April 12, 2008

Luther,

I appreciate the openness of your November 2007 letter to the owners.  It was a refreshing change from the approach of past administrations.

I am also delighted to see that RML has finally fully implemented all of the changes that I urged so aggressively two years ago - i.e., individualized accounting, market rate fee structure and the abolition of the absurd owner use excise tax that used to be charged to owners who wanted to use their own units during prime time.

While all of that is good - it, unfortunately, comes too late.

As a management consultant to many hundreds of companies worldwide, I am often asked by my clients to predict the future - and give them my best macro and micro economic predictions that relate to their own specific companies and markets. 

Using this same approach, I've looked in the crystal ball at Deer Ridge and foresee a quickly coming confluence of economic factors that will most probably have a major and very dire impact on all of us owners at Deer Ridge Mountain Resort.  The purpose of this open letter to the Deer Ridge Board is to alert the Board, and all owners, to these "perfect storm" trends and propose how we can best defend against them to protect all of our economic investments.

During the next two to three years, my crystal ball shows the following:

Major Macro Trends

•  Oil has already quickly exceeded $107 per barrel and may exceed $140 in the next 12 months.
   

•  Gasoline prices will reach or exceed $4.00 a gallon - diesel is already there - and gasoline will be there before the end of 2009 - and possibly before the end of 2008.
   

•  Airline ticket prices will skyrocket as a result of the higher fuel prices - with several airlines going out of business and others required to merge for survival.
   

•  The sub prime mortgage debacle will impact the availability of ALL mortgage loans - including those that would have been available for prime borrowers.
   

•  Foreclosures will exceed one million homes in 2008 as monthly payments for adjustable rate mortgages skyrocket with resets.
   

•  At the time of this writing, over 20,000 families lose their home every week.
   

•  Over 2.5 million Americans will lose their job in 2008 - over 1 million more people than the number who were laid off in 2007.
   

•  Home values will drop to prices last seen in the 1980s - or even lower.
   

•  Real estate will receive such bad press that buyers will all but disappear - especially with the unavailability of mortgage loans.
   

•  The Consumer Confidence Index will continue to plummet as perceived wealth disappears with quickly lowering home values.
   

•  Local municipalities will see their tax base drop by 20% or more as homes get re-assessed at much lower values due to all the localized foreclosures and fire sales.
   

•  Home builders will see a 60% or greater reduction in new home construction.
   

•  Real estate related industries like builders, mortgage companies, subcontractors, building materials companies, home improvement companies, etc. will suffer through massive layoffs which will in turn will create other layoffs in many other industries including travel, leisure, restaurant and virtually all discretionary industries.
   

•  Credit card delinquencies, auto loan delinquencies and personal bankruptcies have already begun to rise, nationwide, providing more evidence that consumer spending is in jeopardy.
   

•  For the past few years, consumer spending has accounted for about 67% of the USA economy.  As the consumer crunch grows, so does the certainty of recession. Consumer spending has gone from a 3% growth rate to zero growth - and is expected to go negative in 2009, if not before.
   

•  Much of the USA population has supported their negative cash flow life styles with credit card debt that was periodically paid down by home equity loans.  Although these loans are quickly disappearing, many will continue to spend until they have maxed out their credit cards and then have no choice but to change their life style and spending habits. 
   

•  Many of these folks have bought second homes with the expectation of benefiting from historical real estate appreciation.
   

•  With much of their prior paper equity already squandered on credit card pay downs, the ongoing drop in real estate values and their inability to refinance, many will have no choice but to allow their properties to be foreclosed - especially vacation homes - so that they can do all they can to keep their primary residence from being foreclosed.
   

•  As a result of all of the above, there is a near certainty of a major, national recession in the next two years. Its already started in Florida and California and Nevada - and will spread nationally within the next few months.

Probable Impacts On Deer Ridge

•  The traditional sale of units at Deer Ridge will drop from 15-18 per year to less than a half dozen units per year for the next 2-3 years.
   

•  Those units that are sold will be mostly to owner-occupants seeking inexpensive, primary homes - or homes to replaced more expensive residences that have been foreclosed.
   

