As we enter the sixth year of the current credit and development cycle, one question I am asked a lot is “When is this South Florida condo market going to go bust?” That is a reasonable question given the “boom-bust” history of the South Florida condo market and its reputation for real estate overbuilding. However, many are also asking, “Does there have to be a bust? Or is a soft landing or gradual correction possible with only minor to moderate pain incurred by a few late to the game developers and lenders?”
First, by “bust” I am referring to a total halt to new development and a shutdown of available debt and equity investment. In other words, you would know it when it happens. Certainly, the cumulative weight of a global recession, a natural disaster or even a terrorist act could dramatically negatively impact the South Florida condo market like any market; however, left to its own devices there are indications that a soft landing or gradual correction may be possible.
Let’s explore some of the reasons why.
Things are different now, I promise!
This cycle is different from the hyper-hot run up that led up to the Great Recession. There is much less speculation, more skin in the game by buyers, and bank lenders have been much more prudent this time around. Many still stinging from losses taken during the last run up and struggling to exist in a sea of stifling federal regulation and bureaucracy. Rising construction costs, a persistently strong dollar and ailing South American and European economies are just a few of the headwinds facing the Miami condo market. However, it is these same headwinds, along with intense competition, that have kept many projects on the sidelines and help keep a lid on price increases, which is a good thing.
According to a recent study by ISG World in Miami, more than 13,000 newly built units have sold in South Florida since mid-2011, the starting point of the current recovery. This represents more than three-quarters of the total units built or currently in the pipeline. However, sales have slowed for all of the above reasons. Since September, only 302 units have sold, down from 537 sales recorded in the third quarter and 800 units in the second quarter.
Cranespotters.com reports that there are nearly 15,000 units under construction in South Florida and 12,000 more are approved and planned. However, according to a study recently completed by IRR Miami for the Miami DDA, approximately 75% of the inventory under construction is pre-contracted, and 85% of the 2016 deliveries are pre-contracted. They also forecasted that in the Miami market, under construction pipeline would not grow for the balance of 2016. This is key since Miami dominates the South Florida market with approximately 70% of the overall market.
Show Me the Money!!!
Even in the face of a market slowdown for non-waterfront Miami condo markets, the affluent markets continued to shine until recently. Areas like Miami Beach, Coconut Grove, Bal Harbour, Sunny Isles and Surfside had recently been performing well reflecting pricing between $1,500 and $2,500 per square foot with some of the best units exceeding $3,000 per square foot. However, the United States Treasury’s recent policy change that requires buyers to disclose the original source of their funds has hampered sales according to top agents we interviewed. Therefore, for now, it looks like even the affluent market is taking a breather. Again, another organic tapping of the brakes that may help keep unneeded additional product on the drawing boards.
There is more good news in that we will likely see less new or inexperienced developers or lenders entering the market in the next year – only existing developers that have a stronghold in the market will move forward. We are also seeing signs of increased competition in the form of bigger sales commissions being offered by developers and less down payments required by buyers. Whereas most of the initial wave of Miami condo development was fully financed with buyer equity and 50% deposits, the trend has been toward more construction loans from banks and less down payment required. Typically, when the cycle is getting overheated, we tend to see less experienced out of state lenders seeking to provide construction funds for second-string developers on “B” sites. I have not seen as much of that yet. I do see loan participations that include unfamiliar out of market lenders; however, these deals are typically led by bank lenders with extensive market experience who are dealing with the best developers on the best sites.
“Affordable” Housing on the Way.
Although most buyers and developers have invested much more equity this time around, what we need to keep an eye on are developers that may have to discount their remaining units to move them faster. This is especially true in the face of a growing supply of resale units. A recent study commissioned by Miami lender StatFunding reflects that of 3,231 condo units in the Miami market, 716 (22%) are on the resale market and only 34 have closed within the last six months. Based on this study, there appears to be over 126 months of supply of resale condos within the 14 projects surveyed that have been built since 2012. Even more troubling, the study indicated that three pre-construction buyers have sold for a loss and 14 sellers within these projects have listed their units for a price that result in a loss. It is unclear why these sellers have sold for a loss or are willing to sell for a loss but this is a trend worth following. The bottom line is that it seems for now that there are more sellers than there are buyers and prices should start to level off and in some cases come down. Are we not all clamoring for more “affordable” housing options for our local population? Maybe price reductions and tighter profits are not a bad thing. To start with, most condo developments are wildly profitable.
