Article published in the June 11, 2010 Tampa Bay Business Journal (VOL. 30 NO 25). Written by Jay Kelley and Keith Hyatt of Focus Management Group.
It is not a question of how we arrived at this point – the question that remains is, “Where do we go from here?” For the constituents in Community Development Districts (“CDDs”) the homeowners and lot owners, the holders of CDD bonds (also known as “Dirt Bonds”), developers of the real estate projects, and the banks that lent money to developers - that question is of topical interest as CDD defaults continue to escalate. Each of these constituents has competing interests. As CDD defaults continue to escalate, each of these parties needs to develop a better understanding of the issues and opportunities within CDDs.
CDD bond payments are made semi-annually, with payments due in May and November. According to Interactive Data Corp., out of the approximately $5.6 billion in CDD bonds outstanding, during 2009 the number of bonds either failing to make interest payments or drawing from their debt service reserves (which triggers a technical default) rose from $1.7 billion in May 2009 to $2.4 billion in November 2009. Since November 2009, over 40% of the outstanding CDD bonds have been unable to service their interest payments from ongoing operating cash flow. Defaults are primarily occurring in bonds issued from 2004 to 2007.
Background on CDDs
Background on CDDS
Developers in Florida used the formation of CDDs to finance infrastructure for master planned communities by having the CDD issue tax-exempt bonds. The CDD is a local unit of special purpose government, established under the Uniform Community Development Act of 1980 which has the expressed ability to act as an independent taxing district. Upon the issuance of bonds, the CDD imposes assessments against the community to obtain the funds for the payments on the bonds, including the interest and principal payments. Two types of bonds are typically used in the funding of the developer’s ambitions:
- A Bonds – usually paid back over 30 years by the purchasers of lots within the development.
- B Bonds – usually paid back over a five to seven year period by the developer upon the sale of each lot or parcel.
CDD assessments have the same priority as ad valorem taxes. Any unpaid assessments have priority over bank acquisition and construction financing.
In addition to bond payments, the CDD assesses property owners for operating and maintenance expenses, which include costs of field maintenance and administrative costs. These costs are allocated to property owners and are invoiced through the property tax bill. Amounts owed accrue as liens on the property, and rank equal with taxes, county or other special assessment liens.
Once regarded as low-risk, the nature of the CDD bonds changed when master planned communities began to fail as developers and homebuilders were unable to sell vacant lots and homes. Without the sale of lots and homes, the source of bond repayment shifts from new property owners in the CDD to the current owner – the developer. As a developer’s liquidity fails, the CDD accesses the interest reserves that traditionally accompany the bond issue. If these interest reserves are depleted before the real estate market recovers, the bonds (and bondholders) are exposed to imminent failure.
How prevalent is the problem?
Within the state of Florida, the use of CDDs exploded during the last decade with a total of 576 active CDDs today. CDDs were formed at the following pace:
- 1980 – 1990: 13 new CDDs
- 1990 – 2000: 86 new CDDs
- 2000 – 2005: 201 new CDDs
- 2005 – 2010: 276 new CDDs
Of the 576 active CDDs, prior to the May 2010 payment date, 184 bond series representing 96 districts were distressed, with the vast majority having been issued since 2004.
According to Interactive Data Corp., as of November 2009, there were over $1 billion in CDD bonds issued since 2004 that were not in arrears, but secured by properties with minimal construction activity. As a result, it is expected that when the May 2010 payment data is made available, the number of distressed CDD bonds will have significantly increased from November 2009.
A consequence of the failure of the CDD – often overlooked as attention usually centers on the financial participants – is that home and lot owners that have already bought in the community have tremendous exposure. As the bonds fail, the source of operating and maintenance funding goes away. This lack of cash could result in grass in common areas such as parks, entrance features, and road medians becoming overgrown and community pools turning green. Not only are these early buyers in the community stuck with most likely having overpaid for their home, but they are looking at a potential nightmare based upon the degrading nature of the community.
What’s Next
The dynamics of the real estate market today are not supportive of an immediate recovery. With the serious looming impact of spiraling CDD bond failures, it is becoming clearer to CDD constituents that the recovery in the overall housing markets and easing in the credit markets will not come soon enough to protect all stakeholders in these developments.
Focus Management Group is a leading business restructuring firm headquartered in Tampa, with offices in Atlanta, Chicago, Cleveland, Columbus, Dallas, L.A. and Philadelphia. Over the last two years, Focus has advised on real estate restructurings valued at over $6 billion. For more information on Community Development District solutions, contact Jay Kelley or Keith Hyatt at (813) 281-0062 or visit www.FocusMG.com