at least some of the finished lots soon, for as little as they’d have to pay for them, they could build and sell highly affordable homes and generate cash to live through another quarter. Estimates of as many of 80,000 to 90,000 finished lots are tied up in CDDs whose future remains uncertain.
So, in a sense, while the resolution of CDDs heading to foreclosure can take more than 12 months, there’s actually a shortage of lots in Florida, a shortage of lots that can pencil to sell into today’s market.
In early July, Rizzetta was to host a meeting among the larger CDD bondholders –Goldman Sachs Asset Management, Oppenheimer Funds, Van Kampen Investments, Vanguard, Nuveen, and Alliance Bernstein Investments. “We want to make sure the lines of communication are open and that we’re hearing face to face what the concerns are and where there might be opportunities to work through some restructuring of the bond debt in some cases,” says Rizzetta.
For the bondholders’ part, CDDs were never the sexiest play, although they became kind of flashy during the run up. But while the expectations were never that high, they certainly weren’t supposed to be such big losers. So, the dilemma over whether to hit eject or become landowners will come to the fore as more and more of the districts fail to perform.
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