The Housing Chronicles Blog: New condos about the hit the market will add to existing inventory

Saturday, March 22, 2008

New condos about the hit the market will add to existing inventory

Building condos, especially those in large projects, is a lot trickier than building single-family homes. For one thing, they usually can't be built in phases, so once construction starts the builder has little choice but to finish the project. For another, the time in between when marketing begins and buyers move in can be as long as 3 years -- a period in which construction costs can rise and when both economics and buyer psychology can change dramatically.

Consequently, buyers who can't get financing or change their minds in a troubled market add to cancellation rates already approaching 40 or 50 percent for some projects, putting the squeeze on builders trying to pay back construction loans. Condo inventory -- already at 10 months -- will likely rise in markets such as Atlanta, Miami and San Diego as projects under construction are released to the market, although that could help bring down rents in those areas and provide opportunities for vulture investors. From the Wall Street Journal:

The condominium market is about to get worse as many cities brace for a flood of new supply this year -- the result of construction started at the height of the housing boom.

More than 4,000 new units will be completed in both Atlanta and Phoenix by the end of the year. Developers in Miami and Fort Lauderdale, Fla., are readying nearly 10,000 total new units in a market already struggling with canyons of unsold condos. San Diego, another hard-hit region, will add 2,500 units, according to estimates provided by Reis Inc., a New York-based real-estate-research firm.

The new building comes on top of unprecedented supply. The U.S. finished 2007 with a supply of condos large enough to absorb 10 months of demand, the highest level since the National Association of Realtors began the tally in 1999.

The deluge means bad news for developers and potentially lower prices, including in cities such as Atlanta and Dallas that have avoided the worst of the housing bust. If defaults and foreclosures rise, lenders will feel the pain too.

Regulators have been sounding the alarm for weeks about the exposure of small and mid-size banks to commercial real estate, which mostly means construction loans to developers of condos and single-family housing.

Lenders of all sizes have $42 billion of condominium debt on their books, according to Foresight Analytics. In just three months -- between the third and fourth quarters of last year -- the delinquency rate rose to 10% from 5.9%, says the Oakland, Calif., research firm.

The news isn't bad for everyone. Vulture buyers have started to circle, hoping to take advantage of foreclosed properties that banks may start dumping at fire-sale prices. Also, some condos are being converted to rental units, increasing supply for renters and putting downward pressure on prices...

However, developers and lenders can more easily shelve projects that are still in the early stages. Many developments nationwide are being canceled, suggesting that by next year or 2010, the number of new condos coming onto the market may slow to a trickle.

One big question hanging over the market is how many of the buyers who have put down deposits during construction will show up to close the deal. Some deposits were as little as 3% of the purchase price. The price of a condo has frequently fallen more than the amount of the deposit, giving the buyer an incentive to forfeit the deposit...

The rising supply is a reflection of the picture in 2004 through 2006 -- a time of huge demand for condos. Speculation was rampant as investors believed empty nesters and young professionals seeking an urban experience akin to what they watched on "Friends" would prop up the condo market for years.

Most projects take about three years from the time they are marketed to potential buyers to the time they are ready to be moved into. Deposits help developers get a construction loan that is to be paid off when the buyers close on their new condos years later.

However, cancellations are rising, meaning developers may not be able to pay back their banks. Peter Zalewski, founder of Condo Vultures Realty LLC in Miami, says condo developers he is working with are expecting 20% to 40% of buyers who put down deposits to walk away from the deal. In some areas, such as inland buildings and new projects along the river in Miami "walkaways" are expected to be even higher.

Unlike single-family housing, condos tend to be concentrated in certain areas, meaning the pain is limited to pockets of the country...

One option for a developer is to convert the condos to apartments. However, these projects are usually financed with the presumption that sales of individual condos pay off more than rents from a comparably sized apartment building. Also, lenders typically expect developers to pay off condo construction loans with the millions of dollars they receive when closing on the sales. Such a quick payout isn't possible if the developer is only receiving monthly rental payments...

As more condominium projects get into trouble, investors are looking to pounce. Some 700 people showed up for a distressed-real-estate conference this past week in Miami where the condo glut was the dominant discussion subject.

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