It is the new lamento borincano: not being able to count on home appreciation any longer for future financial needs, the result of several long-term trends just now beginning to sink in. The implications for the economy as a whole are huge.
The numbers are daunting. There are 260,000 empty housing units in Puerto Rico, nearly triple the historic norm, following the biggest construction bubble since home building began in earnest in the 1940s. New construction and foreclosures inflate that number every month.
Yet, with more than 200,000 people having lost their jobs in the island's five-year recession-turned-depression— with the economy offering few signs of recovering those jobs and incomes anytime soon—plus a population that nosedived this past decade by 150,000 and continues to age at a record pace, there are scant few people buying.
The combination of few buyers and a flood of sellers equals falling home prices. The extended slow recovery, stiffer federal regulations on condominiums, and continued aging and population loss mean home values likely will continue to fall or remain stuck for several more years before showing signs of life, depressing returns on real-estate investments and hurting the confidence and spending power of consumers who do own a home.
In the more immediate term, the expiration of government incentives that have led to a spike in home sales in recent months, and still-restrictive mortgage lending by banks, will only exacerbate the crisis.
The result is that housing, a sector that has contributed to economic recoveries in previous cycles, won't do so this time around.
There are more than $17 billion in loans secured by family residential properties in Puerto Rico. According to the 2008 State Handbook of Economics, Demographic & Fiscal Indicators, properties in Puerto Rico have declined in value 8.5% over the past year and a total of 14% since it speak. This represents a loss in value of almost $2.4 billion in homeowner equity.
"We all grew up under the belief that real-estate values, specifically residential properties and raw land, would continue to grow exponentially forever; that the house we purchased in Cupey in 1970 for $30,000 would be worth $300,000 in 2010; that the condominium in Condado that we bought in 2000 would be worth twice as much in 2010; and that the $5,500 houses in Puerto Nuevo and hundreds of similar developments built in the 1950s and 1960s—acquired with great sacrifices by our displaced jíbaros— would now be worth $150,000, if not more," commented Francisco Arriví, president of Pulte International Caribbean Corp., as if articulating the new lamento borincano of our time.
Perhaps the biggest single factor that drives nearby home values down are foreclosures. A recent stateside study by Massachusetts Institute of Technology, which provides a good yardstick for Puerto Rico as well, concludes a neighbor's foreclosed home can slash the value of homes within 250 feet of the foreclosed properties by an average of 27%.
"The growing inventory of defaulted mortgages continues to weigh down any recovery in the housing market. Problems in housing markets can impact economic growth," said Federal Reserve Governor Joseph Tracy in his economic outlook for 2011.
GLUT
Despite the local government's September 2009 implementation of one of the most aggressive housing incentives in the world, only 15,392 housing units have been sold according to government statistics. This represents an average of 770 houses a month or 9,240 a year.
In 2009, nearly 5,000 new housing units were sold. That fell to roughly 3,000 last year, according to the Housing Finance Authority, and industry observers expect sales of 2,000 or so new housing units a year for the coming years.
With approximately 15,000 to 18,000 new housing units constructed or substantially completed at present, that translates into a seven-to 10-year supply of new inventory in the housing sector, on top of the 260,000 already flooding the market and the new units to be built above demand going forward.
Continued overbuilding, that is, is only making the problem worse.
THE 272,000 MISREAD
Developers take five to seven years to build a project from the conception phase to final permitting and delivery to the buyer. Therefore, much of the current inventory was conceived from 2004 to 2006.
At the time, developers not only had no way of anticipating the recession would turn into a
depression, but neither could they also have known the U.S. Census and Puerto Rico Planning Board would miss the mark so badly on the island's population estimates for the decade, which is one of the principal indicators developers use to determine the future market for buyers.
As recently as 2005, both entities estimated Puerto Rico's population would reach 4,022,500 by the end of the decade. As it turns out, the 2010 Census placed the population at 3,750,500, or a stunning 272,000 fewer residents.
