I have 35 new rental projects in my downtown San Diego database. In addition, I also have a small list of projects that are supposed to be condominiums, but there does not seem to be any dirt being moved for those projects.
Vertical condominiums are scary things to develop. Here’s why:
First, the typical vertical condominium takes 24 months to process, including creating the working drawings and getting them through the permit process. Then it takes two years to build.
Therefore, developers have to convince themselves that the market will be there in four years. After all, you cannot close escrow on one unit until all the units are built and you have a certificate of occupancy.
Second, you have to determine four years in advance exactly what the market will want at the time the units are ready for occupancy. Condominium markets have changing tastes as many a developer has found out. What unit mix should you lock in?
The big problem with planning vertical condominiums is that once you have made a decision on unit mix and sizes, you are pretty well locked in for the duration.
Third, the costs of construction are in motion. A developer applies for a loan to acquire the land and construct the project, but no general contractor is going to lock in pricing that far in advance. In today’s world, the price of materials is not exactly stable and the price of labor is creeping up.
Fourth, from day one, prices have to be established. You can’t get a loan without knowing what the product will sell for. And that means you have to project years in advance what the state of the market will be at the time of project completion.
Fifth, it is necessary to determine what interest rates will be in four years, as well as during the period of the construction loan. What would be the effect on projected sales and pricing if interest went from their current level to maybe six or seven percent?
Sixth, developers are inevitably faced with an absence of knowledge about their competition. There is a herd mentality in the industry. In the last round, there were 50-plus condominium projects built downtown in a seven-year time-frame (plus a half-dozen condominium conversions). Most of the developers made money or at least came out alive. Those who came in early in the game did particularly well.
Now, we are in a strange time. No one has broken ground on a new condominium project in downtown San Diego in almost a decade and it will be at least three years before the next one is complete (unless some of the rental projects under or near construction sells to a condominium developer).
Fortunately, in the 2000 to 2007 time frame, the market was steaming; loans were ridiculously easy to obtain (including liar loans); and the national economy was buoyant. Then the economy started to unravel.
Also, fortunately, we did not have a major overhang of unsold units. In Miami, there were 30,000 high-rise condominium units under construction or completed and unsold when the wheels came off the economy.
And seventh, and finally, the developer must roll the dice on what the national and local economy will be doing in four years. What will the job market look like? How about inflation? Will we be engaged in warlike activities somewhere in the globe?
What is it like for a developer who is building a 200-unit high-rise to have the market go sideways after the building is complete and only half the units are sold?
Such is the life of a vertical condominium developer.
P.S. And then there is also the specter of litigation. Of the 57 projects built downtown from 2000 to 2007, 42 were subject to litigation. No laughing matter.
Nevin is a team leader in market research and forensic services at Xpera Group, the West Coast’s largest source of experts in construction and real estate. He can be reached at firstname.lastname@example.org.