Condotels Are Going to Hell: Cay Clubs Gives "Investors" Another Reason Not to But a Condotel Unit

Cay Clubs Non and Late Payments to 140 Investors Shows the Downside of Investing in Florida Rental Schemes

I have been alluding to big "local" developers' growing problems in the Keys. And as soon as I find time, I will be showing photographic proof how badly their bets are going.

Many of these developers tore down longstanding hotels which had high occupancy rates and built expensive condos in their place which people could buy and have the condo-management team . . . assembled by the developers . . . rent out for income producing purposes.

In the past three months, my brother-in-arms blogger in the Keys, Cayo Dave, alerted me to the problems of out of town developer, Cay Clubs, was having in the Keys with his short piece Has Cay Clubs Bit Off More Than It Can Chew? In this piece, Cayo Dave explained how Cay Clubs was forced to cut 80 jobs in the Keys due to what Vice-President of Operations, Dave Rego, wanted us to believe was an upcoming merger with Keys Acquistion Company Corp.

Cayo Dave quoted Dave Rego on Cay Clubs's intent to "go public" (i.e. list publicly traded shares of a company on a stock exchange) with the following, "It is a down market. Several developers across the country are going out of business," Rego said. "We need to make sure we can prosper through a down market so we're one of the companies that stay in business."

But as Cayo Dave and I both believe, there is a major systemic change for reality based Real Estate pricing in this crashing market. You cannot keep the Ponzi Scheme alive if inventory continues to spike upward, prices continue to contract, and consumers are stretched thin and cannot continue vacationing in Florida . . . especially at higher priced Condo and Hotel prices.

I reprint parts of Cayo Dave's blog to show how he was having none of the "calming effect" b.s. from Cay Club's VP of Operations.

As Cayo Dave so eloquently explained,

Cay Clubs is now among the largest developers in the Florida Keys. The question that we should be asking: "Have they bitten off more than they can chew?. And what effects will it have on the Keys should Cay Clubs and it's new parent company become financially unstable?"

Cay Clubs, only recently formed in the past decade, is betting that people will continue to buy expensive second homes, boat slips, and condominiums. Plus, they recently acquired the Turtle Kraals, Half Shell, and A&B Lobster House restaurants.

Remember, during the go-go-go real estate craze of the past few years, hotels in Key West were being bought up, closed, and turned from transient rentals to condominiums. Now that buyers are nearly non-existant, what will happen to the hundreds of hotel rooms stuck in limbo? What if the whole enchilada goes belly up....will we be left holding the bag?

With most of the Cay Clubs holdings in Florida, aren't they particularly sensitive to market shocks? Since Florida is suffering the biggest declines in real estate, should we worry about one of the largest developers here in our backyard? Think about this: in only the past 2.5 years, Cay Clubs has aquired at least 8 Florida Keys locations.

Well, let's look at today's Miami Herald to see how one lucky couple feels after buying the b.s. "investment theme" by purchasing a Cay Clubs Condo in Orlando.

The story is titled "Housing's ills imperil condo deals"

And here is the heartbreaking lead paragraphs directly from the story as written by Douglas Hanks of the Miami Herald:

Horacio and Patsy Parra cashed out two retirement accounts last year to buy an Orlando condominium they couldn't afford.

At the time, they weren't worried. The developer, Cay Clubs Resorts & Marinas, agreed to lease back the $307,000 unit for 15 percent of the sales price -- enough cash to cover the mortgage for nearly two years.

But the Parras now expect to lose their unit to foreclosure, they say, because Cay Clubs owes them about $40,000 in unpaid rent.

Let's stop right there.

The Parras only paid $307,000 for the unit up in Orlando which their friendly developer, Cay Clubs, agreed to lease back for two years at 15% of the purchase price. (I italicized the word only as most condos in the Keys are selling for above $1 million.) Cay Clubs would then "rent" out the condo to vacationers and keep anything over and beyond what they were to owe the Parras.

Doing simple math in my head, the Parras should have received over $45,000 in "rent" on their lease agreement with Cay Clubs and are claiming they are owed about $40,000 in back rent now.

Seems to me Cay Clubs may have started making payments but suddenly stopped. Why?

