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.
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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 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.
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 percent from 5.9 percent, 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.
It may seem surprising that anyone would want to add supply to a market whose troubles have been well-publicized for many months. But the economics of condo building encourage developers to bring half-finished projects to completion, even when prices and demand are plunging.
Developers usually put up their own money for a project first, then spend borrowed funds. Once developers have spent their money and have commitments from lenders, they have a strong incentive to keep building to finish the project.
“These developers had millions of dollars tied up and they had them financed so they just moved forward,” says J. Ronald Terwilliger, chief executive of Trammell Crow Residential, which builds many rental apartment buildings and also some condos. “What they hope is that by the time the project is finished the market comes back.”
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 percent 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.
For example, if a buyer put down $50,000 for a unit priced at $500,000, and the value falls to $400,000, the buyer is apt to walk away — or find some fault with the unit and sue the developer to get the deposit back. Furthermore, some buyers who still want to move in are finding that they no longer qualify for mortgage loans.
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 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. 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 percent to 40 percent of buyers who put down deposits to walk away from the deal.
In Jacksonville, Fla., developer Cameron Kuhn had planned to redevelop the SunTrust office tower into office condos. Now the condo tower is on hold, dashing city officials’ hopes that the project would help to bring parking, residents and more life to the downtown.
Prices dropped nearly 20 percent in Tucson, Ariz., and 12 percent in the Atlanta area during that time, according to National Association of Realtors data. Inside the newly minted Quantum on the Bay in Miami, prices for two-bedroom units have fallen from the high $700,000s to around $500,000.
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.
Terwilliger says Trammell Crow plans its condo developments with an eye toward converting them into rentals if necessary. But its profits are cut when it does that because the company typically spends more for land and amenities when developing condos, he says.