Within the distressed realm of residential lending, the condominium sector is laboring beneath unique pressures. Even as parts of the housing market are beginning to show the first stirrings of rejuvenation, condominiums are still ailing.
‘This is one of the hardest-hit markets in the country,’ says Scott Stern, CEO of Lenders One, St. Louis. ‘Although the purchase market is heating up, the condo sector is still lagging.’
The full extent of the sector's woes is difficult to ascertain, since its progress is charted in a somewhat curious manner.
‘There is no one measuring new-condo sales,’ explains Walt Maloney, a spokesman with the National Association of Realtors (NAR). ‘There is no data on that. Our organization tracks sales on existing condos, and the U.S. Census Bureau measures all new-housing starts. But the Census Bureau doesn't single out condos for coverage.’
But those who are keeping track of specific condo-related activity in certain parts of the country have observed that this sector is still in the throes of ill health. To understand what went wrong and why it is still wrong, a few key factors need to be considered. According to Maloney, for many years, condominiums primarily represented a niche market with a very specific core audience.
‘Historically, condos became popular as an affordable alternative in higher-priced housing markets – mostly in the Northeast and a few Midwest markets like Chicago,’ he says. ‘This appealed to first-time buyers, emptynesters and retirees.’
But a decade ago, a rewrite in federal laws suddenly made condominiums more attractive to a wider customer base. ‘The 1998 capital gains tax law change opened the market further,’ adds Maloney. ‘Condos became more of a lifestyle choice, and that led to an increased popularity in condos in lower-cost markets.’Â
In some areas, the appeal of condominiums during the past decade seemed insatiable.
‘In the southern half of Florida, we had an incredible boom in terms of construction,’ recalls Sean Snaith, director of the University of Central Florida's Institute for Economic Competitiveness. ‘We had a ton of inventory in Miami.’Â
While the economy was strong, the decade-long expansion in new condominium projects seemed like a sure bet. When the economy tanked, however, it turned out to be a bad bet.
Las Vegas is a key example of what went wrong. According to Keith Schwer, director of the Center for Business and Economic Research at the University of Nevada, Las Vegas, the rise of the city's condominium sector was capped by the collapse of the state's economy.
‘Las Vegas is 71 percent of the state's population,’ explains Schwer. ‘A major problem here is our excess supply of housing. We have over 15,000 unsold homes. As of July 1, there are 2,600 vacant condominiums in Las Vegas.’
Schwer notes that some condominium owners are trying to bring in renters to keep their properties occupied, but they are fighting a tough battle.
‘The economy is very soft here,’ he continues. ‘Unemployment is over 12% and continues to rise. We're also seeing some population loss, which is very unusual for us. Our economy will pick up at a much more slower pace than [that of] the national economy – we can expect tough sledding ahead.’
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Within the condominium sector, vacant units are only part of the problem. There is also the issue of projects that remained unfinished when the recession hit.
‘Condo developers are required to pay off construction loans shortly after construction is completed,’ says Bill Bradway, managing director of Bradway Research LLC in Boston. ‘But with condo sales stalled in markets like south Florida, developers are defaulting, creating headaches for lenders. Some of these projects are 'see-throughs,' where the high-rise condo has few sold or occupied units.’
Bradway points out that one major lender in the condo development market, Corus Bankshares in Chicago, was particularly hard hit by the sector's collapse.
‘Corus has seen its $3.7 billion portfolio of condo loans – as of the second quarter of 2008 – deteriorate,’ he says. ‘The value of the bank's nonperforming assets has skyrocketed to $242 million in the quarter that ended June 30, 2008, from $620,000 in the same period in 2007. Ironically, the bank continued to make big loans, including three new-condo loans worth $400 million in the second quarter of 2008.’
Dean Wegner, a mortgage originator with W.J. Bradley Mortgage Capital in Phoenix, has already seen the problem in the Arizona market that he covers. ‘When we get a contract on a condo, there is a 50-50 chance of getting it done,’ he says. ‘We need to do a full investigation of a condo project to make sure it is solvent.’
In today's market, the oversupply of condominiums is all too evident – especially in comparison to the single-family houses on the market.
‘On the single-family side, we have a nine-month supply of inventory,’ says NAR's Maloney. ‘On the condo side, however, we have a 15-month supply.’
But with acute price-slashing on new single-family homes, condominiums are seeing one of their original core audience segments disappear.
‘The affordability of new single-family homes has hurt the condo market,’ says Tom Millon, president and CEO of Capital Markets Cooperative, Ponte Vedra Beach, Fla. ‘Condos are the typical entry point for first-time buyers, but since new homes are inexpensive, condos are in less demand.’
Millon notes, however, that there is one new audience segment turning to condominiums (though perhaps due to current recession-based circumstances).
‘Activity is picking up from those trading down out of expensive homes,’ he adds. ‘For example, those who had to get out of the $3 million house and move into a condo that has dropped in value and is cheaper to maintain.’
Complicating the state of the condominium market are standards imposed by Freddie Mac and Fannie Mae on this sector. Beginning April 1, the government-sponsored enterprises (GSEs) implemented a new requirement in which condominium applicants who cannot come up with a 25% down payment are charged a three-quarter point add-on penalty. The applicant's credit score is irrelevant to the process – Fannie and Freddie have argued that the higher fees were meant to counter the higher risks and losses that plagued the sector.
Needless to say, mortgage bankers are not happy with this standard.
‘It becomes a little more difficult to get financing based on the tightened Fannie and Freddie guidelines,’ says Howard Nelson, president of the Mortgage Bankers Association of Florida (MBAF). ‘That adds to the difficulty in our current economic environment.’
Wegner has already run up against these tighter standards, and he's seen potential condominium buyers do an end-run around the traditional mortgage market.
‘Either these people will pay in cash or pursue other creative financing,’ he says. ‘For some, there is no other way around that.’
‘Getting a condo loan is tougher to do than for a single-family residence, particularly for any new-construction condo,’ adds Bradway. ‘It is almost a Catch-22 scenario: Mortgage lenders want to see commitment to occupy – with greater than 50 percent sales penetration of owner occupants versus no or very few investors – and solid financials for the condo association.’
Fannie Mae has also gone further in its tightened standards on condominium mortgages. In March, the GSE said it would stop guaranteeing mortgages on condominiums in buildings where less than 70% of the units are sold; previously, the cutoff was 51%. It also announced it would no longer purchase mortgages in buildings where one owner had more than 10% of the units or where 15% of the owners were delinquent on their association fees.
Two Congressmen – Rep. Barney Frank, D-Mass., and Rep. Anthony Weiner, D-N.Y. – sent a letter to the heads of Fannie Mae and Freddie Mac in June, asking that the GSEs ‘make appropriate adjustments’ to guidelines that could be seen as ‘too onerous.’ To date, no indication was made that the standards would be loosened. However, MBAF's Nelson believes some movement will occur.
‘The industry is cyclical,’ he says. ‘Over time, the guidelines will relax some. But some factors will remain in place for years to come.’
Michael L. Larssen, president of Larssen Consulting in Clearwater, Fla., hopes this situation will abate sooner rather later.
‘Recent guideline changes by Fannie Mae and other purchasers of condominium loans are necessary for certain markets to manage risk, but they regrettably penalize other stable condominium markets,’ he says. ‘Condominiums are an important gateway for first-time homebuyers, and we must work with Washington to ensure that this option remains viable, while preventing current overreaction that will further damage this important market.’