Well, as an observer of Key West condotel conversions, I'll bet what has gone wrong in Cay Clubs inability to pay the Parras what they owe them is vacationers cannot afford higher Cay Clubs unit rents in a town where they are already paying $100 a day or more for tickets to Disney World. And another point is this: inventory of rental properties is flooding the market. If you want to rent in Vegas or Orlando, there is so much oversupply of rooms to rent you need only go to priceline.com and name the price you are willing to pay, or, you can try hotels.com and shop for lower rates. I've seen ticket books for hotels advertised on I-95 advertising Kissimmee motels going for $39 a night.

The Internet is the new boxing ring for hotels and motels to slug it out to attract customers. Room rates on the many websites I've been surfing are fast coming down. In Marathon, Islamorada and Key Largo, for instance, Cay Clubs have dropped their prices on some units to $89 a night on weekends. In the Keys, Cay Clubs is now undercutting big chain hotels, hoping to put some heads in their empty beds.

(Next week I hope to show photographs of a rental management company with photos of long-term rentals in Key West where three rentals are now offering "first month's rent FREE".)

In other words, like most developers, Cay Clubs's future outlook in 2004-2005 was one where Real Estate would keep its hyper growth curves going with a fully opened up fire hydrant flow of cheap and easy available credit. In 2004-2005, too, Cay Clubs was looking at non-stop growth in tourism. Hence, selling small-time "investors" on lease-back programs where the developer probably showed over-confidence in making back their downpayment in two years was not the kind of "slam dunk" move you'd expect from savvier developers who know Real Estate does go down and up in cycles . . . similar to the stock markets.

None of the genius developers . . . or homebuilders . . . who were overbuying at the Top of the Housing Bubble ever looked back in History at how all manias end. Instead, they buried their heads in the sands of Florida, kept repeating the mantra "Real Estate in Florida will continue to double every 3 to 5 years," and kept building condos like Woodpeckers on Crack.

The Herald further documents,

Fueled by investors' hunger for resort condominiums, Cay Clubs vaulted from a small start-up in late 2004 to a major developer whose 14 properties and marinas include eight in the Florida Keys. The firm, whose billboards dot the Overseas Highway, says it manages nearly 3,000 condominium units and more than 900 boat slips.

Now, the nationwide real-estate downturn has brought a cash squeeze that forced Cay Clubs to lay off dozens of workers, slow redevelopment plans, and ask roughly 140 buyers like the Parras to wait for their rent checks.

The 'money is just not available to make the necessary payments and continue to maintain Cay Clubs' long-term viability during this down market,'' Chief Executive Dave Clark in May wrote to condo buyers awaiting lease-back checks.

Uh-oh. We've got a problem Houston.

Again, I will bet stinking Smathers Beach seaweed to dollars that there is diminishing revenue, a shrinking pool of condo buyers, and less of a chance to borrow a big hunk of money at privately held Cay Clubs (again soon to go "public" in a merger) but we cannot access the privately held books to back up my hunch.

Still, for this company to come out and admit that 140 "owners" of condos are suffering from Cay Clubs inability to pay on time the rents their investment units generated is the stuff of lawsuit prone Real Estate Attorneys.

Then Clark of Cay Clubs lays this egg in the next few paragraphs of the Herald story . . .

Clark says Cay Clubs' finances have improved since then. It has sent rental checks to about 20 buyers to cover one or two months' worth of mortgage bills. The company hopes to refinance its debt, and a pending merger with a publicly traded holding company would bring an additional $47 million this fall. ''Our problems are fixable 100 percent,'' he said.

But on Friday, Cay Clubs disclosed that this year's sales slowdown forced it to accept less lucrative terms for the planned merger with Key Hospitality Acquisition, regulatory filings say. Clark and his top deputy, David Schwarz, agreed to receive 46 percent fewer shares in the new company -- a loss of $197 million in value based on Friday's share price.

The troubles that the Clearwater company faces symbolize wider concerns about South Florida's battered condominium market.

Real-estate analysts say too many developers depended on investors who stretched their bankbooks buying condominiums during the housing boom on the assumption that others would buy or rent them only a year or two later.

Faced instead with anemic demand for real estate, those investors are left scrambling to pay the bills, said Jack Winston, a condominium analyst with Goodkin Consulting in Miami. 'It's the same people: `Hey, let's invest in some real estate! We'll flip
it. . . .' Then, all of a sudden, they find they have to reach into their pocket every month to cover the mortgage. And it's a shock.''

The company hopes to refinance its debt? Hope in one hand, Mr. Clark, and spit in the other. See what you get in this market of Credit Implosion and leveraged buyout deals going bust leaving major Wall Street banks holding the bag for junk bonds they could not sell. There is a major liquidity squeeze here on Planet Earth, Mr. Clark, and all the easy money has fled these types of companies such as your Cay Clubs.