Domestic Buyers Stepping Up
Although there is a slowdown on mid-priced condo sales product, the devaluation of foreign currencies will not fully chase out deep-pocketed South American buyers whose goal is simply preservation of capital. There has also been recent evidence that domestic and local move-up buyers are helping to fill the void. This is particularly true in the Fort Lauderdale and Palm Beach markets. California, Texas, Georgia, New York and Virginia are the primary states of buyer origin according to the Miami Association of Realtors. Last year’s record-breaking $60 million Faena House penthouse sale in Miami Beach involved a U.S. hedge fund buyer.
Another difference between this cycle and the last is the abundance of market information and market transparency. Firms such as Cranespotters.com and many others do a great job keeping all stakeholders informed about the status of the South Florida condo market. Even the casual observer does not have to look far to get a sense of what condo product is being planned and built, what markets are saturated and what units are selling for. We even have a better sense of where the buyers are coming from and how much unsold product there is. With all of this information available, it makes it very difficult for lenders and developers to make the case to build new product, thereby effectively putting the brakes on the delivery of unnecessary condo product.
Where the Boys Are
While most acknowledge that Miami-Dade is taking a breather, the primary beneficiaries of this have been Fort Lauderdale and West Palm Beach. Seeking less expensive dirt, developers have moved up the coast and secured best in class sites at prices much less than Miami-Dade. As a result, several new projects are under way and in the pipeline in those markets at prices well below Miami-Dade. While high-end product exceeds $3000 per square foot in Miami-Dade, the highest price points in Fort Lauderdale and West Palm Beach are roughly $1,700 and just over $1,000 per square foot respectively for the best product in those markets. Fort Lauderdale is not as well known to South American buyers but developers such as Related Group and others with their international following help to expose Fort Lauderdale to a new set of buyers. Traditionally, Palm Beach buyers are primarily domestic and move-up empty nester buyers and that is currently the case as well in that market. In addition, while Miami has significant market depth, Palm Beach does not and it is truly a “first in” market where the first project on the best site will succeed but others may not. A good example of this is Bristol condominium in Palm Beach. The project is well located on a best in class site and is reporting that they are 60% pre-sold at prices exceeding $1,000 per square foot in a market where pricing rarely, if ever, exceeds that price point.
Despite the headwinds noted previously, there are potentially positive factors that may serve to improve the market. Many industry insiders are hopeful in a decrease in construction costs. Although the supply of subcontractors remains relatively tight, there are signs that increased competition from European contractors has domestic firms tightening their bidding. Additionally, there is hope that the market may find a second wind in the event of a decline in the value of the dollar. The strong dollar, as much as anything has served to hold back foreign national investment in the Miami condo market. Developers are also seeking other uses for previously planned condo sites such as office and retail The demand for office assets has been strong in South Florida. Rents are rising and many argue that South Florida needs new office product. All of these factors could help the South Florida condo market and keep it from overbuilding.
Some real estate pundits claim that despite relatively healthy conditions in South Florida that the weight of a world recession will finally bring the good times to a halt as early as 2017. Factors such as low oil prices, falling import demand from emerging economies, volatile financial markets, deflation, possible negative interest rates and current exchange rate fluctuations give legitimate cause for concern. Given the dependence on foreign investment in South Florida, this argument has merit. However, the difference is that unlike last cycle the current run up has not been as steep or as rapid so this is much less to fall and others argue that a total collapse is unlikely because the market has been slowing down naturally on its own for the last several years.
Given current market metrics, it is certainly possible that anyone who paid high prices for land subsequent to 2014 and cannot develop now will incur substantial holding costs and face possible financial loss. Additionally, there is the likelihood that some unit owners will end up on the losing side of their investment, but as of now, a total collapse similar to 2008 seems unlikely given what we know. I counsel my lender clients that there is still time to make sound loans in the this cycle, but to minimize risk they should stick to proven developers with excellent track records and strong sales history that have tied up the best sites in the best markets. This is not the time to experiment with new relationships or on second tier sites with no proven history given some of the looming warning signs. That is a recipe for disaster.
Walter Duke + Partners is a market leading provider of valuation advisory and market metrics to a variety of private, government, institutional and non-profit clients in the Florida market. During this cycle alone, Walter Duke + Partners has completed over 500 multi-family assignments exceeding $12 Billion in overall value. www.walterdukeandpartners.com