Minnesota's housing wastelands

On a bluff overlooking downtown Cannon Falls, Minn., roads are crumbling on soil that residents say was never fit for development. Near Watertown, bent scaffolding and other construction debris lie amid a field of weeds that was set to be home to rows of Italian-themed townhouses.

Outside Dassel, whenever it rains, dirt piled five stories high in a partially completed subdivision flows into driveways and the city's sewer system.

It's all stark evidence of the housing bust. And, more precisely, the collapse of an Eagan lender named Lakeland Construction Finance LLC, which loaned hundreds of millions of dollars to developers, sometimes without visiting sites or requiring an appraisal.

"It's like we're being held hostage," said Aaron Reeves, city administrator for Cannon Falls, as he walked on crumbling asphalt left at Sandstone Ridge, a housing development financed by Lakeland. "The money's gone, and no one seems willing to take responsibility for what's happened."

Work at more than a dozen Lakeland projects has screeched to a halt during the past two years as the firm defaulted on more than $400 million in loans from the Bank of Scotland. Local government officials, now owed millions of dollars by the firm, were surprised to learn that specialty lenders such as Lakeland are unregulated. No state or federal agency checks their finances, and there's little recourse when the companies fail.

Just as mortgage lenders such as Countrywide and Washington Mutual made credit too easily available to consumers buying new homes, Lakeland kept money flowing to Minnesota developers well after the housing market had showed signs of cratering.

Now, people who bought houses in Lakeland-financed projects around the state thinking that they would be part of thriving communities find themselves surrounded by vacant land and unfinished roads.

Molly Carlson bought a Hugo townhouse in a project called Generation Acres in late 2006, about 15 months before Lakeland defaulted on its loans and stopped paying contractors. About 40 townhouses were planned, but only eight were built and two sit vacant.

Carlson, who is 70, has been forced to do the shoveling, lawn mowing and some of the building repairs herself. "A 70-year-old lady is not supposed to be climbing a 16-foot stepladder," she said.

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Lakeland is not a bank. It has no customer deposits, and because it lent money to land speculators and home builders and not home buyers, it occupied a place largely free from regulatory oversight. That allowed it and other specialty lenders to back developers and write loans that banks might avoid.

In return for this increased risk, these speciality lenders charged interest rates and fees that many bankers would not contemplate. Some continued extending credit to developers well after the housing market had begun to stall, slide and then plummet.

"They got pretty reckless on some of those loans," said Rudy Novak, a developer who worked with Lakeland on Savannah Village, an unfinished housing project in Becker. "They did stuff that no bank would ever do."

Like other specialty finance companies in the Twin Cities that flourished during the housing boom, Lakeland put money to work on behalf of financial institutions and wealthy investors. Area home builders count about a dozen firms that made an estimated $2 billion or more in residential real estate loans in and around the Twin Cities, often in far-flung suburbs that have been hardest hit by the sharp downturn in housing prices.

Lakeland was founded in 1999 by former Northwest Airlines senior manager Jeff Majkrzak. It grew into a major player in the Twin Cities residential lending market after it attracted the financial backing of Ted Waitt, who had made more than $1 billion from the sale of Gateway Computers, the personal computer-maker he founded in an Iowa farmhouse in 1985.

Officials from Lakeland did not return multiple telephone calls. On a recent weekday, the firm's office in Eagan was eerily quiet, with no one sitting at the front desk. A person who described himself as a "consultant" emerged, but insisted he was not an employee and declined to talk. The firm's receiver, Lighthouse Management Group Inc., also did not return telephone calls. Waitt's investment firm, Avalon Capital Group in La Jolla, Calif., referred all questions to its general counsel, Nicole Blakely, who did not return calls.

According to court documents, Lakeland's profits surged along with the Twin Cities housing market. But Majkrzak increasingly found himself clashing with his biggest investor. Court records indicate he resigned as the company's chief executive in 2003 over strategic differences with Avalon. About two years later, Waitt recruited Joseph Burke, a former Blockbuster Entertainment executive known for building franchise operations, to be CEO.

Majkrzak declined to be interviewed for this article because of a confidentiality agreement with Lakeland, as did a number of other former executives. According to a November 2008 court deposition, Majkrzak said he disagreed with one of Avalon's executives, Rose Ann Ignell, who hired consultants from Utah to position the company for growth.

"However strong the market is, you have to have very intimate knowledge in a given market and I didn't feel at all that these individuals brought any experience," he said in the deposition.

It was about this time, say local developers, that Lakeland began giving more authority to a loan officer named Robert Machacek. A short, stockily built man in his late 30s, Machacek had a reputation in development circles as a dealmaker. He eventually became Lakeland's chief operating officer.

He also had a criminal record. In 2000, Machacek pleaded guilty to two charges of mail fraud in connection with the embezzlement of $355,000 from Builders Development & Finance of Wayzata, a rival residential-construction lender, where he had worked as CFO. He was sentenced to a year in prison. Citing the criminal conviction, the American Institute of Certified Public Accountants terminated his certificate to practice as an accountant in 2002.

Machacek was dismissed from Lakeland in December 2007, and is now suing the company for wrongful dismissal and breach of contract. He does not have a locally published telephone number and did not respond to written notes left at a house listed under his name on Safari Heights Trail in Eagan.

Among local developers, Machacek and his counterparts at Lakeland became the go-to people to obtain complicated development loans quickly. Deals that would take weeks or months for banks to approve, Lakeland would arrange in a matter of days.

To be sure, plenty of regulated banks got in trouble by loosening their lending standards during the credit boom. But banks are required by regulators to maintain minimum capital levels and cash reserves that act as cushions against loan losses, while specialty finance companies like Lakeland are not.