Still, Clark claims this problem is "fixable 100%" and he's banking on the merger going through and giving his company $47 million to rectify the late rents it owes 140 "investors".

However, I must ask Clark the following questions:

How does one expect to increase revenue in a declining tourist market (the Florida Keys are in a Tourist Recession the likes of which we haven't seen since 1990) and how does one stay cashflow positive? There is not only a shortage of buyers in this downturn of Housing, but there is downturn of "renters" by-the-night in this downturn of Tourism.

Does Clark think his units in the Keys will rent as easy in late 2007 as they did just 12 months ago? It appears that fast falling rental prices at Cay Clubs up in the Middle and Upper Keys are telling us a story of sweat stains under the armpits of Cay Club execs's Hawaiian shirts. At least they are trying to compete by slashing nightly rental prices.

Does Clark ever walk Duval Street in Key West's downtown and take note of all the businesses closing their doors forever?

Has Clark not seen the two or three cars in the overpriced Santa Maria Condotel's parking lot (Santa Maria is a non-Cay Club Condo with $350 to $450 a night rooms and units which start at $1.2 million for buyers who cannot do simple math) on weekdays, while nearby motels and small hotels still charging only $99 to $150 nightly have plenty of rooms rented? I think Clark sees the writing on the wall: overpriced condo rooms will not rent during the week, and will only rent as the "last option" on weekends when maybe all hotels and motels are "No Vacancy".

Moreso, Clark has probably read the stories of Santa Maria condo owners who lost their $200,000 deposits but who are battling the developers with class action lawsuits. That has got have Cay Clubs especially anxious to close their merger and IPO deal. My advice to Clark and others in Cay Clubs executive offices if they close the deal to merge: get those options, cash out the day your "lockup" provision ends, and whistle a sigh of relief you made it before the Big Crash I expect in credit markets.

Lastly, who in their right mind would invest in a Cay Club Condo after this latest fiasco as highlighted in today's Miami Herald? I hate to say it guys, but maybe you should have sold off a couple of Lexus's, a vacation home, you know, take a hit on your own to make good on your promises. Now your name is mud and you can't unring that Bad PR Clock.

Cay Clubs needs investors to buy and then not demand rental revenues owed them in this Ponzi Economy which depends on a selling an overpriced asset at continuing higher prices. An important part of the funding program for Cay Clubs expansion was this lease-back program. The buyers of Cay Clubs's units are actually the small lenders which make the developments fly in a market of Condo oversupply. What Cay Clubs needs most is not just a major refi of big loans, but they need small "lenders" . . . i.e., mom and pop investors" . . . to turn over their retirement money and not ask for any of it back until the market returns and makes Cay Clubs's bet look good.

As the Herald explains:

Clark, the former head of a development company that built the Mariner's Club in Key Largo, launched Cay Clubs in 2004 with the goal of creating a chain of luxury vacation spots in soughtafter destinations.

Instead of shouldering the development costs alone, Cay Clubs adopted a familiar strategy in South Florida: selling off rooms in resorts as condo-hotel units to individual buyers, who could then share in the rental revenue. That financing mechanism helped others, such as Miami's Four Seasons hotel, Key Biscayne's Ritz Carlton and the new St. Regis in Fort Lauderdale.

But Cay Clubs gave the strategy a twist: The developer would contract to rent units back from buyers for two years, refunding as much as 15 percent of the sales price upfront. In those two years, construction crews would convert the property -- typically an apartment complex or budget motel -- into a top-tier resort, according to sales materials.

Condominium converters often lease apartments back from buyers to free the new owners from serving as landlords. The programs aren't common among condo-hotel developers, but more projects are turning to the tactic as a way to woo buyers in a cold market, according to the National Association of Condo-Hotel Owners. The group lists 13 Florida condo-hotel projects offering lease-back programs, mostly in the Orlando area.

Yep, the words "lease-back program" are the words anyone with retirement savings ready to invest in Real Estate should run away from at sprinter's speed, in my opinion.

I have never read a Cay Clubs brochure trying to sell an investor on the reasons he or she should buy such an income producing condo. One thing I can assure you we will never read in such a brochure wold be the following in big bold print:

Oh. By the way, we might not be able to make those promised timely rental payments to you if market conditions turn against our company. The company comes first. If we go bust, you will have no one to rent and maintain your unit. Capiche? So late payments are part of the "promise".

