Industry Outlook 2005 - Residential Real Estate
The market continues to sizzle. A bubble isn't likely in most places in Florida, but Miami's condo market bears watching.
Since then, residential real estate -- especially in Florida -- has replaced the stock market as the favorite "get-rich-quick" investment strategy for many Americans. As a result, many new condominium developments in markets like Miami, Fort Lauderdale, West Palm Beach and Orlando report long lines of buyers when their sales offices open. The developments announce "sellouts" within a few days -- even though it may be two or three years before those "sales" are actually closed.
In fact, a significant portion of those buyers are investors who plan to reserve several condominium units at preconstruction prices, then resell, or "flip," their units to new buyers at a substantial profit as the project nears completion. At some fast-selling projects, speculators account for as much as 80% of sales.
Today's speculative buyers are betting:
- Florida's residential market will continue to boom
- Condominium prices will continue to escalate
- Interest rates will remain low
- There will be no bad news to create an exodus out of the market
Unfortunately, these speculative buyers -- as well as many developers of multifamily housing projects -- are coming to the market at a very late point in the current real estate cycle. Just as the technology boom of the late 1990s came to a crashing halt, the potential exists for a relatively sudden readjustment in the market, otherwise known as a "housing bubble."
The clear danger is that Florida developers may face serious financial difficulties if thousands of condo units hit the market in 2005-06 and produce something like a giant margin call. If there is not enough demand from buyers at that time, investors could be forced to sell at bargain prices, which developers would have to match. The result could be a series of costly foreclosures or financial "workouts" with lenders.
A cyclical industry
Bubbles resulting from unexpected changes in demand or overbuilding by developers have occurred throughout Florida's history, although they have usually been confined to relatively limited markets. In the mid-1920s, for instance, promoters of vacant land in Coral Gables generated such strong demand that Northern visitors would sign a "binder" to purchase a lot, then "flip" that contract to a new buyer at a higher price a few days later. In 1926, after two years of frenzied real estate activity, a devastating hurricane burst that bubble.
In the early 1970s, condominium developers built thousands of units throughout the state, only to find themselves with vast quantities of unsold inventory when a national recession hit in 1974. A few years later, oil-rich buyers from Venezuela and other Latin American countries began purchasing multiple condominium units on Miami's Brickell Avenue. A sudden drop in oil prices left many investors unable to close, forcing developers to resell their units at significantly lower prices.
While some developers today actively court this type of speculative demand, others do their best to discourage it. "We do everything we can to keep out the so-called speculators," says Bruce Weiner, president of Turnberry Associates in Aventura. "We put in safeguards so that the original purchaser has to close on the unit. Of course, what they do afterwards is up to them."
Developers say that lenders are also more stringent on their presale requirements than they were even a few years ago. "The banks want to see sales with at least a 20% deposit, and they count multiple units by a buyer as just one sale," says Daniel Kodsi, president and CEO of Royal Palm Communities in Boca Raton. "We like the idea that they're trying to keep the market as honest as they can."
A statewide perspective
Looking at the state as a whole, there appears to be little danger of a housing bubble in 2005, barring a huge jump in interest rates or a catastrophic terrorist incident. Estimates predict Florida's population will increase by about 350,000 in 2005 and add 130,000 jobs.Statewide, the number of housing starts is predicted to be in the 125,000 range. The number could be less if builders in some markets focus on repairing the state's 50,000-plus hurricane-damaged homes. In addition, higher costs for construction labor, building materials and developable land may cause some developers to reduce their 2005 forecasts.
Continued strong demand and limited supply statistics point to a continued rise in housing prices, although the rate of increase is likely to be lower than in the past two years. According to the Florida Association of Realtors, for the first nine months of 2004 existing-home prices rose 23% statewide to $194,700, despite a third-quarter slowdown as a result of Hurricanes Charley, Frances, Ivan and Jeanne. Just one year earlier, in September 2003, the average resale price was $158,900.
In the Tampa market, median home prices rose 17.8% over the past year to $168,000, surpassing Atlanta's $156,000.
In another sign of escalating home prices, Broward County recently voted to expand the limits on what qualifies as affordable housing. A family of four earning $48,150, the county decided, now qualifies as low income and eligible for housing assistance. The price of a home that qualifies is now raised to a maximum of $229,000 for new construction and $152,000 for existing.
"As long as Florida's economic fundamentals sustain themselves, price escalation will be a function of demand," says real estate attorney Ted R. Brown, shareholder at Akerman Senterfitt's Orlando office. "Restrictions on new development and growth management regulations also act to constrain growth of new housing, making the existing inventory more valuable and pricing it higher."
The rate of price escalation will be a key factor in how the market develops: A volatile situation could occur if the prices of units rise beyond the reach of buyers -- particularly in the hottest markets, where speculation is a factor in driving prices upward.
In any Florida market, there is always the possibility that supply could outstrip demand for the short term, says Al Hoffman, CEO of WCI Communities in Bonita Springs, one of the state's largest developers of high-end single-family and condominium communities. "But the aging of the Baby Boomers and the transfer of wealth between generations is having a real impact on Florida's second-home and preretirement home markets."
Hoffman says inventories in major metropolitan areas like Tampa Bay and Orlando are in the normal two- to three-year supply range. Since it can take up to five years to win approval for major residential developments, there's no sign of oversupply.
