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Sunday's Billings Gazette article had a comforting headline for the real estate and construction industries:

After long recession, home building in Billings is on the rise again

There's only one problem: It's not exactly true. That headline gives the impression of a solid, sustained increase in building that will last throughout the year. Here's the reality of single family building permits so far this year:



Year to date, the totals are definitely better than the bleak beginning of 2009. Unfortunately, a large portion of the increase is simply due to the $8,000 first time homebuyer tax credit. Builders like Wells in Riverfront Pointe and Oakland in Twin Oaks worked furiously this spring to meet demand for first time homebuyers. The construction frenzy reached its peak in March, as builders tried to stay ahead of the April 30 deadline for contracts to be in place. Some were pre-sold; Some were spec homes.

As evidenced by the last two weeks, that breakneck pace could not be sustained. The majority of building was in entry-level homes supported by an expiring $8,000 government giveaway. I do not believe these construction levels will be sustained throughout the year. Home inventory levels are very high and rising. We have probably not yet seen the bottom for home building in Billings.

Spurred on by the First Time Homebuyer Tax Credit, Billings area builders put up nearly 300 houses in the last 15 months. I've put together the locations for all these houses onto a Google Maps overlay which you can view by clicking below.

Some locations could not be geocoded correctly and are just approximations. Note that there are three major clusters where building has been concentrated: The Wicks Lane/Lake Hills/Skyview area in the Heights, Riverfront Pointe/Josephine Crossing to the south, and Copper Ridge/Falcon Ridge/Ironwood on the West End.

The stats are in for March building permits, and they are really surprising. 45 permits were issued for single family construction in Billings. Only 2001 and 2005 saw higher numbers for March in the last decade.

Even when you count the generally busier summer months, March 2010 was the best month since clear back to May 2007. Housing starts are generally an indicator of a healthy housing market. So what's the problem? Here it is:



For this early in the year, single family home inventory is higher than it's ever been since I started tracking. Building new houses is fine when we need them. But as I've stated before, the $8,000 Homebuyer Tax Credit seemed to spur new construction when I think we already have too many houses.

If sales really sag after the tax credit expires later this spring, prices could really take a dive due to the oversupply of houses.

See Part 1 here if you missed it. We continue with two more subdivisions which I believe epitomize the excesses and unrealistic expectations of Red Lodge area real estate.




Dot Calm Ranches
The Premise: Large lots, mountain views
The Problem: It's on a dry, treeless bench that's miles from anywhere

Red Lodge real estate agent and developer Jeanne Rizzotto was distributing the above flier in 2006. It promoted her new "Dot Calm Ranches" subdivision 16 miles north of Red Lodge (near Roberts). Dot Calm promised big lots and prices far below what you'd pay in town.

Some people do want to live out in the country, so I'm sure there's some demand for lots in this area. But Dot Calm seems to combine the worst of both worlds-- you're fairly close to your neighbors (2-4 acre lots), yet miles from town. The development is on a treeless bench instead of down in the more protected and scenic Rock Creek valley. Are there really 159 buyers that want all these factors together, for $25,000+/acre?

Evidently not. Take a look at the photo below (click to enlarge), taken two weeks ago, and see how many houses you can find:



Note that the original flier claimed "40+ lots already on hold." I don't know how many of those actually closed, but I do know how many houses have been built in 3 1/2 years-- Zero. There is one house at Dot Calm, but it's one that Rizzotto had moved there for a relative.

Dot Calm was perhaps the first example of Rizzotto's overblown pumping of her real estate developments. But it certainly was not the last.




Of Course! RV and Golf Resort
The Premise: Purchase a lot for your RV, then come park it and golf
The Problems: Too many to list

You may find it hard to believe, but the photo above shows a location that Jeanne Rizzotto believes will quickly become a $60 million, 190 acre "RV Resort" and golf course north of Red Lodge. The idea is that instead of leasing a space for your RV by the month, or parking it for the night, you "buy" the lot (actually it's a 99-year lease). Then you can come and park whenever you want, and play golf.

Sounds a little crazy, but maybe there are some retirees that would go for this. Those retirees might have a heart attack when they see the prices though: The smallest lots are 50x60 (3,000 square feet) and start at $159,000. This works out to an insane $2.3 million/acre.

Think about it. 3,000 square feet is less than half the size of a standard city lot. We're talking about a glorified parking space for $159k-$400k. You can't even build a house there, except for some lots that allow "park models" which are like tiny mobile homes.

A quick but important aside: Red Lodge was not the only area that Rizzotto targeted with her RV golf course idea. In March 2008, she came to Navajo country in Arizona promising that she wasn't one of the "fast-talking" swindlers they'd all seen before. She claimed to have already sold 203 of the 522 lots in a proposed "Hole in Juan" development on the San Juan River. By September she had gone missing, leaving a "trail of worthless checks and empty promises."