And a second thought. Nobody ever said Real Estate was a sure fire investment, did they?

Can you imagine anyone wanting to buy a Cay Clubs lease back property today after reading this Herald piece?

Can you imagine anyone wanting to buy any Florida condotel property built by anyone else?

And this vaunted "lease-back" program. Can't go wrong there, brother, as everytime someone rents your condo, you'll receive a check in the mail at the end of the month.

That's not the emphasis Cay Clubs gave in their advertising? Oh, really?

". . . virtually two years of FREE appreciation" and 90% of Cay Club Condo buyers opt for the lease-back option.

From the same Herald article:

Ricky Stokes, a top seller for Cay Clubs, touted the lease-back arrangement in a May 2006 online presentation as providing ''virtually two years of free appreciation'' because, for most buyers, it would cover ownership costs for 20 months. Stokes did not respond to interview requests.

Company executives said about 90 percent of Cay Clubs' buyers chose to sign a lease with Cay Clubs. They included the Parras, full-time landlords who have acquired 20 houses and apartments within a half-hour's drive of their Castle Rock, Colo., home.

Last summer, they accepted an invitation to a Stokes Web talk from a company called the National Association of Women Real Estate Investors.

''This developer has put together an unheard of package for investors,'' read the e-mail from NAWREI, which received finder's fees for Cay Clubs sales. ``Immediate equity. . . . Guaranteed rental income. . . . Anticipated appreciation.''

Even with their large real-estate holdings in Colorado, Patsy Parra says she and her husband do not have the extra income to handle another mortgage payment.

But they took out four loans to buy two Cay Clubs units: the one in Orlando and another in a planned Las Vegas hotel. They counted on 20 months of lease-back payments to cover the $4,500 in monthly costs for both. After that, the Parras needed appreciation gains to make the investment work.

''I'd have to refinance to get the next five or six months of payments,'' Parra said. ``They were supposed to be very valuable.''

Other buyers depended on the lease-back cash to pay their mortgages, too. ''I have clients that are filing bankruptcy because they can't afford their payments,'' said Gene Denton, president of Select Market Real Estate, a Colorado firm that sold Cay Club units through Internet presentations.

NAWREI wrote to Clark on June 7 that Cay Clubs owed members nearly $240,000 in back rent, leaving members ``facing personal financial hardship including bankruptcy.''

I've said it before, I'll say it again,

"Never trust any stranger who looks at you

as just their next commission check!"

Look at how Cay Clubs had ancillary marketers hosting Web conferences under the auspices of people who collected a commission for every sale generated by buyers not even seeing the properties being discussed.

This is the stuff of " . . . and I've got some (swamp)land down in Florida I want to sell you" sarcasm you heard during the Great Depression. Here I was feeling sorry for the Parras at the beginning of the Herald piece and then I read they owned 20 rental properties in the Denver area before making the worst Real Estate investment of their careers.

Let's re-read what the Parras 'fessed to:

Even with their large real-estate holdings in Colorado, Patsy Parra says she and her husband do not have the extra income to handle another mortgage payment.

But they took out four loans to buy two Cay Clubs units: the one in Orlando and another in a planned Las Vegas hotel. They counted on 20 months of lease-back payments to cover the $4,500 in monthly costs for both. After that, the Parras needed appreciation gains to make the investment work.

''I'd have to refinance to get the next five or six months of payments,'' Parra said. ``They were supposed to be very valuable.''

The Parras were experienced Real Estate landlords. Yet, they let greed get the better of them. They overextended themselves buying two Cay Club condos, one in Orlando, one in Vegas. They used four loans to make the purchases happen. And then they banked on Cay Clubs making 20 monthly payments to them for rentals on both units to help them make the $4,500 in monthly mortgages.

And now they, the Parras, cannot make those monthly mortgages?

And they already own 20 income producing rentals in and around Denver?

Hello. You own 20 income producing rentals and you cannot afford $4,500 in monthly mortgage payments on two losers?

Can anybody here explain how these folks are poster kids on "How to Make Millions in Real Estate"?

Again, "Where Are the Adults?"

Okay, I'm not pointing my finger at Cay Clubs exclusively. Although they marketed the miracle of having your condo leased back and two years of rental fees coming into your account to help pay monthly mortgage, I had to shake my head in quiet agreement at this last bit in the Herald article:

Cay Clubs executives question how buyers unable to pay mortgages out of their pockets could have qualified for loans in the first place. A Cay Clubs spokesman noted that the Parras' mortgages bar putting their Orlando condo into a rental program.