In 2000, there were
1,418,476 housing units in Puerto Rico. Ten years later, and despite the fact the population had decreased, an additional 118,469 units were constructed, representing an additional 15.4% available housing units.
To be sure, while the population estimates contributed to the overbuilding, the banking industry and development community aren't completely devoid of fault.
The Census Bureau presented a clear description of the percent distribution of households
by income in 2006, indicating that 85.3% of all households in Puerto Rico had an income of less than $50,000, and 62.7% of all households had an income of less than $25,000.
That means the primary market for housing should have been directed at the market segment capable of paying $650 to $1,300 a month in mortgage payments, or homes in the $100,000 to $250,000 price range.
Instead, developers flooded the market with units worth more than $300,000. Thanks to the five-year recession, the gap has only widened, since the number of households earning less than $50,000 is now substantially higher than the 85.3% reported in 2006, leaving even fewer high-end buyers.
"In 2006, new-home sales were 13,500, of which 57% were less than $200,000," stated Silvio López, executive vice president of Banco Popular de Puerto Rico's construction- lending group and former head of Popular Mortgage. "Currently, 60% of the existing inventory is in units priced more than $300,000, not to mention the thousands of properties in foreclosure or in the process of foreclosure," López added.
FALLING PRICES
Throughout Puerto Rico, the median list price of properties dropped 8.5% from the same period last year. The current median list price of a property is $215,000, down from its peak within the past three years of $250,000 in July 2009. This trend is consistent among single-family detached homes (SFDs) and condominiums.
Condos peaked in July 2009 with a median list price of $270,000, and single-family homes also peaked in July 2009 at $247,000. Both are currently at their three-year low—$235,000 and $205,000, respectively.
The trend is consistent across the island. The hardest-hit area has been the east coast, where Fajardo has seen house values plummet 34.8% over the past year. The median list price of a property in Fajardo was $200,000 in November 2009; it is currently at its lowest list median price over the past three years at $123,300. The median peak price for SFDs reached $200,000 in August 2009 and is at one of its lowest points over the past three years at $114,000. Condos reached a median peak of $265,000 in June 2009 and now is at its three-year low of $185,000.
San Juan and Ponce have been similarly impacted, with decreases in property values of 23.5% and 24.1%, respectively. Carolina was less severely impacted, with a decrease of only 9.1%—a modest contraction compared to the 40% drop experienced by Coamo over the past year.
ADJUSTMENTS BY BANKS
To attract buyers to its own foreclosed properties and others in the market, banks have raised eyebrows with mortgage deals viewed with concern by some industry observers.
Although the economy in Puerto Rico has been stagnant over the past six years, it hasn't been as hard hit by the subprime-mortgage crisis as in other parts of the U.S. However, this may change soon. Banks that have financed construction projects of condominiums and housing developments are beginning to offer creative financing incentives to buyers reminiscent of the deals that created the mortgage crisis in the States and almost led to the collapse of the entire financial system.
To avoid high initial mortgage payments, it is now common for banks to offer 2.99% financing for the first five years on 40-year nonconforming mortgages. After the first five years, the interest rate on the mortgage increases to 5.5% to 6%.
This has a significant impact on the monthly mortgage payment. A $289,000 loan financed at 2.99% has a mortgage payment of $1,121. Once the rate increases, the monthly payments go up by more than 50% to $1,829—precisely the terms that led to massive foreclosures in the States.
By contrast, the mortgage decline in Puerto Rico thus far has been the result of a contracting economy and a decrease in consumer purchasing power over the past five years.
The fear now is that these lenient mortgages will be thrown into foreclosure and the toxic-asset column if consumers are unable to rebound during the coming sluggish recovery and extended job shortage, making the housing crisis worse still.
