Is The Condo Market Dead?

The Real Estate Espresso Podcast

Is The Condo Market Dead?

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Welcome to the Real Estate Espresso podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce.

On today’s show, we’re looking at something that appears to be news if you strictly follow the headlines. But if you’re following the industry, you’ll recognize that the media are reporting news that, quite frankly, is several years old. The issue is in the condo market.

The problem is that the condo model is flawed, at least in its current incarnation. When you have a condo association that’s governed by ordinary residents who don’t truly understand real estate, they don’t understand management, it’s no surprise that decisions get made that are not in the best interests of the long-term health of the project.

We also now have experience that many homeowner associations are extremely litigious. When something goes wrong in a project, they’re quick to sue the architect, the engineers, the general contractor, the developer, anyone who might have had a role in the development of the project in some way.

The natural response to that environment is that architects and engineers take extra steps to cover their behind and make sure that they have no liability. The net result is higher costs for the homeowner association.

Layer on top of that the notion that any condo developer needs to achieve somewhere between 60% to 80% presale of units in order to qualify for their construction financing. The presales process is full of uncertainty. New condos are just not selling.

The way developers in the past have got a jump on the sales process is to sell somewhere between 20% to 30% of the units to investors. That means designing units that are very small and will generate the most rent per square foot.

Developers have also frequently relied on the so-called friends and family contingent of buyers. These are sometimes subcontractors to the project who will commit to buy a few units, knowing that they’ll likely never take occupancy. These units will be sold after completion, or perhaps some of these contracts will be assigned prior to finalizing the condo registration.

Even with that, many of these units are more expensive to purchase than existing units in the market today, and even units that were delivered five or ten years ago are experiencing negative cashflow at today’s interest rates. So that eliminates the 20% to 30% of the buyers right off the top. It’s now almost mathematically impossible to achieve the presale targets without the investor component.

There are literally hundreds of incomplete condo projects across the US and Canada that are stalled and in danger of going back to the lender. In some cases, the projects never achieved their construction metrics. In other cases, construction was started and then costs escalated between the time of presales and the actual construction.

That leaves the developer with an uncomfortable choice. If the purchase contract with the individual buyers had an escalation clause, these costs could be passed on to the buyers, but that’s going to be unpopular. Most of them will not have their final financing commitments, and maybe the buyer will be able to absorb the increase, but if the increase is substantial some buyers may choose to cancel their purchase contract. And then that leaves the developer in a precarious position with the construction lender.

In some cases, the buyers that were anticipated have evaporated completely. In Miami, many of the buyers were from South America looking for a place to park cash that would be safer than in a bank in Argentina or Venezuela. Now we know that the current immigration policy in Washington is not encouraging a ton of new people to buy condos in Miami.

The new condo rules in Florida have resulted in a lot of existing condos appearing in the market with very few buyers. That’s pushing prices down in the market by a lot.

But this is not only a Florida story. Softness is appearing in numerous other condo markets. That includes Atlanta, Austin, Dallas, Phoenix, and many others.

I have several architects who will simply refuse to design buildings that are destined for the condo market. There’s just too many examples of architects getting caught up in lawsuits.

The Wall Street Journal reported this week that condos in Boston were built in anticipation of New York–type demand spilling over into the Boston market. A lot of condo projects were launched with that thesis in mind, and the buyers never materialized. The net result is projects that are not meeting their financial metrics. Many will go back to the bank with unsold units.

Now we’ve talked about the meltdown in the condo market in Toronto and Vancouver on the show before. I’ve seen a few projects in Toronto selling units at below their construction costs. The developer is doing anything and everything, whatever they can, to liquidate units and get out alive.

But while this is considered news in the media, we saw it coming in 2022. We had a project that started as a condo project in 2021. By 2022, it was clear that the only path was to convert that project to rental. Condo sales had already slowed in 2022, and many of the concerns being raised today were apparent back then if you were paying attention.

The data showed up in the absorption metrics for large, established developers. When we looked at the traffic at new launches, it simply wasn’t there when we visited the sales centers for competing projects.

We looked at the numbers. Some developers were showing a number of units as sold on the first day of the launch, but we knew this wasn’t true. It was merely a tactic designed to generate a false sense of scarcity. Maybe these manipulative tactics might have worked with retail consumers in years past, but today nobody’s falling for it.

When major developers needing 70% presales are only getting 20%, the writing’s on the wall. The condo market’s dead. It’s not clear what it will take for condos to return or what needs to change in the model.

Some of these projects may become candidates for conversion to rental, but that’s a difficult legal path to pursue. The buyer needs to get a supermajority of unit holders, depending on the jurisdiction, all willing to sell at the same time in order to enable a conversion.

We looked at one such project in Houston a couple of years ago, and here too, the risks were well above our threshold to give the project serious consideration.

As you think about that, have an awesome rest of your day. Go make some great things happen. We’ll talk to you again tomorrow!

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