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Predicting the Condo Meltdown: 6 Ways to Spot a Fragile Condo Market

Mar 25, 2008
Across the country, the last five years has seen a boom in urban high-rise condo development. With many cities experiencing unprecedented levels of luxury condo development, a condo glut has caused severe problems in markets from Miami to Las Vegas to Madison, Wisconsin.

While many markets have been overbuilt, resulting in project bankruptcies and condo unit fire sales, other cities such as Austin, Texas and New York City have remained quite strong.

If you are planning to buy or sell a condo, it is important to understand the health of your local market. These six rules will help you judge the strength of your local high rise condo market, and identify warning signs before prices fall.

Test # 1: Are Condo Developers experiencing financial troubles?

When supply exceeds demand, developers are often the first to feel financial pain. Typically, projects break-ground when 30-50% of the units have been pre-sold. In order to pay back the construction loans, developers need to sell the vast majority of units by the time construction is complete. If condo market conditions deteriorate, developers will begin to default on loans and projects may even go bankrupt. When this happens, it is a clear sign of condo market problems.

One important note, it's common for projects to be cancelled prior to construction. Many projects are ill conceived or poorly marketed. For these projects the market works perfectly: they underwhelm buyers, fail to meet sales goals, and are unable to get financing. Even in good markets, bad projects should fail before construction begins. When this happens, it's not necessarily a sign of market distress.

Test # 2: Frozen Construction

Developers have a strong incentive to complete projects quickly. With big loans come big interest payments. The quicker construction is done, the higher the financial return on the project. When cost overruns, financing problems, or weak demand lead to a construction freeze, it's a big sign of trouble.

Test # 3: Discounting After Construction Begins

In normal to strong markets, the biggest discounts go to the buyers of the earliest units: the ones who take the biggest risk on a project that may or may not be built. As construction proceeds, prices tend to go up. When developers cut prices on units during construction, it typically means there is a problem with demand.

Test # 4: Condo Projects Converting to Rentals

Condo and rental projects are designed and built for different buyers and different standards. Conversion from a condo project to a rental project after construction ha commenced is an act of desperation, and a sure sign of market problems.

Test # 5: Disproportionate Weakness with Existing Condo Sales

While many housing markets are declining, the key test is whether the local market for condos is weaker than the broader local housing market. To check, look at historical sales for centrally located condos and single-family housing. If condos sales prices have seen greater depreciation, or if condos take many more days to sell, this could be a sign of market problems.

Test # 6: Housing Markets With Significant Price Deflation

In markets with high levels of new condo project development and significant price deflation - markets like Boston, Las Vegas and San Diego - developers will be in trouble. As prices go down by 10%, 20%, or more and costs stay the same, few new condo projects will be able to survive.

In today's tumultuous real estate market, it can be hard to tell the difference between broad market troubles and condo market over-supply or dips in condo demand. So before you make the decision to buy or sell, apply these 6 tests. When markets are weak, buyers will be in control. If you are in a weak market and want to sell, you may need to price aggressively. If you are buying, you will have a strong ability to negotiate, and may even be better off waiting for the market to bottom out.
About the Author
Paul D'Arcy is an expert on condo development and an active real estate investor. A graduate of Wesleyan University and Harvard Business School, he is currently the Editor of AustinTowers.net which analyzes the downtown Austin condo market and major high-rise condo trends around the country.
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