Anyway, back to Of Course! Rizzotto had a course designer, landscaper, and Engineering, Inc. lined up in 2008, and expected to be playing golf "before the snow flies" that fall. But something went wrong. Just a year later, she declared bankruptcy.

At this point, I thought the whole silly idea would just go away.



Not so fast. Thanks to bankruptcy court and a debt settlement plan, the Of Course! idea has new life. "I'm back" is what a "gleeful" Rizzotto was quoted as saying in a recent Gazette article. The plan is to continue development of the RV resort, and hopefully it will make enough back to cover Rizzotto's debts.

Creditors might not be feeling quite as gleeful as Rizzotto is. Billings' upstart Beartooth Bank somehow got mixed up in financing Rizzotto's messes, and they are owed $1.9 million. Her debts total close to $5 million. Nevertheless, the hype machine for Of Course! is already running at full speed. From the article:

Rizzotto expects the development to bring in about $10 million in its first year ... Rizzotto said she has 196 reservations from people who have expressed interest in making the initial leasing payment of $50,000.

Where have we heard all this before? Remember how Dot Calm and Hole in Juan also started with claims of huge sales numbers? They've gone nowhere. Besides, if Rizzotto really had so much interest, why did the Of Course! development never take off in the first place?

“There’s no comparison to it in Montana. These sorts of developments are found in California and Arizona,” said Rizzotto’s special counsel Rob Stephens.

Hmmm. Perhaps it's because those states tend to have more than 5 months of golfing weather. The Gazette article contains two more jaw-dropping quotes. First:

“You’re dealing with a different clientele that is generally insulated from the consequences of the recession,” said Rizzotto’s special counsel, Rob Stephens

Has Mr. Stephens been completely isolated from any news in the last year? Did he perhaps miss the fact that prices have been free-falling even here in Montana, in high-end places like Big Sky? Outside the state, did he happen to hear that Park City UT prices are up to 45% off? And the "clientele" he refers to have even been avoiding the supposedly bulletproof Jackson Hole market-- sales are down a staggering 80% since 2005. And we won't even get into RV sales..

Because there’s nothing else like it in the Rocky Mountains, Rizzotto said, she expects the leasing to proceed smoothly. “This is the easy part for me,” Rizzotto said. “This is what I’m good at — selling.”

I want to laugh at all this, but I can't. From the article, it appears that Rizzotto will be seeking additional financing for construction of the course. Who's going to pony up the funds this time? And is it really wise to allow Rizzotto to blow more money on this project that could easily fail once again?

Maybe I'm misreading this market and underestimating the demand. Maybe this will work out and everyone will get paid-- but given Rizzotto's track record so far, I'm not too optimistic.

Honestly-- I try not to be negative about real estate development and new subdivisions. Cities grow and people need places to live. I understand that. But sometimes, developers move forward with projects that seem to completely defy common sense. The Red Lodge area has four subdivisions that I think fit that description.

Most of these subdivisions seem to have been planned with a wildly optimistic idea: The idea that Red Lodge is just now being "discovered" and will soon have property values rivaling those in Jackson Hole or other ritzy ski destinations.

Red Lodge isn't Aspen. It's as simple as that. It's not even Big Sky or Sun Valley. Red Lodge is a simply a tourism-fueled community with a fun, but modest, hometown ski area. You won't find rows of private jets at the Red Lodge airport. You won't even find slopeside lodging or condos (yet). But developers are planning and pricing their subdivisions as if everyone in America will soon be lusting after a little piece of land near Red Lodge. Below you'll find a run-down of some major projects in the area and the problems I see with them



The Island at Rock Creek
The Premise: "Creek side resort living" within walking distance of downtown
The Problem: Narrow, attached townhouse units start at half a million dollars

This subdivision actually sounds pretty appealing, and looks nice. You can live creekside, walk to downtown and all its activities, and it's just a short trip to ski at RLM. It all sounds wonderful until you take a look at pricing. Creekside townhouse units are asking north of $500,000. Sure, they're fairly large (2,500 square feet or so), but we're still talking $200+/square foot. You have to share a wall (or two) with your neighbors, and you don't even get your own yard.

$500,000? With Montana wages being what they are, that ought to buy a mansion, not what amounts to an apartment on a tiny lot.

Speaking of lots, land prices at the Island aren't any better. Single-family creekside lots had initially been asking around the equivalent of $800,000/acre ($330,000 for a 0.43 acre lot). However, some of these lots sold at auction in 2008 for less than 70% of list. A current listing is asking $235,000 for a 0.43 acre lot.

