THE CONDO CONUMDRUM – 10 REASONS WHY THERE AREN’T MORE NEW CONSTRUCTION “FOR SALE” MULTIFAMILY DEVELOPMENTS IN SEATTLE
Seattle is the fastest-growing large city in the US with the median home prices rising more here than any other metro area in the nation. That means developers are building new condominiums at a record clip, right? Nope, it’s actually the opposite. There is currently a real of in-city condominiums resulting in high median home prices, rising more than 30-percent year-over-year to $660,000 – about the same as the typical home in King County. And 94-percent of the projected 27,000 new housing units built in downtown Seattle this decade will be for rent and not for sale, leaving many to scratch their heads. This topic was recently explored by The Seattle Times and King 5 TV News as prospective buyers have literally camped out overnight to book their opportunity to own. So, what gives? Here are ten reasons why consumers consider condos but most developers don’t.
- Developers Chose the Path of Least Resistance
It’s a common misconception that developers are in social service, delivering housing as needed to balance supply and demand. The reality is that most developers focus on the highest returns with the lowest risks. So, unless building new condominiums fits this profile, it’s not getting built.
- The Washington’s Condo Act.
The Act “overprotects” purchasers with unattainable warranties of quality and severe restrictions on purchaser deposits. During the last cycle, litigation was the norm, not the exception. The result is that as this cycle begins, nearly everyone is afraid to work with condos – developers, lenders, architects, contractors, and attorneys.
Source of the litigation?
- Implied warranties of quality:
- Sound engineering design;
- Workmanlike construction;
- Non-defective materials;
- Compliance with all applicable laws; and
- Suitable for the ordinary uses of real estate of its type.
- Warranties may not be disclaimed via a typical “AS-IS” clause.
- Warranties last for at least four years from the closing of the first unit sale.
- Inexperienced directors and officers of the condo association are easily convinced that they must investigate the building before the warranty period passes.
- Attorneys have inspectors that are very good at finding “defects” among the grey areas of the building code and design/construction standards and offer to work on a contingency basis. It is a rare board that decides to not bring condo defect claims under this pressure.
- Higher Lending and Insurance Costs for Condos.
The inherent risk of condo defect litigation substantially increases the cost of building condos:
- The few condo lenders available require more equity, charge higher interest rates, and impose strict presale standards before the condo sales may close;
- Fewer design and construction professionals willing to work on condos versus apartments charge more and demand a project-specific WRAP policy;
- The WRAP policy is double the cost of traditional insurance for apartments;
- Litigation takes time away from other projects (e.g., responding to subpoenas and sitting through depositions, site inspections, mediations, court proceedings).
- Restrictions on Purchaser Deposits:
In many other mature condo markets, like Vancouver BC or Miami, FL it’s common for buyers to deposit 20, 30 or even 50-percent of the purchase price of a new development, investing significant “at-risk” monies that are often released to the developer to help fund the construction of the project. Not so in Washington, which means the developer has relatively little security in the buyers knowing they can walk away at any time before closing:
- RCW 64.34.430 requires that all deposits made in connection with the purchase or reservation of a condo home be held in trust or escrow pending closing.
- RCW 64.04.005 limits the “safe harbour” amount of those deposits to five percent (5%) of the purchase price and requires that the developer limit its remedy for a purchaser default to forfeiture of the 5% deposit.
- If the market value of the condo home falls by more than 5% during construction, the purchaser is encouraged to cancel the purchase and forfeit the earnest money leaving the developer with an empty building and a difficult market.
- Other jurisdictions with more condo homes (e.g., Vancouver) allow much higher purchaser deposits and allow the developer to use those deposits as collateral for the construction loan.
- If WA law allowed a condo developer to collect 10% to 15% of the purchase price and then pledge those deposits to the construction lender, more lender would be willing to fund condo developments and more developers would be able to raise the balance of the equity required to build.
