Condo Crazy
Construction is frenzied, and prices are going through the roof. Is it too much, too fast?
In Los Angeles, a builder unveils plans for a new condominium development, and more than 2,000 people sign up for the chance to buy one of the 135 $500,000 lofts that will be built in 2006. In Naples, Fla., frantic real-estate investors close on not-yet-built condos in the morning and resell them for 10 to 15 percent more that afternoon. Along Mississippi's Gulf Coast, buyers reserve new waterfront units at $350 per square foot, only to be told on contract-signing day that the price has climbed to $500 per square foot. They pay up without hesitation.
Condomania is back.
While the nation has been focusing on the white-hot single-family-home market, condos have been staging a pretty impressive run-up of their own. The median price of an existing condo in the United States jumped 17 percent in 2004 to $193,600, compared with a gain of 8.3 percent to $184,100 for a single-family dwelling. And that was the fourth year in a row that condos, co-ops, and townhouses have increased in value faster than their single-family counterparts. Some 15 years ago, homeowners feared that condo values wouldn't hold, but today, says Bruce Karatz, CEO of Los Angeles-based KB Home, "People are a lot more confident these days that the value of a condo is solid."
Maybe too confident. With prices climbing so high, so fast, and with new construction moving at such a frenzied pace, some experts warn that the sizzling condo market--indeed, the entire real-estate market--could start to fizzle. David Lereah, chief economist for the National Association of Realtors and author of the new book Are You Missing the Real Estate Boom? is not among them. "There is not going to be a bust," he says, although he concedes that prices will most likely level off in some overheated markets. "The economy is healthy, and sometimes you just have to say it: It's the demographics, stupid" --a reference to the baby boomers, millions of whom are in their peak earning years or heading into retirement, with a tremendous buying power to acquire bigger homes, smaller homes (often condos or townhouses), second homes (ditto), and investment properties (double ditto).
Also fueling the boom are the so-called echo boomers, who are reaching first-time-buying age and want to be closer to work and play. Then there are a growing number of single parents, young couples without children, and particularly new immigrants, who may be priced out of a single-family home or are eager to trade a shorter commute and more convenience for a smaller place and a condo fee. "We're looking at a whole generation of people who may never own a single-family home," says Jerry Starkey, CEO of WCI Communities, which builds luxury condos and single-family homes.
Although condo prices have been rising rapidly, low interest rates have helped dull the pain. The average interest rate on a 30-year, fixed-rate mortgage has stayed below 6.5 percent since mid-2002, and though rates are inching up, most experts agree with Lereah that rates would have to take a pretty big leap (to as high as 8 percent) to really put the brakes on. And many baby boomers and retirees, who are sitting on fat nest eggs, are buying their new nests with cash.
Handy home. With money so affordable, naval officers Chris and Rhonda Walker, 31, had no intention of buying a condo when they were reassigned from Virginia to San Diego in 2003. A self-admitted "attached-living snob," Chris, 32, was set on buying a single-family home. Then he saw the price of San Diego real estate. "I was at $700,000 before I saw something we could actually live in," he says. By the time the Walkers moved into their new $500,000 condo last month, it had already appreciated nearly 10 percent. And Walker has quickly adjusted, seeing the advantages of having someone else mow his lawn, for example, and guard his home when he and his wife are at sea. "I'm not preaching about single-family homes anymore," he says.
That's not to say that the time-honored American dream of owning a home in the suburbs has died; there are just fewer people chasing it. Today, families with children account for fewer than 25 percent of American households--and that percentage is expected to drop to just 20 percent within two decades, according to the National Multi Housing Council in Washington.
At the same time, the range, diversity, and location of condos have expanded to accommodate a variety of tastes. "It's not one-size-fits-all anymore," says Karatz. In fact, in the span of a few large blocks in Los Angeles, you can go from colonial-style townhouses to Mediterranean-inspired villas to New York-style artists' lofts--all condos. Developments are increasingly being built near or in urban centers with close-by shops, restaurants, and theaters. Luxury towers with multimillion-dollar penthouses are going up in cities like New York, Chicago, and Philadelphia, luring suburban refugees and second-home buyers back downtown. And condos are increasingly tricked out with every imaginable luxury from gourmet kitchens to sleek and spacious bathrooms to top-notch gyms and spas. At many condo buildings, a concierge will, for example, make restaurant reservations, stock refrigerators, and hire baby sitters.
