Monday, November 21, 2011

Condo project appraisal in Cozumel

I am currently revisiting a condo project in Cozumel, Mexico, that I appraised three years ago. Cozumel is an island off of Mexico's Yucatan peninsula, a land full of lush tropical jungles and Mayan pyramids.

This particular condo project had a successful, sold-out first phase, but by late 2008 it was apparent that many vacation condo projects all over the world were in trouble. Many condo projects that I was visiting had stopped making sales altogether.

This project in Cozumel was faring slightly better; its rate of sales was down only 50% due to one of Cozumel’s unique attractions– it is a mecca for scuba divers from all over North America. Condo buyers at this particular project were typically both doctors and scuba divers, and the recession had hit this population subgroup less severely. Still, the forecast of a prolonged absorption of the unsold units resulted in a decision to not fund the construction of another phase. It was hoped that another lender would step in, but as can be seen in the photo, construction has been halted since 2008.

General worldwide conditions for vacation condos

The last three years or more have been difficult for second-home markets all over the world, as I have witnessed in such far-ranging locales as Barbados, Fiji, the Dominican Republic, Costa Rica and Canada.

Many of the failed overseas second home projects were high end luxury projects focused on a growing number of “multi-millionaires” in the world. Each project tried to achieve a certain prestige by promising top shelf amenities vital to the ultimate success of such luxury projects.

Unfortunately, the market for vacation real estate is discretionary, and the purchase of vacation real estate has moved further down the priority scale for a large number of potential buyers. For instance, one of the main motivations for the purchase of vacation real estate has been the potential for financial return from the investment. While there were forces in place for price appreciation in advance of the recent financial crisis, buyers now recognize that the potential for appreciation of luxury second homes has significantly deteriorated. As for the ability subsidize ownership costs or earn a return on investment by renting out one’s property, a worldwide oversupply of vacation homes is driving down returns on investment.

Another concern from likely buyers relates to the continued financial viability of substantially unsold projects, and the risk of promised amenities not being built or else operating at a substantial deficit which would require increases in homeowners association dues. For instance, many golf course sales nowadays are to homeowners associations trying to rescue an affiliated golf course from bankruptcy. That often requires a substantial increase in POA dues.

In addition, the allure of owning a home in high-end vacation communities comes from the prestige of belonging to a successful community. The financial distress and litigation associated with an unsuccessful project may instead have the opposite impact. Being associated with a troubled project affects the psychology of potential luxury real estate buyers. Instead of looking savvy, a purchaser could now look naive. This makes the proposition for purchase due to a project’s prestige more difficult than before.

The valuation of a failed project is exceedingly difficult, as it typically takes several years to get such a project restarted if at all. Patient capital is required, and it is difficult to construct a discounted cash flow model that can correctly forecast the timing of the project’s turnaround.

Other Yucatecan ruins

The following photos are of ruins left behind in Cozumel by a post-Mayan race of people known as "speculative real estate developers".

Next stop: London
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Sunday, November 13, 2011

South African update: Will the ouster of Malema stop the decline in farm values?

In my last report on South Africa, I mentioned two possible factors in the price decline for South African game farms. One factor was the overall world surplus of vacation properties for the super-rich, and the second factor was political rhetoric calling for uncompensated government expropriation of white-owned land, rhetoric amplified by a rising star in South African politics, Julius Malema, the ANC’s Youth League President. Last Thursday, Malema was removed from his position and suspended from ANC for five years for bringing disrepute to the party, because of his divisive speeches within South Africa as well as his interference in the politics of neighboring countries. He has been constantly opposed by President Jacob Zuma.

The removal of Malema may help restore investor confidence, although the Johannesburg Stock Exchange All Shares Index was up by less than one percent after his sacking. The JSE AS index was hit hard earlier this week by a sovereign ratings downgrade from Moody’s.

Expropriation of white-owned properties

Confiscation of white-owned properties occurred during the 1990s in nearby Zimbabwe (formerly known as Rhodesia) and has resulted in a decline in agricultural productivity there and an overall implosion of the economy after a period of hyperinflation.

At end of the Apartheid Period of South Africa in the 1990s, 87% of commercial farmland was white-owned, and the new ANC-led government pledged a compensated program of land redistribution that would transfer 30% of white-owned land to blacks. Progress has been slow, and whites still own 84% of commercial farmland.

It is difficult to calculate the effect of the removal of Malema in restoring real estate market confidence. The ANC Youth League which he presided over still insists, after his ouster, on the nationalization of mines, a similar issue, and this matter is still being actively studied by the African National Congress despite the insistence of national leaders that it would never happen.

One problem also besetting the agricultural sector is the reportedly high murder rate of white farmers, most who are allegedly killed during ordinary robberies rather than politically motivated violence. More than 3000 farmers are alleged to have been murdered so far, a very alarming number, and Malema's removal will have little effect in stopping this trend.
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