•  Many marginal owners at Deer Ridge bought because it was the cheapest real estate, in absolute dollars, in the Gatlinburg area and it was all they could afford - even in the best of times.  Many will be adversely affected by the above mentioned recession, layoffs and credit crunch and, regrettably, will have no choice but to let their Deer Ridge property be foreclosed. 
   

•  As a result, I predict that:
   

  •  Several units at Deer Ridge will not be able to be sold even with aggressive panic price discounting and that a total of between 10 and 20 units of the 84 units at Deer Ridge will be foreclosed. Others will be sold at fire sale prices - just in the nick of time, before the foreclosure posting.
     

  • When that percentage of a neighborhood goes into foreclosure, it often results in the whole place looking like an abandoned ghost town and becoming stigmatized - acquiring a reputation of being an undesirable neighborhood.
     

  • Prior to foreclosure, many owners will become delinquent in their payments of HOA fees and RML assessments - especially the outrageous fixed water bill charged by Cobbly Nob. Once the foreclosures take place, the HOA may or may not eventually receive the past due payments - but at best will receive them many months after they were due - potentially resulting in a MAJOR cash flow problem for the HOA and requiring a major assessment to ALL remaining owners.
     

  • Once the properties go into foreclosure, the properties will probably be owned by lenders and carried as REO assets for many months until regulators force the lenders to clear their books and force them to recognize their actual losses by marking the properties to their true market value.
     

  • Once these properties are again marked down in price, they will be placed on the market thereby depressing ALL property values, again, at Deer Ridge.
     

  •  Because of the aggressive price discounting, property values at Deer Ridge will drop at least 20%-25% over the next two to three years.  This assumes that 10 of the 84 units here end up as REO properties.  If this number is 20 units, then I project that property values may drop as much as 30%-40% from April 2008 prices. 
     

  • I would not be surprised to see selling prices for Deer Ridge units plummeting to below $60 per square foot from the current asking price range of $95 to $100 per sq ft. (Today, I would be a prospect myself for buying a 2-2-loft for under $60 per sq. ft.)
     

  •  Because of Deer Ridge's remote location, its desirability will suffer in the marketplace compared to similar deep discounted fire sales of much more desirable properties and locations in the Gatlinburg area. These other more desirable properties will be suffering the same economic downturn and market conditions that we do - but because they are newer, closer in, don't have Cobbly Nob taxes and water, etc. - the effect will be that those more desirable properties will siphon off virtually all of the very thin buyer demand that might still remain.
     

  • All of this will cause more owners to want to bail out of Deer Ridge at whatever price possible.
     

•  With the general nationwide economy tanking over the next 2-3 years, the market for vacation home buyers will virtually evaporate...even with deep discount pricing.   
   
•  Those buying the properties out of deep discount foreclosure will probably only do so either for their own occupancy or at terms which make financial sense on a rental basis - which almost certainly means they will NOT use RML, even with its newly revised rates.  Instead, new buyers who do not intend on being full time residents will probably opt for long term monthly rentals.
   
•  As I pointed out two years ago at the Homeowners' Meeting, Deer Ridge is a guaranteed loss as an investment at the then current rental rates and economic occupancy levels - even if the property is debt free with zero mortgage payment.
   
•  As a result of my www.DeerRidgeOwners.com website, I get a lot of emails from prospective buyers interested in Deer Ridge - with many complaining that the numbers just don't make sense to them with the sky high condo fees, the high fixed water bill and other fixed charges like cable TV.  These combined costs will keep more buyers away as the real estate crash accelerates and will require even greater sales price discounting in the future.
   
•  With rising gas prices, skyrocketing airline tickets, a falling economy and a down real estate market, I expect both rental rates and occupancy levels to fall - meaning that the units of Deer Ridge will offer NO economic incentive for purchase as an investment - until prices drop at least 30% to 40% - and only then when rented under long term leases like an apartment building.
   
•  This will also have the effect of changing the on site occupant profile to one that may be less appealing than the current resort renter profile - with the effective impact of driving away even more of the very few second home buyers that might still exist.

Probable Impacts on RML / Ridge Realty Resort

•  Ridge Management will lose a significant number of the current units from the rental pool as a combined result of the foreclosures, the trend toward owner occupancy and long term rentals by real estate investment vultures.
   

