Where have all the condos gone?

Courtesy of Stonebridge Lofts
Stonebridge Lofts already has commitments for 75 percent of its units, even though it won't be finished until April.

Time was, not so long ago, when condominiums were the default homeownership option for people at opposite ends of the age spectrum — those starting out and those winding up.

To young people, condos offered a path to ownership at a lower price than a conventional single-family house. For older folks, they were an efficient way to exchange their labor-intensive (think lawn mowing and snow shoveling) suburban manse for a dwelling that was efficient and less costly to maintain.

These days, however, new condo developments have become as rare as Bactrian camels. In the Twin Cities metro, where apartment complexes are rising out of practically every vacant piece of land, you can count the number of condo complexes under way on the paw of a three-toed sloth. You heard right — I found only three. Stonebridge Lofts, a 164-unit luxury project on 2nd Street South near the Mississippi River in Minneapolis; ParkSide, near Shelard Parkway in St. Louis Park with 22 units ranging in price from $169,000 to $399,000; and Regatta Wayzata Bay Residences in downtown Wayzata, a complex with 59 units priced from $450,000 to $2 million.

Those paltry numbers present a dramatic contrast when you put them alongside the condo totals for the Twin Cities a decade ago. In 2004, Minneapolis had 1,900 units under construction and 2,700 proposed. In St. Paul, 980 were being built with 775 in the planning stages, and in the suburbs some 2,300 units were on the rise.

So what happened?

For starters, there was the traumatic collapse of the housing bubble in 2008. During any downturn, condo prices usually drop more drastically than single-family houses, and this time was no different.

Previously, says Caren Dewar, executive director of Urban Land Institute Minnesota, a nonprofit land use and real estate development organization,”people were buying anything.” Young condo owners figured — incorrectly — that prices would continue to rise, allowing them to sell and trade up to a single-family house. Instead, prices dropped, and owners saw their equity disappear, leaving them unable to move. The retirement crowd, for their part, couldn’t sell the houses they owned; ergo, they couldn’t buy condos, no matter how much they lusted for indoor swimming pools and underground parking.   

Renters can walk away

Younger buyers came to see ownership as risky. “People discovered renting,” says Dewar. A condo with an underwater mortgage keeps its owner stuck in place. A renter, however, can walk away without penalty. And under the cold light of analysis, it became clear that homeownership wasn’t exactly an investment bonanza. From 1994 to 2009, the value of homes in 10 cities rose by 4.7 percent annually. That’s a real return of only 2.2 percent after inflation. Sinking one’s entire net worth into a house started to look a bit stupid.

“It became way cooler to rent,” says Dewar.

Maybe so, but in survey after survey, most Americans still affirm that they want to own. And, insists Arthur Nelson, director of the Metropolitan Research Center at the University of Utah and author of “Reshaping Metropolitan America,” “there’s been no change in preferences for condo opportunities.

In fact, demand is pretty high — at least for the few projects now under way in the Twin Cities. Stonebridge already has commitments for 75 percent of its units, even though it won’t be finished until April. ParkSide has sold nearly half of its units, and Regatta Bay has only 36 left even though it may not be ready for occupancy until early 2015.

Condo building should be booming, but, says Nelson, very odd financial and regulatory quirks are choking off development.

Financing is a huge obstacle. After bingeing on condo projects during the bubble, banks suffered a bulimic reaction when the market collapsed. Now they’re gorging on financings for apartment developments.

“They always react to the last crisis,” says Phyllis Baumann, professor of real estate law at Northeastern University in Boston. “The next crisis might be a glut of apartments.”

Post-bubble requirements

Banks might overcome their condo nausea, says Nelson, were it not for post-bubble requirements exacted of condo developers by FHA, Fannie Mae and Freddie Mac, who are the largest bundlers and resellers of loans for multifamily projects. For condos to be eligible for a Fannie Mae-insured loan, developers must presell 70 percent of their units. (The threshhold used to be 51 percent.) Freddie Mac adopted a similar guideline in 2010. The FHA requires that 30 percent of the units be presold and that at least half of a building’s units belong to owners who occupy their units, and that no more than 10 percent be owned by a single investor.

Banks are following the agency rules, which, Nelson says, are “crude and insensitive.” They were designed to correct excesses that occurred in the markets that overbuilt the most during the housing bubble, for example, Miami, Las Vegas and Phoenix. “The FHA is using a sledge-hammer,” he insists. “There’s no reason why the requirement shouldn’t be calibrated to reflect conditions in the local market, why Minneapolis and St. Paul couldn’t have a 25 percent requirement.” As things stand now, says Nelson, “the agencies are depriving whole segments of the population” of dwellings they might want to buy.

The presale requirement spells delay for developers. To hit the 50 percent threshhold may take six months, says Mary Bujold, president of Maxfield Research, a Minneapolis real-estate research consultancy. That’s on top of all the two years or so needed for financing, construction and everything else. Pre-construction buyers would have to make a purchase commitment 30 months ahead of moving in. “It’s hard to get presales that early,” Bujold says. “A lot of people don’t want to wait that long.”  