When Judith and Herman Palarz sold their Los Angeles home in the mid-'90s to move to Northern California to open a bookstore, they never intended to come back. But the bookstore didn't happen, and the Palarzes recently moved into one of more than a dozen condominium complexes clustered in Playa Vista, on the west side of Los Angeles. "We wanted something urban, close to entertainment and culture, but with open space," says Palarz, a former educator. They found it in a $600,000 Frank Lloyd Wright-inspired townhouse in a small development known as Paraiso.
But the transition to condo living proved to be easier than the transaction. The Palarzes were among hundreds of hopefuls vying to buy one of the modern townhouses with open interiors and third-story lofts. First they had to enter a lottery that would determine the buying pool. (Judith chatted up every salesperson within walking distance.) Then they had to make it through another round to get the unit of their choice. "There was so much drama with the waiting," she says.
Despite the legendary waiting lists and fierce competition, some experts worry that as interest rates and inventories climb, there won't be enough Judith Palarzes to fill the umpteen thousand condos that are cropping up each month. The rush by developers and investors to cash in on what they see as the best get-rich-quick scheme since the dot-com days has turned cities like Las Vegas and nearly all of southern Florida into full-blown construction zones. In Miami alone, more than 55,000 residential condo units were in some phase of development at the end of January, and the number has been climbing since. That's up from a total of 7,000 units built over the past decade.
Many of those buyers will never step foot in their purchases, much less Florida. Nearly 25 percent of home sales nationwide last year were made by people who had no intention of living in them. Others will flip their units the day a building opens. And it will be the same story in Las Vegas, along the Gulf Coast, and in cities such as Philadelphia; Portland, Ore.; Seattle; and Washington, D.C. Some investors are even planning to rent out their condos at a loss, counting on making their money on rising prices instead.
All telling signs, says Robert Shiller, an economist at Yale University and author of Irrational Exuberance, which foretold the late '90s stock market crash and has been updated to include a chapter on the current real-estate mania. "You can't tell when the real-estate bubble will pop, but it will, and history isn't on the new investors' side," he says. Although Shiller acknowledges that there is a fundamental difference between real estate and stocks--you can actually live in a house, and you're unlikely to "panic sell" just because your neighbor is selling his--he's worried. "People think that investments can't go bad, that they will make you rich, that you are stupid if you're not in the game, and that home values will just keep going up," he says. "But they aren't asking how or why."
Insulation. If they were, Shiller might not be able to tell them, as even he admits he doesn't know when doomsday will be here, if it comes at all. Whatever happens, builders and developers have gotten a lot smarter about protecting themselves and aren't likely to end up as part of the carnage. At KB Home and several other large builders, for instance, only projects that are substantially pre-sold get built. If the bottom falls out of the market, it will be the individuals who bought the properties, not the builders, who will suffer.
Some builders have also instituted antiflipping rules that discourage buyers from selling their units within less than a year or 18 months. But they can be difficult to enforce and have done little so far to dampen speculation. Some markets like Las Vegas have attracted so many real-estate investors that avoiding them has become a buying criterion. For Robert and Angie Douglas, having owners as neighbors was a big part of their decision to purchase a condo in the Sandhurst, a new Las Vegas tower--priced from $250,000 for a one-bedroom to $3 million for a penthouse--that won't be completed until 2006. "We wanted a building where people were more likely to live than invest," says Robert. What makes him think he got that? The building has attracted a lot of young professionals like the Douglases who want to be close to their jobs. It has a no-flipping clause, and the developers have been very vocal about wanting the units to be occupied by owners. In the end, Robert knows it will probably be impossible to tell who owns and who rents. Nonetheless, he'll be on the alert for any moving vans.
This story appears in the April 25, 2005 print edition of U.S. News & World Report.