Banks wouldn't even talk to developer Alan Gilyard of Becker after a medical condition forced him to file for personal bankruptcy years earlier, but Lakeland was a willing partner on more than 20 housing projects scattered throughout central Minnesota.

Along the way, Gilyard, the son of a dairy farmer, built a sprawling country home and bought 620 acres of hunting land and three restaurants.

"I owe everything I have to Lakeland," Gilyard said as he drove past his hunting land outside of Becker. "And now I'm losing it all."

Gilyard's experience offers a window into the way Lakeland operated.

In a decade of doing business with Lakeland, Gilyard said, the firm never asked him for an appraisal or a soil test -- standard requests by banks that make development loans. On most of Lakeland's land loans, he said, it was enough to give the firm a single piece of paper that showed how much the lots would sell for and a schedule for how the loan would be repaid.

Unlike a bank, which often demands a down payment of at least 10 percent on a development loan, Lakeland financed up to 100 percent of the cost of a project. Developers say the papers often were signed over breakfast at a Perkins restaurant or in a developer's SUV parked near a project site.

"In all my years with Lakeland, I don't ever recall them doing an appraisal," said Kurt Manley, vice president of Manley Brothers Construction. "It definitely set them apart."

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Easy credit came with a price, though.

Developers say Lakeland often charged interest rates that were 3 or 4 percentage points higher than many banks, plus origination fees of up to 2.25 percent of the amount borrowed. As loans came due, Lakeland would automatically renew the loans and collect more fees, developers said. They also had first security rights to the property in case of default.

On some Lakeland-financed projects that did not proceed as planned, the accrued interest and fees added up to many times the original amounts lent.

In 2000, for instance, Lakeland made a $4 million loan to Anoka-based Edina Development Corp. to acquire 180 acres of farmland in Blaine, known as the Finn Farm. But a national builder's plan to buy the land and build 800 houses fell through, and Edina Development has since filed for bankruptcy protection. According to court documents, the firm now owes an estimated $30 million to Lakeland on the Finn Farm project, or about seven times the amount originally lent. The site remains undeveloped.

Rick Lewandowski, president of Edina Development, declined to comment.

"It's beyond comprehension how they thought all of this would work," said Bill Keenan, president of Builders Development & Finance in Wayzata. "They appeared to be betting on inflation" in land prices, he said.

By 2006, the housing market in the Twin Cities had slowed. In the following years it would slide and plummet. Lakeland began putting pressure on its borrowers.

In the summer of 2007, Gilyard said, Lakeland demanded immediate payment of its loans. The following January, Lakeland defaulted on its loans from the Bank of Scotland.

Gilyard estimates that he owes $22 million to the company. He has canceled work on about 10 new housing projects, including one in Onamia called Woodland Meadows, which is now overgrown with weeds. Contractors on his projects are still owed about $1 million, he says.

Gilyard says he was getting so many telephone calls from angry creditors that he switched cell phone numbers. Like many developers who dealt with Lakeland, he is convinced that he could have made his payments and come out ahead -- if only Lakeland would have given him more time to sell his unfinished lots.

Woodland Meadows is one of at least a dozen Lakeland-financed projects across the state that are foundering, and cities and townships are still dealing with the aftermath.

In Pine City, city officials have all but given up trying to get Lakeland to honor a $250,000 letter of credit and finish work on basic infrastructure improvements, including roads and sewer systems, on a housing project called Fawn Meadows.

Going forward, the city will never again approve a new housing project based on a financial guarantee from an unregulated finance company, said Don Howard, city administrator. "It will have to be an FDIC-insured institution or a regulated bank," he said. "We will never walk down this road again."

As of December, Lakeland had 42 outstanding letters of credit with a face value of about $28 million issued on behalf of its borrowers to governmental and developmental agencies, according to a receiver's report filed with the court. The balance due on those letters of credit was $11.23 million.

Court documents indicate that Lakeland has about 565 outstanding loans to 151 different borrowers.

In Dassel, city officials are still trying to persuade Lakeland to remove more than 100,000 cubic yards of dirt and clay that builders left at Summit Hills, an unfinished subdivision on a scenic hillside outside the downtown. With each rain, mud from the hill seeps into the town's sewers, and city engineers fear it could clog the system. Meanwhile, the handful of families that moved into Summit Hills are worried that someone will get hurt on the dirt pile, which is nearly 60 feet high on one side.

"A child could get buried over there if that caved in," said Kristi Rorah, a resident of Summit Hills and mother of two children.

In Cannon Falls, city officials have tried working with Lakeland to clean up a series of dilapidated streets on a scenic bluff overlooking downtown.

Reeves, the city administrator, said he contacted Lakeland to see whether the firm would consider selling the land to the city, which could turn it into a public park with soccer and baseball fields. Lakeland, which now owns the land through foreclosure, hasn't responded, Reeves said.

It may take years for the courts and the receiver to sift through the mess and sell all of the property. However, developers involved in the process say the longer these unfinished projects fester without a buyer, the less money there will be for Lakeland's main creditor, the Bank of Scotland.

The extent of Lakeland's losses remain unclear. Even if Lakeland were to liquidate all of its assets over 20 months, it would still have unpaid debts of $206 million, according to court documents. Nearly 80 percent of the company's collateral consists of raw land or finished lots with no houses -- the toughest real estate to sell during a severe housing slump.

Keenan, president of Builders Development & Finance, argues that government regulation doesn't address Lakeland's main problem -- that it had an out-of-state owner in Waitt who did not understand the Twin Cities real estate market. "Most companies of our type are operated by boards or owners who literally go out and look at every project before they make a loan," he said. "In their case, they had an absentee owner who contributed a lot of capital. ... And it looks like no one was minding the store."

Staff researcher John Wareham contributed to this article. Chris Serres • 612-673-4308 cserres@startribune.com