Top 10 Reasons Why There Aren't More New Construction "For Sale" Multifamily Developments in Seattle
The Condo Conundrum
By Dean Jones
President & CEO, Realogics Sotheby's International Realty
Seattle is the fastest-growing large city in the US with the median home prices rising more 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 shortage of in-city condominiums resulting in high median home prices, rising by 19-percent year-over-year in November 2017 to $660,000 – about the same value as the median home price in King County. And 94-percent of the projected 27,000 new housing units to be 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.
1. Developers Choose 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.
2. The Washington State Condominium 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 gray 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.
3. Higher Lending & 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, etc.).
4. 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 (and that money can't be used to fund the construction).
Here are the specific issues:
- 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 harbor" 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 in 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 Washington state allowed a condo developer to collect 10-to-15% of the purchase price and then pledge those deposits to the construction lender, more lenders would be willing to fund condo developments and more developers would be able to raise the balance of equity required to build.
5. 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 U.S., according to their 2018 "Emerging Trends in Real Estate" report. That means there are often multiple, willing and able investment groups prepared to pounce on an apartment tower that is offered for sale. And having multiple bidders means that the price paid to own the rental tower rises to a point that is similar to the value of a condominium alternative.
6. Investors Love Seattle
It takes developers many years to conceive and construct a high-rise community. Most want to invest in the long-term holding of this asset 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 common goal is to hold these assets within a rising market. A similar trend can be witnessed with individual investors for condominium units, however most developers will limit the percentage of units being sold to buyers that are not intending to reside in the condominium as a primary residence or second home. Selling too many "investor" units could complicate the mortgage options for the building and adversely affect the other residents.
7. Rents Keep Rising
With typical rents in Seattle rising 50-percent since 2010, it's good to be a landlord. So, 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 U.S., according to Census Data, with the median rent rising $92 per month to $1,448 in 2016. Merchant builders have figured out that high rents and low cap rates makes the business of developing and selling rent stabilized apartment towers very profitable without the marketing costs or risks associated with condominium development.
8. 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 prospect of high income, 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. They paid attention during the global credit crunch that may have affected their older siblings or parents. As most preferred to rent, millennials skipped a housing cycle and also missed out on the equity gains of recent years. 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.
9. Rising Construction Costs
With all the booming development in Seattle, it's of little surprise that costs to deliver new projects are rising at 6-to-8% per year. When presale requirements from construction lenders demand selling a condominium a year or two before delivering, the revenues get set while the construction costs remain variable, exposing developers to risk. A primary benefit for buyers to participate in presales is to realize this increase in pricing during construction, however that means the developer's only ability to benefit is to raise prices on the unsold homes.
10. Presales Are Relatively New in Seattle
Seattle's urban renaissance is relatively young. Its high-rise zoning, known as the City Center 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 later replaced by a boom of apartment building. This means most local consumers and brokers have, perhaps one or two market cycles of experience with presales. In the most recent cycle, the difference between presale values to resale values, represented 20-to-30% increases (note: secured by just a 5% deposit). If more consumers knew about 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 favor of for-sale housing but like all cycles, the early bird gets the worm. This was the case with NEXUS, a 389-unit condominium tower being developed by Vancouver, BC-based Burrard Group, located at the corner of Minor Avenue and Howell Street. When the much-anticipated project hit the market in March 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., a condominium attorney that works with developers. "I suspect that legislation may eventually change, but until then, condos will be few and 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, according to the Northwest Multiple Listing Service.
"It can take up to four years or more to move from initial concept to final closing with high-rise developments," adds Dean Jones, President & 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 presold.