Tuesday, July 26, 2005

The eToys of the Real Estate Market


I’m not which headline is more interesting:

Oil Profits May Be Peaking

Or

Existing-Home Sales Rise 2.7%, Paced by Demand for Condos.

Both appear in today’s WSJ, and both are worth noting—the former because of its potential to be viewed as a wrong-way kind of complacency indicator; the latter because it reveals the seeds of the eventual real estate glut which are now being sown.

I’ll go with the condo story.


Here’s a piece of it:

Sales rose for all types of homes in all regions of the U.S., reports the WSJ, but the star performers were condos and cooperatives, where the sales pace has been running twice as fast as for single-family homes.

During the second quarter, condo sales were up about 37% on an annualized basis, compared with 22% for single-family homes.

The reason I find this especially interesting is 1) experience, and 2) what I’m hearing lately.

My experience with condominiums is that they are the eToys of the real estate business. You all remember eToys—the online toy merchant that came public in a burst of Amazon.com-initiated enthusiasm…and not too long afterwards hit the trees, as a friend of mine likes to say, with no flaps down.

Like all the other speculative, me-too dot-coms that were dreamed up, funded and brought public in the wake of Amazon’s spectacular success, eToys fulfilled a need: the need for investors who missed the early opportunity to invest with legitimate ground-breaking businesses to buy something—anything—that got them into the game.

And condos are like that, too: when housing gets tight, and real estate gets hot, investors look to condos to make some dough.

After all, they don’t require much effort, given that any condo in any development is pretty much the same as any other condo in that development. The school system, the distance to town, the neighborhood, the yard, the landscaping, the driveway, the roof, the gutters, the shingles, the wiring, the pipes, the basement—none of that stuff particularly matters.


After all, you're not going to own it forever. You might live there a few years until you get enough vig for a real house; more likely you're going to rent it to out and sell it a few years later to some greater fool.

Condos were the last part of the east coast real estate market to spike in the bull market of the mid-to-late 1980’s, and they seemed like such a no-brainer that my church bought a condo for an associate minister—the theory being that when the minister moved on, we owned an appreciating asset that could be used to fund great things.

But the condo did not appreciate. It did not even hold its value. And the equity got wiped out about as quickly as eToys stock. We were, it turned out, the greater fools...and when a church loses money, it hurts.

As for what I am hearing right now, let’s go back to that WSJ story:

Condo sales are strong nationwide and have reached frenzied levels in Miami, Las Vegas and San Diego.

And that's interesting because of what I am hearing.

What I am hearing is that housing sales have hit a wall in Vegas, with certain developers offering cars to buyers of newly built McMansions. The reason? There are something like 100 condo projects in Las Vegas, and condo-mania is siphoning the speculative—er, "investment"—buyers out of the housing market.

Hence, a sudden glut of McMansions blooming in the desert.

Whether that glut is real or just a mirage on an otherwise tranquil horizon remains to be proven.

Informed observations are welcome.



Jeff Matthews
I Am Not Making This Up



The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

15 comments:

antlord said...

This observation is not really informed since I rent in Manhattan but I do wonder if the increase in condos is part of the glacial migration towards urban living. I was in Phoenix, Arizona a few weeks ago and came across some multi-use building part of a outdoor mall, condo and green space park. I was absolutely shocked. Then I thought, "Wow. Add a few restaurants, a movie theater and some stollers and it will be just like the Upper West Side."

Michael Comeau said...

My sister is a student at UNLV in Las Vegas. A new trend there is for parents to buy a condo for their kids to live in during college with the intention of selling at graduation for a profit. It's worked pretty well for a while, but it can't go on forever.

Alesha said...

Anecdotal and empirical evidence both suggest that housing prices in certain markets (primarily coastal cities + Las Vegas & Phoenix) are pretty frothy. Housing prices (sales, not rentals) as a multiple of income are at historically high levels in these markets. I know of one hedge fund that is actually funding the construction of $5 million spec houses in Greenwich. Bear in mind that the most important factor in all of this is the affordability of a monthly mortgage payment, not the "ASP" (average selling price) of a house. Given the high percentage of interest-only and floating rate debt, the affordability of a mortgage payment will diminish if wages stagnate or decrease in real terms or if rates increase substantially. How long can all of this last? Who knows? As Keynes observed, "the market can remain irrational longer than you can remain solvent."

I can't help but draw a parallel between current conditions in the residential housing market and those in the commercial market. In the case of commercial property, investors in many cases now find 5% annual unlevered yields acceptable (in the form of purchase prices). I'd rather throw my money in a 3.25% savings account, as there is virtually no chance that such misallocated capital invested in an overpriced building will appreciate.

Steve W. said...