"I don't think you'll see a national or a state housing bubble," Hoffman adds. "National averages show housing has steadily increased in value, and unlike a stock market certificate you just put in the vault, people enjoy their real estate investments. It's also important to remember that at any given time only 6% to 8% of homes are for sale. It's very difficult to create a bubble with that low turnover."
Economist Hank Fishkind, president of Fishkind & Associates in Orlando, also believes most housing markets across the state are in reasonable balance, with one exception: South Florida's new condominium market.
Overbuilding in south Florida?
Historically, south Florida enjoys one of the nation's most multifaceted condominium markets, with growing primary demand and an expanding international and domestic second home/vacation market. The market has demonstrated its ability to generate new supply and support impressive price appreciation over the past two decades.
However, the magnitude of new development in south Florida today combined with the high level of speculative purchasing poses a serious risk of a bubble in the condominium market. Compounding the problem is that price levels have climbed sharply in the past four years, reducing the number of potential buyers who can afford to buy the speculators' units.
If there's any doubt about a housing boom in Florida, consider that the state leads the nation in conversions of apartments to condominiums. The housing markets in Miami-Dade and Broward counties combined represented 25% of the $6.3 billion in apartment conversions nationwide through the third quarter of 2004, according to New York-based Real Capital Analytics. Southeast Florida conversions made up 50% of apartment complex sales in the last year.
Recent conversions include the 334-unit Floridian in Miami Beach and the 943-unit Oceancrest Club in Hollywood, but conversions aren't confined to south Florida. Also on the list of recent conversions are Clearwater's 366-unit Grand Venezia at Bay Watch, the 292-unit Bayside Village in Tampa, The Waverly on Lake Eola in Orlando, the 298-unit River Reach complex in Jacksonville, the 408-unit Monterrey in south Fort Myers and the 108-unit Park Vista Apartments in Sarasota.
Amy Welch BrillOne of the analysts most concerned about the pace of new condominium development in south Florida is Michael Y. Cannon, managing director of Integra Realty Resources-South Florida in Miami. "I don't like to use the word bubble, but real estate clearly runs in cycles," he says. "I believe that 2005 and 2006 will be interesting years in our market."
Cannon is keeping a close eye on his firm's statistics, which show a steady increase in new condominium inventory in Miami-Dade and Broward counties. At year end 2000, for instance, there were 6,340 completed but unclosed condos in the Miami market. That number rose to 8,557 at year end 2003 and passed the 9,000 level in the first quarter of 2004, the most recent available total.
"That inventory figure is creeping up, and I will be more concerned if it goes over 10,000 unsold units," Cannon says.
In Broward, which has a much smaller market for new condominiums, unclosed inventory has risen from 1,616 units at year end 2000 to 2,522 at the end of March 2004, according to Integra.
In south Florida, the risk of overdevelopment is neighborhood-specific, says Craig Studnicky, executive vice president and principal of International Sales Group in Aventura. Studnicky, who manages sales campaigns for a number of local developers, says there are no signs of problems in the Aventura, Miami Beach or Kendall markets. "Inventories are low, and buyers are holding on to their units," he says.
But it's a different story in downtown Miami, including Brickell Avenue, where as many as 25,000 units are planned or under construction. That's where Studnicky believes a price adjustment is coming. "There are thousands of units planned with similar floor plans that will be coming online two to four years from now," he says. "We will be flooded with inventory there."
Kodsi believes the location and design of new projects is crucial to their long-term success. "Currently, the market is very healthy," says Kodsi, whose new condominium developments include Paramount Bay, a 46-story, 360-unit development just north of downtown Miami, and Paramount Beach, a 42-story tower with 236 units in Sunny Isles Beach. "We have sites with unobstructed water views that simply can't be replicated," he says. "Also, we're targeting the upscale market with bigger units, while the developments geared to investors and 'flippers' tend to have more studios and one-bedrooms."
Weiner says Turnberry Associates continues to experience strong demand for its condominium developments, including the 260-unit Turnberry Ocean Colony, whose first tower is under construction after selling out at an average price of $1.8 million. "Florida, especially the southeast region, will see tremendous growth over the next decade," he adds. "In the long run, there will be an acute shortage of housing throughout the state."
However, developers like Hoffman and Weiner believe that at least some major condominium projects announced for downtown Miami will be delayed or canceled. "Today, the lenders require you to have sales before you can build," says Hoffman. "That means firm contracts, not just a 5% reservation deposit."
Cannon adds poor planning and rising construction costs may also lead some south Florida developers to fold their projects, especially if their designs were unsuitable or their unit prices were too low. "Nobody wants to be forced to build if their costs exceed proper returns," he says.
But Studnicky cautions that a problem in the Brickell market could lead to a "temporary black mark" on south Florida from international buyers who might not recognize the difference between Brickell and Boca.
Looking ahead to the next two years, many buyers may find that making purchase decisions based on 15% to 20% appreciation rates is a dangerous play. As the number of unsold units grows and interest rates move higher, real estate will become less attractive as a pure investment -- although it will always be necessary to shelter the state's ever-growing population.
Lewis M. Goodkin is president of Goodkin Consulting, a Miami firm with a marketing alliance with URS Corp., a global consulting company.