•  RML will lose a significant amount of income from the substantially lower sales commissions received by Ridge Resort Reality in recent years.
   

•  The following are based on the 2008 budgets sent out last November 20, 2007:
   

  •  RML was projected to make a $1,973 positive cash flow for all of 2008.
     

    • However, this is shown in the budget to be based on a management fee from Deer Ridge owners of 45% - the new agreement that is marked to market is only at 40%
       
    • This, alone, is an 11.11% reduction in income from the expected, participating Deer Ridge units.
       
    • Since the 45% fee was projected to be $460,920 for 2008, this means that an 11% reduction will reduce this revenue by $51,208.
       
    • Since the original positive cash flow projection for RML was only $1,973, this one change alone appears to create a 2008 negative cash flow of $49,235.  Let's just round to an annual negative cash flow of $50,000 assuming everything else in Joe's budget is correct.
       

  • The 2008 budget for RML has a cryptic "Other Income" line item for a nice round $200,000 that is referenced in "Schedule 1."  However, there was no Schedule 1 included with the budget that was sent to all owners.  I have no idea how real this phantom, undocumented revenue item is - but since it represents almost 25% of ALL revenue, and is such a round number, I question both its authenticity and likelihood.  
     

  • The 2008 budget also shows Other Direct Costs of $131,000, but again, there is no Schedule 2 included that would show the owners what these monies are used for.
     

  • RML started 2007 with 72 units under management.  My memory is that number was already down to 68 several months ago. 
     

  • Based on prior analysis, I believe RML receives, on average, approximately $9,000 a year in total aggregate benefits from each unit that they manage.
     

  • If RML continues to lose properties and they were to lose just another dozen properties due to all the above factors, that means that RML revenues would plunge an additional $108,000 per year.
     

  • Assuming the $50,000 negative cash flow is right, then losing an additional dozen units from rental would mean that RML will cost all homeowners $158,000 - just to cover RML's negative cash flow for 2008.
     

  • On top of this, the revenue component from Ridge Resort Realty which receives commissions on the sale of units here is going to also drop significantly from prior years when 15 to 18 units were sold per annum.  Although the Board refuses to tell the owners exactly the compensation components for Joe Thomas, I assume there is a 50/50 commission split.  Based on prior years, I am assuming that the RML / Joe Thomas split has been about $30,000 a year for each.  With the above scenario on the plummeting property sales for the next two years, I am assuming that RML will lose $20,000 of this $30,000 revenue contribution...and the 2008 budget line item of $22,564 is suspect.
     

  • With the historically high gas prices and air fares, and the loss of discretionary income to so many blue collar workers who frequent Gatlinburg, tourism to this whole area will also plummet. 
     

  • Although occupancy seems to have risen somewhat in 2007, actual net collected rents have dropped due to the leasing costs of using Hotels.com, etc.
     

  • My expectation is that economic occupancy at Deer Ridge for the next two years will be at least 10% below 2006.  If this occurs, this could also reduce RML income by another $46,000 per year.
     

  • The combined loss of income to RML from the reduced number of units from the rental pool; the drop in sales commissions; and the lower economic rental occupancy could add up to a total of $158,000 + $20,000 + $45,000 = $223,000 a year in negative cash flow. 
     

  • This $223,000 a year loss by RML would have to be funded by the HOA - which would probably mean that each of the 84 units would face an annual assessment of $2,650 a year - just for the wonderful opportunity of GGRC owning RML!
     

•  As a non-RML user and non-RML beneficiary in any way, I personally and vehemently object that I should have to pay anything to support RML.  It is my opinion that RML should only be supported by assessments to those owners who use RML. 
   

•  Right now, about 20% of the owners at Deer Ridge are non-RML users. As the above economic scenario plays out, it is highly likely that this number will quickly rise with all of the increasing number of non-RML users creating a unified voice and vote of objection to the continued subsidies of RML.
   

•  In addition, due to the reduced economic occupancy for the next two or more years, the rental income seen by the owners using RML will drop significantly, thereby increasing the annual cost of ownership for those in the rental pool as a result of the reduced net check they receive from RML. This, again, will cause even more economic strain on many of our owners and will serve, in many cases, to be the tipping point at which they will be forced to allow their unit to be foreclosed.
   