Anecdotal and empirical evidence both suggest that housing prices in certain markets (primarily coastal cities + Las Vegas & Phoenix) are pretty frothy. Housing prices (sales, not rentals) as a multiple of income are at historically high levels in these markets. I know of one hedge fund that is actually funding the construction of $5 million spec houses in Greenwich. Bear in mind that the most important factor in all of this is the affordability of a monthly mortgage payment, not the "ASP" (average selling price) of a house. Given the high percentage of interest-only and floating rate debt, the affordability of a mortgage payment will diminish if wages stagnate or decrease in real terms or if rates increase substantially. How long can all of this last? Who knows? As Keynes observed, "the market can remain irrational longer than you can remain solvent."

I can't help but draw a parallel between current conditions in the residential housing market and those in the commercial market. In the case of commercial property, investors in many cases now find 5% annual unlevered yields acceptable (in the form of purchase prices). I'd rather throw my money in a 3.25% savings account, as there is virtually no chance that such misallocated capital invested in an overpriced building will appreciate.

Steve W. said...

Alesha,

Sorry for the post that erroneously attributed your name to my entry. I think there was an error at blogger.com.

Steve W.

Alonso said...

I live in Reno, NV - a market that has been going nuts for quite some time while never really getting any national attention. With houses (really shacks, truly awful) selling for >$500/sq foot on small pieces of land the condo phenom is in full bloom here. The city does a poor job of managing developers (in my opinion) so we have lots of developers dropping condos in the middle of housing neighborhoods on the random vacant lot.

At this point, they are selling like hotcakes. If you are not in line on the day they begin selling, forget it. Lots and lots of people dont buy 1, but a handful.

I think you describe the action very well. The condo craze has only caught on once the houses are out of reach. I mean look at this 1910 POS on .16 acres selling for > $500/sq foot.

http://www.realtor.com/FindHome/HomeListing.asp?frm=byxmls&xlid=1049190441&lnksrc=00045&poe=realtor

Steve W. said...

Quote from a Corus Bank 7/11/05 press release:

"$56.8 million loan to finance the acquisition and conversion to condominiums of the Canyon Lake Apartments, located in Las Vegas, NV. The project consists of 28 two-story buildings containing 504 condominium units with 504,432 residential square feet. The property also has three swimming pools, two gyms, and racquetball, volleyball, and tennis courts. Corus was able to provide both the senior and mezzanine financing for this project, on a nonrecourse basis and with no pre-sales due to its experience in the Las Vegas condominium market."

These banks and/or "investors" are going to get burned. I've seen this movie before, having worked for a group that liquidated an $8 billion loan and real estate owned (REO) portfolio between 1989 and 1992. The scope of institutional amnesia that we are witnessing today is simply amazing.

dthorn said...

Condo sales would certainly help explain low median home prices which are helping the affordability numbers. My impression is that whenever pricing data is reported for the Boston area, where I live, or anywhere else for that matter, the median price is lower than any price I see listed in R/E windows. If we assume that the 20% of purchases that are investor related are skewed to condos and the lower end of transaction prices, then removing these sales from the calculation would produce a higher median price for any serious home buyer in the market. If this is true, then the supposedly benign affordability environment, that is used as evidence of there being no bubble,looks very different.

carnack the great said...

In San Diego 35% of condo sales are spec. 25% of all real estate sales are financed with interest only mortgages. Condo's peaked here in the early 80's and were down to flat for 15 years.

The average new home in SD is $700K on up. Good neighborhoods are $1.0m+....values for square foot are $300-3000.

Looks a lot like QCOM @ $800 per share than something you would want to invest in.

sainttjames said...

"Prices for condos also are higher than and are rising faster than prices for single-family homes"

hehehe...

J D said...

Back in the 80's I bought a condo conversion for an insider price of 72k..at the time the appraisal was 132k. Six months later you couldn't get 100k..2yrs later they were 80k. It took until 3 years ago to get back to the 132k figure.

jay-b says said...

It would be interesting to know how much the church condo is worth now? Or even 5 to 10 years after it was purchased...

Edge Trader said...

I have spent 15 years working in the real estate and mortgage industry. What you are saying is right. The markets that go down first are condos and towns that are distant from employment centers. The theory has more to do with buyers who are in the market to buy in a market with inflated prices. If you want to live in community A but can't afford your dream home or keep getting outbid, you start looking at alternatives. One alternative is a condo in the same area. Another is the same house in a market that is either less desirable or further from work. Once the market starts to soften, people no longer have that incentive to settle. So demand dries up in the condo market and the town further away from employment that was booming in the thick of the housing bubble. They then get hit worse price-wise than the single family home in the prized community.

BWV said...

fwiw, a college friend recently reported that in Atlanta, a really nice place to live in your 20's-early 30's, many people who want to sell their condo cannot get what they paid out of it. my friend was considering taking a condo off another friend's hands (the person was moving to boston to practice medicine).. i implored him not to buy "just after the top."

to make a long story short, the top is apparently in for Atlanta condo units.

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