This may be close to a dream location, for the Red Lodge area at least, but who's going to buy at these prices? There are 74 townhouses planned at Island at Rock Creek. Are there really that many Billings doctors looking for a second home, or wealthy out-of-staters who want to come here just to live a wall-to-wall with their neighbors? I guess we'll see.

One positive about Island at Rock Creek that separates it from the others: I haven't heard a whole lot of empty PR hype or wild promises from the developers, beyond the usual real estate fluff on their website. They do say that "Every town home has sold for more than previous town home." I don't know how much longer that will be the case.



Spires at Red Lodge
The premise: "Sustainable," affordable living with great views and city utilities
The problem: Not affordable, and Red Lodge doesn't need 400 new lots

2008 was a whirlwind year for the new Spires at Red Lodge subdivision, and everything looked great. Russ Squire had an article in the Billings Gazette where he talked about his "sustainable" new development north of the golf course. City utilities were added that spring. 16 lots were closed or pending already by June. Later that summer, the streets in the first phase were paved.

But I always had my doubts on this one, and I featured it in my 2008 housing video. The eventual number of lots-- 400-- would take decades for Red Lodge (population 2,300) to absorb. Not to mention that the Red Lodge area already had 500+ vacant lots at the time, according to the Gazette article.

Then there's the issue of affordability. Squire has been talking about it since the beginning, and city planners cited "modestly priced options" as being part of the unbinding agreement. But really, what is affordable? The views at the Spires are big, but the lots are small and expensive. 7,000 square foot lots started at $91,900 in 2008. Add anything but the tiniest shack to that, and you're looking at a house that realistically needs a $75,000+ salary to afford.

While developing his subdivision, Russ Squire was also creating an on-line presence attempting to help position Red Lodge for a major resort boom. You can find his articles scattered across the web, with titles such as Is Red Lodge the next Jackson Hole? and A Rare Nugget: An Affordable Ski Town. Here's an excerpt from a particularly interesting article in which Squire talks about how he came to develop the Spires:

After 17 years of residing in what had now come to be known as “Bozangeles” I decided to set out to find that special community that was still reasonably priced but hadn’t been blown out of the water yet through hyper-discovery ... Off we went to Flagstaff, Heber Valley, Fernie, Sheridan, Cody, Red Lodge, to northern and southern Idaho, and to Driggs ... When we were done it was Red Lodge, Montana real estate that won the beauty contest hands down, which meant this was where we were going to make our next big investments.

In 2008, the Spires at Red Lodge webpage contained the language below. It sounds like an expectation, almost a promise, of rapidly rising land values for those who buy:



And Squire had a post on Craigslist in June 2008 offering the whole subdivision for a cool $12m. One line from the ad says, "The developments primary target markets have been retiring and pre-retiring baby boomers and second home owners from Montana's largest city, Billings, which is one hour away."



The hype machine was in full swing in 2008, and the Gazette article linked above stated: "Apparently, others share that vision. Squire said the subdivision has sold $2 million worth of lots since September, making it the hottest-selling development in the Red Lodge area."

But it was all apparently premature. Only two additional lots have sold since 2008. Take a look at how little has changed between the 2008 plat map and the most recent one (file modified 9/2009). Also note the price reductions:



Only one addition house has been built at the Spires since 2008, and it required several affordable housing grants and subsidies (see my previous post). Even with the $8,000 home buyer tax credit, there do not appear to be any houses under construction. The aerial photo below was taken on Saturday (3/13/2010).



At best, Spires at Red Lodge is failing to live up to the hype. At worst, it's a development that's in trouble. But there's one more twist to the story. In late summer 2009, land owners just west of the Spires proposed a gravel pit there. The Squires have been quoted all over about how terrible this will be for their development. Some examples:

Russ Squire: "Our investment is toast if this happens ... If this happens, we're dead. That's the end of our development, because nobody will buy in here."
...
Squire believed that the gravel pit would doom his upscale subdivision where 96 home sites were planned.
...
The Property tax base would be greatly affected said Elaine Squire of The Spires at Red Lodge, whose property is across the road from the proposed gravel operation. Homes will lose equity of 32 percent to 28 percent decline if they lay within half-a-mile of the gravel site she said.

Squire conveniently fails to note that he only sold two lots in the previous year before the gravel pit was ever proposed. Maybe the Spires will be "toast," but not because of the gravel pit. It sounds like Squire is looking to place the blame for the failure of his ill-conceived subdivision squarely on the gravel pit. This will be interesting to watch.

Believe it or not, there are two more subdivisions in the Red Lodge area that rival the craziness of the ones above. Details in my next post.

For the first time since 1989, house prices in Billings are lower than they were a year ago. This according to the Federal Housing Finance Agency's House Price Index (you can read more about how the HPI measures the Billings market here).