•  RML will try to stem the flow by increasing management fees again, which also will increase the annual cost of ownership for those in the rental pool - and cause even more foreclosures.
   

•  GGRC will try to cover all the resulting negative cash flows from RML with special assessments to all owners of Deer Ridge. This action alone will trigger even MORE foreclosures...and make a very bad situation even worse.

We Should Have Acted A Year Ago - We Must Act Now

Over a year ago, I was on the committee to review the sale of RML.  At that time I strongly urged that the Board immediately implement an aggressive sale of RML that, in my opinion, could have produced a one time distribution to ALL owners of $5,000 to $10,000 each and end all potential RML liability to the owners.  Regrettably, the Board did not take my advice and summarily "closed the case." 

All of my recommendations, along with the Board's actions, are still documented in detail at my web site: www.DeerRidgeOwners.com/sellingrml.htm.

The good news is that the opportunity I list there still exists.  With the downturn, there will be many brokerage and management companies scrambling to find incremental income to replace their plummeting property sales commissions.  However, those companies that don't successfully find this incremental income in time will, in many cases, go out of business - and reduce the number of companies that might have an interest in buying RML.

The homeowners of Deer Ridge can no longer afford the luxury of having its own management company and continuing to operate the property like a motel.  If my numbers are anywhere near right, RML will end up costing all owners a huge amount of money in a down market - and contribute nothing in increased valuation of each unit.

We Need To Stop Operating Deer Ridge Like It's "Little Joe's NoTel MoTel & Mountain Resort"

Deer Ridge is NOT a motel. It is NOT a rental property.  It IS owned by about 80 diverse owners who have completely different goals with their ownership. 

Joe Thomas does not own anything at Deer Ridge - yet Joe Thomas appears to operate Deer Ridge as if it is his private piece of income producing real estate - and, based on several reports, he appears to have nothing but visible and vocalized contempt for owners who do not sign his RML agreement and contribute significantly to his own personal income. 

Joe Thomas' apparent approach and intent is to penalize any and all owners who do not want to rent their units through RML.  As this real estate crash deepens, the number of units disappearing from RML's roster will accelerate, as described above - and I predict Joe will use every trick he can to force ALL owners to pay whatever assessments he needs to cover his ongoing overhead so his fiefdom and his personal income can continue unchanged.

As absurd as it sounds, I also predict that Joe Thomas will even try to force, or cajole, the Board into implementing some kind of additional special assessment - except this assessment will ONLY be against owners not using the services of RML. Obviously, any attempt to impose a special assessment targeting only owners who do not use RML would be illegal and, in my opinion, would immediately trigger a class action suit against both GGRC and RML. But, I foresee that Joe will get so desperate to maintain his own income level, that he will preach this kind of special assessment as required for Deer Ridge salvation.

None of us needs to waste any more time with Deer Ridge drama caused by us being in the motel business. It already takes up way too much of the Board's time - when that time would be better spent on protecting all owners against the coming real estate crash in Gatlinburg. We should have sold RML over a year ago. Instead, Margie, as president in her March 8,2007 email, said "no sale" and, "case closed."

Let's right that wrong - starting today.  Let's rid ourselves of the RML albatross ASAP and all of it huge economic risks to all owners.  The longer we wait, the more it will cost us all.

Recommendations

•  Follow all of my recommendations at my web site for selling RML, starting now - www.DeerRidgeOwners.com/sellingrml.htm.
   
•  Fire Joe Thomas.
   
•  Hire Sandy as Property Manager.  My intuition from 15 plus years in the real estate investment and property management business is that she would do an excellent job as Property Manager of GGRC. Hire Tom for maintenance and Wayne for security. 
   
•  From what I remember of the numbers and the budget for GGRC, all three of these outstanding folks could be retained within the current HOA budget - so that Deer Ridge is properly maintained and managed. These three folks are all we need as an HOA - once we finally get out of the motel business.  I expect that most of the other direct employees of RML will be hired by the new management company that buys RML. 
   
