The Economics of Condo Development

More doom and gloom press about the condo market hits the pages of newspapers and online publications every day.  Homeowners continue to worry about their house or condo values going down, home buyers are continually wondering how low prices will go (referred to as “on the fence”) and basically waiting to see what happens to rates, and banks continue to worry about cleaning up the credit mess and rising rate of foreclosures. 

Well, we are not in a wait and see market anymore!  We are right in the middle of things and people are starting to take action.  The Fed is supplying the necessary means to give some comfort to the damage industry, home and condo owners now understand they need to simple hang on and not think short term, and most importantly people are starting to buy again.  Rates are going way down as are values which open the flood gates for buying opportunity from both homebuyers as well as investors who will hold the properties for a long time and rent them out.  News came out today showing homes sales are actually up over 2%.  We will still see some volatility though so let’s not get ahead of ourselves and think that we are out of this.

Thousands of new condos and homes will be hitting the sales path in major cities all over the country as new construction homes and condos in areas like Phoenix, Atlanta, Dallas, San Diego, los Angeles and New York come to completion.  Many are worries what a flood of new units will do to an already saturated market.  Many also ask why condo developers would continue to build and finish projects when there is already so much inventory sitting idle. 

For builders and developers of condos, it is all about the numbers.  Yes, of course the dream and vision of provide new homes for people is always there but let’s put that aside for a moment and think about this from purely a business perspective.  Most condo developers use their own money, at least initially, before diving into construction loans from banks and lending institutions.  That is why the roller coaster game of real estate development is so exciting (and sometimes scary)!  Once the developer burns through their initial funds set aside for the project and then start taking portions of their construction loans, they are committed.  As the market takes the usual cyclical swings builders who start their project on the upswing (or in the middle of the downswing) usually will push forward slowly, control their burn rate, and hope that the market is healthy by the time they are ready to start selling units.  Now of course, the builders are usually supposed to be pre-selling this whole time which is especially difficult in a market downturn.  In addition, some just simply do not have the cash flow to keep the projects going or their lending partner will shut off the flow of money of sales are not met. 

There are some short term alternatives for condos and homes that can help the builder wait things out. When builders are near the end of a project and sales are simply not happening at a good rate, the builder will often finish the project, market the units as rentals so there is a revenue stream to cover holding costs, and then re-market the units as “for sale” later when the buyer return.   When a condo development is in the very early stages it is often easy for a developer to “shelve” the plans for a year or two because they are not far enough along to produce any significant carrying costs.   Many experience development companies will plan to build new construction condos at a size and price that would easily allow for the “back-up” plan of going to rentals should they not sell quickly enough.  These developers would still experience a loss but the hit to their books is not as drastic because of certain financial measures taken throughout the process.

Regardless, as in any real estate cycle, some peoples’ struggles are other peoples’ opportunities.  Buyers and investors are out their looking for condos.  More and more “funds” are being put together to scoop up the over-supply at a good price.