Long-tailed liability

Would-be condo developers have an additional concern: a Minnesota law that holds them — and as of 2010, their subcontractors — responsible for major construction defects for 10 years. Usually, the condo board sues the general contractor. But large projects may have dozens of subcontractors, any of whom might themselves be sued by the general contractor. The result is expensive and lengthy multiparty litigation.

Jocelyn Knoll, chair of the construction and design practice group at Dorsey & Whitney, in a Power Point presentation, observed that condo developers face potential direct liability for a long time. In one case, REC, Inc. developed an Edina condo project in 2002. A buyer who purchased a unit in 2005 discovered “water intrusion” in 2007, and the condo board sued in 2009. So in theory, though the condo developer had completed work in 2002, s/he was still on the hook for damages seven years later.

It’s uncertain just how much litigation has occurred as a result of the law, but the mere whiff of lawsuits is enough to discourage banks from financing condos. What’s more, says Knoll, contractors are trying to mitigate risks by obligating developers not to permit new mutifamily construction to be used for condos. To protect themselves from lawsuits, she adds, contractors either have to buy costly insurance or somehow build the risk into their prices.  

The condo shortage may not change much in the next few years. With hundreds of apartments coming on the market, rents may drop, further discouraging ownership. On the other hand, if demand drives up condo prices, developers might decide to try to overcome all the obstacles to reap heady profits.

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Comments (4)

  1. Submitted by Ray Schoch on 02/25/2014 - 02:52 pm.

    Just to note

    …that, of the three condo complexes mentioned in the column’s 3rd paragraph, all three are out of my financial reach personally (as an old, white, retired male, I should be part of the target demographic, at least in terms of age), with the first and third examples laughably so. That assumes that I would want to live in one. If the $169,000 one is like the one pictured at the top of the column, I might be persuaded, but I’d be amazed if that were the case.

    Having lived in rental apartment, rental house, purchased condo and single-family home in both urban and suburban locales, the worst by far – in my experience – was the condo. It has all the disadvantages of apartment living, coupled with most (though not all) of the disadvantages of single-family ownership, principally revolving around financial responsibility for maintenance, either individually or through an HOA, and let’s not forget real estate taxes. If I have the choice, I will never, ever live in a condo again.

    Condos seem even more outrageous when one notes that, at least in most circumstances, the “owner” owns nothing tangible. Through legal hocus-pocus, what you purchase is the space – not walls, ceiling or floor, just the space – enclosed by the structure that in many states is legally owned by the HOA. Single-family has its drawbacks, to be sure, and especially for that same increasingly elderly white male, for whom shoveling snow, maneuvering the snow thrower, cleaning the gutters, painting, etc., are all more of a challenge with every passing year. When I reach the point where I simply can’t do the maintenance any longer, I’ll have to stop my artistic endeavors (no rental space I’ve found comes close to either the space or the cost per square foot of a basement studio), and at that point, I’ll be back to square one, considering a rental apartment.

    No rental housing I’ve found can match the space and quality of my current single-family home for anything close to the same amount of money per month. When you’re living on an income that doesn’t change, those kinds of considerations trump most others.

    So, the answer to the column’s rhetorical question headline might be that they’ve gone to wherever it is that outmoded housing styles go when they’re no longer fashionable.

  2. Submitted by Rod Loper on 02/26/2014 - 08:01 am.

    Don’t forget condo association politics

    Not only is what you actually get when you buy hard to figure, the governance and management of this enterprise can be a legal tangle. I recall someone who once held high office in the DFL
    who now chaired an owners association board say that all that infighting paled when compaired to what he coped with now .

  3. Submitted by Matt Brillhart on 02/26/2014 - 05:32 pm.

    10 year guarantee too onerous?

    Maybe it’s just me, but holding developers and subcontractors liable for major building defects for 10 years does not seem that burdensome.

    A MinnPost article from last October provided some additional data points on the difficulty of financing condos and just how high the sale price per square foot must be for it to pencil out: http://www.minnpost.com/twin-cities-business/2013/10/can-condos-make-comeback-twin-cities

    “[George] Sherman said that he’s seeing existing units selling in the range of $250 to $300 per square foot, but he said that new construction would call for prices in the range of $335 to $400 per square foot.”

    Marlys: You missed one project, albeit not under construction, but approved by the City (after well known drama surrounding a previous, larger iteration): http://www.lindencrossing.com/ If the website is current, they aren’t exactly pre-selling as quickly as one might expect a mere 16 units in Linden Hills would. Perhaps a follow up article is in order for the Linden Crossing (née Linden Corner) project.

  4. Submitted by Steve Hoffman on 02/26/2014 - 08:02 pm.

    Equivalences

    I can’t speak for anyone else, but when I retired in 2011 I bought a condo. I’m very happy with it and the mortgage payment and association fees are the same amount I was paying monthly to rent an apartment of similar size (but not as nice). I’m less concerned about property value fluctuations because I plan to stay here for a good long while!

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