The HPI lags just a bit, so the latest figures are based on transactions completed in the fourth quarter of 2009. Home sales during that period average 2.66% less than a year earlier. While this is not a terrible drop, you can see from the graph that it is the culmination of several years of declining growth that finally went negative:



Note that we had 5 years of abnormally high, 6%+ home price appreciation. That could not last forever, and now it appears to be tumbling down. With the euphoria of the $8,000 tax credit wearing off this spring, I don't see a return to high appreciation rates anytime soon.

You might think there's little to be negative about with the $8,000 First Time Homebuyer Tax Credit. After all, I've already shown how it boosted sales and housing starts in the Billings area. The credit proved to be so "popular" that it was extended for an additional 7 months (but as one commentator wryly noted, it's hard to find a government giveaway that's not "popular!").

While we're still on the temporary credit-induced high, I'm going to argue that this program will eventually hurt the Billings market more than it has helped it. Here are the four reasons why:

1. The tax credit delayed a necessary downturn

In early 2009, I presented evidence that prices were already falling significantly in Billings. Some sellers were desperately trying to unload at 10% or more below what they paid a few years earlier. Then the homebuyer credit kicked in and changed things. Sales improved, and prices seemed to stabilize.

Propping a market up using a temporary subsidy can work, but only for awhile. The unintended consequences that follow may be worse than the original downturn would have been.

Since 2006, I have been cautioning that the Billings housing market seemed overheated and overpriced for the current income levels. If it needs to come down as I suspect, then it would have been better to allow home prices to take their natural course and come down gradually. Tampering with a market to postpone an inevitable correction only makes that correction sharper when it finally comes.

2. The tax credit encouraged marginally-qualified buyers to jump in

This is not a new phenomenon, but I think the tax credit made it worse. Increasingly over the last decade, the government has encouraged anyone and everyone to buy a house. But the "ownership society" idea missed the simple (and to some, uncomfortable) fact that many people are not in a position to buy a house. Some don't have any money saved, and some don't have the income to support the kind of house they want. People were encouraged to buy anyway instead of working to get into a better position.

5+ years of easy money drew in many people who shouldn't have bought a house when they did, or shouldn't have bought as much as they did. Unfortunately, the tax credit just provided another incentive for people to get themselves in trouble. With interest rates unbelievably low, a free $8,000 just for buying a house, and almost zero cash required, who wouldn't be tempted?

Thanks to this policy, we'll probably see increasing defaults and foreclosure problems in Billings in the coming years.

3. The tax credit spurred homebuilding when we already had too many houses

In early 2009, I presented supply and demand graphs showing how home inventory was rising at the same time that sales were falling. These market forces were driving prices down.

Then the homebuyer credit threw a wrench into things. Sales rose almost immediately as buyers took advantage of the money. These buyers particularly demanded houses in the $100k-$200k range. Local home builders ramped up construction efforts to fill this need.



Above you can see a street in the Riverfront Pointe subdivision. Wells Built Homes filled this street with houses in a matter of months, thanks to the tax credit. These newer, entry-level homes (most of them $180k-$200k) were in high demand by first time home buyers.

In this whirlwind of activity, a few important points may have been overlooked. I'm not sure that the fundamentals in place a year ago really changed. We probably still have too many houses, but that fact was temporarily hidden by the frenzy of sales from the tax credit. Builders built and built (and are still building) during a time that we already had high inventory. When the credit goes away, we may find we are in even worse shape than before-- falling sales, and even higher inventory.

4. The tax credit pulled demand forward even further

Just a generation ago, it was quite common for a married couple to save for years and be well into their 30's before buying a house. The housing boom changed that. Suddenly, it's become quite common to own a house in your mid-20's. For young newlyweds, it's almost expected. We've even seen college students buying houses to get in on the appreciation.

This is known as "pulling demand forward." During the last decade or so, new demographic groups of buyers entered the market as never before. All the normal buyers plus these newer, younger buyers combined to help fuel the housing boom of the last 10 years.

And now this tax credit for new home buyers has pulled demand forward yet again. Anyone who was even thinking about buying recently now has a great incentive-- grab the $8,000 before it goes away in June. Every person who could possibly want a house should have one by this spring.

At the end of this tax credit-- who's left to buy? Sure, we have new workers coming from the college and high school ranks (if they can find good-paying jobs, that is). But we've been so busy selling houses that our metrics for "normal" home sales have been skewed for years. All of those new buying demographic groups have been used up nearly all at once.

Conclusion

This is a tricky issue. We all know people locally who can thank this tax credit (directly or indirectly) for keeping busy or even keeping their job. The homebuilders and Realtors, of course, think Max, Jon, and Denny have really helped Montana by supporting this. Nothing's free in economics, however, and I believe that market manipulation tends to have undesirable side effects. By seeking a temporary fix to a fundamental problem (overpriced and overbuilt housing), we may instead see a longer and deeper downturn in the future.