Even so, the company makes no apologies for giving real-estate investors a place to spend their money.''I think anyone who has been doing real estate in the last four years has been selling to investors, not end users,'' said Mike Matte, Cay Clubs' acting chief financial officer. ``I don't care what company you're talking about.''

Analysts largely agree, blaming the current nationwide housing slump on investors abandoning real estate this year. A July report from Fitch Ratings blamed a spike in rental vacancies across the country on ``investors who are biding their time before putting single-family homes back on the market.''

Clark, the chief executive officer, said Cay Clubs will be able to weather the downturn. Cay Clubs is negotiating with lenders to refinance its $87 million in loans and may sell off land to raise cash as it awaits the Key Hospitality merger scheduled for the fall. Meanwhile, spokesman Chris Brown said Cay Clubs is making ''Band-Aid'' payments to about 20 buyers, including about $4,000 to cover a month's mortgage payment for the Parras.

But Patsy Parra said Friday that she has no cash to pay the mortgage in July or August -- a scenario she said she never anticipated.''When we first bought these condos, I thought everything was fine,'' she said.

``I never in my wildest dreams thought something like this would go wrong.''

So, the company makes a point that any adult who qualified for a loan, should have been able to make mortgage payments on their own in the first place. Point taken. Yet at the same time " . . . a Cay Clubs spokesman noted that the Parras' mortgages bar putting their Orlando condo into a rental program."

The company is claiming the Parra's mortgages barred them from putting their Orlando condo into the lease-back program?

Somebody didn't do their due diligence, or somebody flat out lied. Who's at fault?

Point taken away from Cay Clubs.

But then the CFO of Cay Clubs says,

''I think anyone who has been doing real estate in the last four years has been selling to investors, not end users,'' said Mike Matte, Cay Clubs' acting chief financial officer. ``I don't care what company you're talking about.''

Well no joke, Sherlock. You guys are pushing lease-back programs on the Internet in Webcasts to "investors" who are promised they will make back their monthly mortgage payments in rental fees you will collect and disburse to them.

You are trying to tell me Cay Clubs bears no guilt for the way they've marketed their condotels to investors, not end users?

Clark, the chief executive officer, said Cay Clubs will be able to weather the downturn. Cay Clubs is negotiating with lenders to refinance its $87 million in loans and may sell off land to raise cash as it awaits the Key Hospitality merger scheduled for the fall. Meanwhile, spokesman Chris Brown said Cay Clubs is making ''Band-Aid'' payments to about 20 buyers, including about $4,000 to cover a month's mortgage payment for the Parras.

And Clark still thinks "lenders" are going to refinance $87 million in loans in this new climate of crashing leveraged buyouts where junk bond financing has stopped abrubtly and the Wall Street Investment Banks are now left holding the bag and owing over $30 billion (at last count this morning) on unsubscribed to debt they were trying to sell investors?

In a time of sub-Prime meltdown and now a similar routh in Alt-A loans, does anyone think a company which can't make payments to small lenders, i.e., buyers of their condos, is a safe company to refinance?

Not I.

Like Cayo Dave, I think Cay Clubs is deep in the doo. I don't see how they can possibly work their way out of their own hole digging other than to not only sell off some land for pennies on the dollar, but also sell off some of their completed projects.

The tailwind Cay Clubs and other developers enjoyed in 2004, has now changed to a hellatious headwind. (Just ask the developers of 20,000 new condos coming on line in Miami during the next 18 months in an area that has 75,000 housing units on the market at this moment.)

I expect to see many big scale bankruptcies on condo projects all over Florida. Cay Clubs is just the most notable taking a hit in the Keys. If they don't close their merger deal quickly, I believe these guys will burn up any remaining cash and be bought out from vulture funds.

But it's not just Cay Clubs: the hard rain is going to fall on bigger developers with local ties. I see the evidence all over. This is only the beginning of the Housing Crash and Credit Market Crash. It will affect prime borrowers as well as those in the sub-Prime sector.

Action to take: do not buy Florida Real Estate in Florida. The worst is to come. Wait. Amass cash. Buy only those "safe" Blue Chip Big Cap names in stocks which can weather any major crash in markets. Buy gold, silver and oil as hedges. Keep working hard. Make yourself indispensable to your employer or work at marketing your self-owned busienss better.

Be prepared for Hard Times. And be prepared to profit when Hard Times bottom.