- Rentals Rule the Roost:
Developers have experienced meteoric demand to acquire quality, new construction apartment buildings in what the Urban Land Institute cites as the best investment market in the US, according to their 2018 Emerging Trends in Real Estate survey. That means there are often multiple willing and able investment groups prepared to pounce on an apartment tower. And having multiple bidders means that the price paid to own the rental tower rises to a point that its similar to the value of a condominium alternative.
- Investors Love Seattle:
It takes developers many years to conceive and construct a high-rise community and they want to invest in the long-term holding instead of selling it out. With Seattle following similar investment trends to both West Coast peer cities of Vancouver, BC and San Francisco, CA – the most popular goal is to hold the assets in a rising market.
- Rents Keep Rising:
It’s good to be a landlord in Seattle and for many developers, the idea of preselling two or more years before closing the unit sales means leaving a few years of appreciation on the table. With rents, the final rental rate is booked at the time of occupancy and with most leases being just 12 months long, there’s an opportunity to increase rents each year. To be sure, Seattle is now considered the fifth most expensive large market in the US, according to US Census data with the median rent rising $92 per month to $1,448 in 2016.
- Millennials Among Us:
Housing demand in downtown Seattle (and throughout the Puget Sound region) has been greatly influenced by the job growth within the tech sector. Many of these relocating employees are drawn by the prospects of high incomes, no state income taxes and the opportunity to live and work within a vibrant city on the rise. Most of these youthful recruits came of age during the past decade and witnessed the boom and bust of the past market cycles and the global credit crunch that may have affected their older siblings or parents – effectively, Millennials largely skipped a housing cycle and are more inclined to rent (for now). That said, many of these consumers are now incubating as would-be buyers in apartment towers waiting for their opportunity to own a slice of the expanding skyline. That assumes, of course, that there will be inventory to buy.
- Rising Construction Costs:
With the booming development industry in Seattle, it’s little surprise that the costs to deliver new projects is rising at 6-8-percent per year. When presale requirements demand to sell a condominium a year or two before delivering, the revenues become set while the construction costs can remain variable, exposing the developer to risk.
- Presale Are Relatively New in Seattle
Seattle’s urban renaissance is relatively young and it’s high-rise zoning, known as the Center City Plan, was only adopted in 2006. That provided just a few years of development before the Great Recession shut down the demand and developers struggled to get construction financing (and consumers found mortgage lending equally troublesome). So, just as Seattle was building a head of steam for condominium development, it closed out and was replaced by a boon of an apartment building. This means local consumers and brokers have, perhaps one or two market cycles of experience realizing the value proposition of presale to resale, which can represent 20-30+ percent increases in the value of the home (albeit secured by just a 5-percent deposit). If more consumers knew the advantages of presales, the demand would be even higher, encouraging developers to take the risk to reap the rewards.
These headwinds to condominium development don’t mean there isn’t a market for the product. In fact, the market pendulum has swung fully in the other direction in favour of for-sale housing but like all cycles, the early bird gets the worm. This was the case with NEXUS, a 389-unit condominium being developed by Vancouver, BC-based Burrard Group at the corner of Minor Avenue and Howell Street. When the much-anticipated project hit the market in March of 2017 more than 70-percent of the units were presold within a week of its debut with some eager buyers camping out overnight to secure their piece of the skyline.
“The Washington State Condominium Act is so focused on protecting consumers – it works too well and effectively scares away a lot of developers,” says Kerry Bucklin, Principal of Bucklin Evans Law, LLP. “I suspect that legislation may eventually change but until then, prices will increase.”
Some market pundits are concerned about the crisis of affordability in downtown Seattle housing noting only 57 resale units listed for sale in a city of more than 70,000 urban residents. Most notably, there are only 7 homes actively available at price points below $700,000. The median asking price of available resale homes is nearly $1.4 million.
“It can take up to four years or more to move from initial concept to final closing with high-rise development,” adds Dean Jones, President and CEO of Realogics Sotheby’s International Realty. “So, the reality is developers can’t respond that quickly to opportunities in the market.”
Jones points to several new condominium offerings that are in early stages of design and development, however that supply isn’t expected to deliver until at least 2020. He notes more than two-thirds of the new condo inventory being constructed for earlier occupancy is already pre-sold.