A nonconforming mortgage is a term for a residential mortgage that doesn't conform to the loan-purchasing guidelines set by the Federal National Mortgage Association/ Federal Home Loan Mortgage Corp. (Fannie Mae/Freddie Mac). Mortgages that are nonconforming because they have a dollar amount over the purchasing limit set by Fannie Mae/Freddie Mac often are called "jumbo" mortgages. Mortgages that are nonconforming because they don't meet Fannie Mae/Freddie Mac underwriting guidelines (such as credit quality or loan-to-value ratio) are often called "subprime" mortgages.
Nonconforming loans must remain in a lender's portfolio, or be sold to other companies who purchase nonconforming loans, or be securitized, with the securities being sold to investors seeking nonconforming mortgage-backed securities. Consequently, a premium is paid by those obtaining nonconforming mortgages, generally 0.25% or 0.5 points more than the same loan would cost if it were conforming. The loan amount is adjusted every few years depending upon the average sales price of homes in the U.S.
When the value of a property used to secure a mortgage loan is less than the outstanding balance on the loan, the loan is said to be "underwater," or to have negative equity. The past decade of high loan-to-value lending and 100% financing on nonconforming loans, combined with the sharp decrease in property values throughout the island and the stagnant economy, could be components of a perfect storm, which will lead to a further spiraling of property values.
In the owner-occupied housing market, a drop in the market value of a mortgaged property has the potential of leaving the owner with negative equity. If the borrower defaults on the loan and the bank repossesses the property, the sale of the property by the lender won't generate enough cash to pay off the mortgage, and the borrower will lose the property and still be in debt.
ADJUSTMENTS BY DEVELOPERS
Developers, meanwhile, are making adjustments of their own. Topping the list is a slash in prices of as much as 50%.
In other cases, developers have had to redesign their unconstructed units, reducing their size and the price of remaining subdevelopments.
Developers of high-rise condos and high-end properties have resorted to renting new units with the option to buy. This option wasn't available in the past and is a great opportunity for a buyer to sample a property without committing to buying it. It also provides developers with a revenue stream and populates developments that had fallen to ghost-town status.
Some developers have nearly completed properties and nearly no sales. A recent trend has been utilizing completed portions of a development to generate income until property sales materialize. An example of this is a high-rise condo in the Hato Rey sector of San Juan that operates the building's residential parking area as a commercial parking lot. This provides the developer with some minimal cash fl ow to cover expenses from what otherwise would be an unused space.
Recently, Banco Popular, in conjunction with Sheldon Good & Co., held an auction with no reserve (meaning no minimum amount the property could sell for). A total of 51 units were sold and an additional 117 offers to buy were received from interested buyers.
More than 175 potential buyers attended the auction, each of them had been pre-approved by Popular Mortgage and were required to bring a certified bank check for $5,000. All properties offered for sale were developer-owned and originally priced from $275,000 to $511,000.
John Cuticelli, CEO of Sheldon Good & Co., expressed satisfaction with "the reduction in inventory as a result of the sales made."
Real-estate broker & professor Alfredo Rivera Pizarro said, "A novel approach that could be taken by the government to stimulate resort- property sales is to engage in trade missions similar to ones taken to attract foreign capital into manufacturing products in Puerto Rico. The government spends millions attracting tourists to visit the island. We should spend at least the same encouraging foreigners to consider Puerto Rico as an ideal location for their vacation homes."
FRACTIONAL OWNERSHIP
Yet another adjustment has been made by people themselves. The practice by family and friends to share ownership of a vacation property has been around for many years. These first fractional developments recognized that people didn't want to buy whole homes, which they would only use for a few weeks a year.
According to research firm Ragatz Associates, there were more than 250 fractional developments in North America in 2006, and fractional properties now can be found throughout the world.
Fractional ownership divides a property into more affordable segments for individuals and also matches their ownership time to the actual usage time. A fractional share gives the owners certain privileges, such as a number of days or weeks when they can use the property.