•  Sell RML, starting yesterday, so that a bigger company can benefit from the revenue stream of Deer Ridge and our fellow homeowners are not straddled with funding assessment after assessment to keep RML running.
   
•  The new management company will be zero liability to all owners - both to those who rent their units and to those who do not.  The new management company, due to their economy of scale of managing a lot more than the 84 units at Deer Ridge, will be positioned to give renting owners at least as good income results as RML.

Questions

Regrettably, Janet and I won't be able to attend the homeowners' meeting this year since we will be attending our daughter's graduation from NYU during the same time frame.  However, I wanted to again alert all owners to this RML ticking time bomb - with the goal of motivating the Board and all owners to discuss this issue during the HOA meeting - and drill down to the reality of the Perfect Storm and its impact on Deer Ridge - and what should be done with RML.

Luther, questions I would like answers to include:

1.  My numbers are based on what was sent by you to all owners last November.  Does the Board have new numbers that more properly reflect today's reality since so much has changed in the last five months?
    
2.  Please let me know what, if any, substantive mistakes I might have in my analysis.  I am sure some of my numbers may be off to some degree - but the big picture is still going to be the same. Again, I've not had the time to get any more information than what has been provided to all owners.  If I've overlooked anything that would have a material impact on my logic or their crystal clear conclusions, please let me know so that I can update my analysis.
    
3.  How many of the 84 units at Deer Ridge are currently being managed by RML? What is Joe projecting this number to be at the end of 2008?  At the end of 2009?
    
4.  Where is the break-even point for RML with its current management fee level?  In other words, how many units must be rented at this year's expected occupancy and rental rates for all costs associated with RML to be totally covered without any support from GGRC?
    
5.  As an employee of GGRC and RML, what is Joe's total payroll cost to the owners of Deer Ridge, inclusive of all salaries, fees, bonuses and associated compensation for the year ending 2007?  W-2s and 1099s have to be issued by January 31, 2008 - so these must be known numbers. All owners deserve to know the true cost of his employment.
    
6.  For the past 12 months, how much revenue, if any, has directly resulted from The Joe Thomas Memorial Pavilion? 
    
   •  Exactly how much did the banquet hall end up costing all homeowners, inclusive of all hard and soft costs related to its design, construction, outfitting and operation? 
      
   •  How many days of paid use have been booked, so far for 2008? 
      
   •  At the current running rate for the past 10 months, how many years will it take for the owners to recoup all costs associated with the Pavilion?
      
7.  What has the Board done, anticipatorily, to prepare for the biggest real estate downturn since the 1980s?
    
8.  Does the Board plan on recommending to the owners at the meeting this month that it immediately sell RML?
    
   •  If yes, what is the Board's detailed game plan for action and results?
      
   •  If no, how does the Board plan on covering the expected huge negative cash flow for RML?
      
9.  What is the undefined $200,000 line item of revenue shown in the RML budget - and what is the likelihood that it will be a 2008 exact reality?
    
10.  What is the undefined $131,000 of direct costs shown in the RML budget?

Luther, since we cannot attend the meeting, please email me the answers to these questions at your earliest convenience.

Don't Kill The Messenger

Luther, I hope none of the above is a surprise to anyone on the Board. I hope you and every member of the Board have already spent countless hours of detailed financial analysis with endless contingency discussions.

I hope that you all have already considered all of the above points and have a logical, detailed plan of attack to immediately protect all owners from the huge risk of RML's negative cash flow and the unlimited liability it potentially gives every owner of Deer Ridge.

With the recession and the worse real estate crash in 30 years, the owners of Deer Ridge cannot afford the thousands of dollars of special assessments against each unit. 

The coming economic Perfect Storm is going to hit all homeowners badly enough at Deer Ridge. The above numbers speak for themselves. My goal is that RML does not make a very bad situation SIGNIFICANTLY worse for us all. 

I certainly do not wish any of the above to happen...as a matter of fact, I would be delighted to be wrong on every point. 

Unfortunately for us all, I am afraid that I am going to be mostly right.

Robert & Janet
A-202

PS: Click Foreclosures to see a current listing of all current foreclosures in the Gatlinburg market.