Sign In     
Big Builder Magazine story on CDDs

Source: BIG BUILDER Magazinebr
Publication date: July 8, 2009
By John McManus

We start here with a dream. The dream was of 1,750 acres near the Gulf side of Florida, north of Fort Myers and south of Port Charlotte. 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, a fitness center, a 60-room hotel, and 85 units of commercial office space. To jump-start 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 Community Development District (CDD) has the financial and operational clout to move a project from a dream to reality, where real people buy the 1,810 or so homes. To do that, the CDD uses power to collect tax payments from the property owner first, the developer, and then the home buyers. The kicker is this: Like a shark has to move constantly and eat often, a new CDD must be propelled forward by new-home demand to live. When growth stops, the youngest of these things die. With assured tax payments from property owners, developers and, one believed, an 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 fronted $61 million for the project's first mortgage. 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, winds up at an advertised foreclosure sale on June 29, 2007, and walks away with title to the entire tract for $100.

What happens when a lawn mowing company picks up title to 1,750 acres for $100? He owes bondholders a lot of money. 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 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, with legal complexities too numerous to go into. Now, multiply the Tern Bay case by 120 or 130, with upward of $2 billion in bond debt collateralizing land that may be worthless or at least worth far less than the face value of the bonds outstanding. It is estimated that 100 to 150 CDDs set up in Florida during the go-go years 2003 to 2007 are either already in distress or are likely headed for default and foreclosure. All told, there are just less than 400 Florida CDDs, with about $8 billion in bond debt outstanding. The highest casualty rate is for CDDs that cropped up during the great real estate surge. Billions of dollars in bond money has been spent on roads, sewer and water, parks, golf courses, etc., on vast tracts with tens of thousands of finished lots ready to go, and going nowhere. The means for bondholders to get their money back has evaporated as paths of growth morphed into trails to real estate paralysis-and the values of everything have plummeted to a fraction of the money spent on horizontal development. Tern Bay is viewed by many as the poster child of CDDs gone bad. The dream is now seen for what it was-a pipe dream-and what it is-a nightmare. Ironically, though, some of the hugeness of the CDD problem in Florida may be its solution, as the massive deleveraging of the economy and resetting of asset values grind toward a conclusion. Take the toxicity out of the asset, and you've got an asset of some value. The big question is: Is an asset worth a dollar in 2006 worth a dime today? Or $0.40? Or $0.85? A CDD's interest and principal payments on bonds come due twice a year, May 1 and Nov. 1, with May 1 being the more important. When things go right, CDDs collect assessments as property taxes and make payments versus "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 up-front dollars so that developers and builders could put in infrastructure.

CDD distress has 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, a no-no that trips covenants. Depending on how bad things get, a CDD may not be able to make its interest and principal payment on May 1. It taps the emergency reserve fund to pay bondholders but then is technically in default. The CDD, working in the interest of the bondholders who are 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, or to take the land 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 for more than 100 CDDs. Still, their future as a sensible financial building block for planned residential development is in question. Part of the irony for home builders is that there's actually a shortage of lots in Florida that can pencil to sell in today's market. If builders could get their hands on at least some of the 80,000 to 90,000 finished distressed CDD lots soon at low costs, they could build and sell highly affordable homes and generate cash to live through another quarter. But pulling CDDs out of foreclosure can take more than 12 months.