In addition to luxury, private-residence clubs, single "stand-alone" vacation homes and condos can be converted to fractional ownership. This fractional home-conversion process can be accomplished by any knowledgeable seller or through a fractional-consulting company. The benefit of fractional home conversion includes the ability of homeowners to keep a portion of the ownership for themselves, pay off debt and reduce expenses.
TOP-10 MUNICIPALITIES WITH HIGHEST VACANCIES
San Juan has the largest number of vacant units of the total available in the municipality. Despite losing almost 40,000 residents, or 9% of its population, an additional 17,807 housing units were constructed in the city in the past decade. The capital city had a housing vacancy rate of 11% in 2000 and now has a vacancy rate of 21%, or 34,599 units.
Rounding out the top-10 municipalities with the highest number of unoccupied housing units are: Carolina with 12,650, or 15.8%, of its total housing units; Cabo Rojo with 10,390, or a whopping 34.4%; Ponce 9,581, or 13.8%; Bayamón 9,226, or 10.7%; Caguas 7,098, or 11.8%; Mayagüez 7,020, or 16.4%; Arecibo 6,674, or 15.4%; Humacao 6,320, or 22.5%; and Fajardo with 5,469, or 28.2%.
It is obvious larger municipalities would have a larger absolute number of unoccupied housing since they have a larger number of Puerto Rico's total housing units. However, closer analysis presents a different scenario for smaller municipalities. In the States, unoccupied housing averages about 14%.
TOP-10 MUNICIPALITIES WITH HIGHEST PERCENTAGE OF VACANCIES
In Culebra, 854, or 53.3%, of its total housing units are unoccupied. This is followed by Rincón with 3,696, or 38.1% vacant; Cabo Rojo 10,390, or 34.4%; Vieques 1,875, or 33.8%; Luquillo 3,666, or 33.4%; Ceiba 2,542, or 32.8%; Fajardo 5,469, or 28.2%; followed by Guánica with 2,443 units, or 25.3%.
Humacao and Río Grande complete the list of the top-10 municipalities with the highest percentage of unoccupied housing units at 22.5%, or 6,320, and 22.3%, or 5,430, respectively.
"The critical situation of unoccupied housing units will continue to put downward pressure on housing values and prices in Puerto Rico. Residences are the principal asset of the Puerto Rican family, which own a larger percentage of their homes than in the States," commented Héctor Luis Acevedo, former San Juan mayor and secretary of state. He is engaged in current housing dynamics in his current work on political redistricting.
WHAT'S NEXT?
The government currently is winding down one of the most aggressive housing-purchase incentives ever attempted. Although encouraged by the results of the initiative, housing sales are nowhere near where they were during their peak in the past decade, and when the incentives expire, the market only will return to the unhappy fundamentals outlined above.
Still, inventories in certain market segments are beginning to see full absorption. For instance, developments such as San Juan View, Puerto de la Bahía (San Juan), Arboleda (Humacao) and Puerta del Mar (Aguadilla), all priced in the $100,000 to $200,000 segment, are close to sold out.
Meanwhile, sales of high-rise metro condos are on the increase, even though the bulk remains vacant.
By all accounts, it will take a multilateral effort on the part of the government, banks, municipalities and developers to create the necessary environment to stabilize the housing market.
Further price reductions will be necessary in the high-end segment to more closely align supply with demand, experts believe.
Mayors of metro areas will have to work to make it attractive once again for people to repopulate the cities. The rising gas prices and ever-increasing traffic problems could help in this regard.
Foreclosures and negative equity must come down. A recent government program aimed at mitigating foreclosures ran out of applications only days after it was announced, and industry executives are suggesting additional programs along these lines must be implemented.
Finally, "it is the economy, stupid," to adopt the famous phrase coined during the 1992 U.S. presidential elections. The housing industry is counting on job and income growth to turn things around and create greater demand, which is perhaps the biggest reason to feel cautious, given the slim chance of that happening anytime soon.
