Condo prices near a cliff - Apartment developers cheaply taking over failed conversion projects

Condo prices near a cliff - Apartment developers cheaply taking over failed conversion projects
By Susan Diesenhouse
Copyright © 2006, Chicago Tribune
Published September 23, 2006


So far the housing slump has been marked by slowing sales. Now there are signs that rapidly falling prices could be on the way.

Earlier this month a Chicago developer sold 150 condominiums in a two-hour lottery by discounting prices about 20 percent from what he would have asked last spring, an indication that industry observers say could signal widespread price reductions here and around the country.

For the first time in his 37 years as a developer, Nicholas S. Gouletas, chairman of Chicago-based American Invsco Corp., held a lottery to sell his condos, in this case 150 moderately priced residences in a 292-unit vintage high-rise at 182 W. Lake St. in the Loop.

Gouletas figures he still could make a 10 percent profit by cutting future carrying costs. He will avoid the expense of 2 1/2 years of mortgage interest payments, marketing, maintenance, insurance and taxes by not struggling to sell condos against the headwinds of a slowing housing market.

"We're responding to a dramatically changed market," said Gouletas, who plans to conduct lotteries to sell about 2,000 more units in nine other projects he is developing in Chicago, Las Vegas, Orlando and Boynton Beach, Fla. "Let's admit it's a buyer's market and what they want is the best price they can get."

For those anxious to assess how far the decelerating housing market will fall, a lottery sale like this could indicate a steeper decline in prices as veterans in an industry replete with optimists head for the exits to salvage profits and avoid big losses. If this becomes a broad trend it would generate a dynamic destined to ripple through the overall economy.

"I haven't heard of a lottery elsewhere, but I've been waiting for them," said Mark Zandi, chief economist for Moody's Economy.com, a research firm in West Chester, Pa. It could signal a change in attitude among sellers who so far have been "holding tough on prices," he added.

"The condo market is quickly unraveling and reeling nationwide, with sales down 15 percent and prices down about 3 percent," Zandi said. Since new housing is still being built he expects sales and prices to continue to fall for a year and to remain flat in 2008.

"As the overall housing correction intensifies, the broader economy will weaken further," Zandi said.

On the bright side, Zandi said, Chicago and other big cities with diversified economies will fare better than smaller ones in a national economy that will continue to grow, albeit weakly.

However, he forecasts that metropolitan Chicago will add only about 35,000 new jobs in 2007, down approximately 25 percent from this year. "In the best of times Chicago doesn't generate a lot of jobs," he said.

But the distress reflected by Gouletas' lottery here is not an isolated incident of one unlucky project in a so-so location. In New York and Washington other developers are abandoning plans to convert big apartment buildings into condos.

A day after Gouletas' lottery the nation's largest apartment real estate investment trust, Chicago-based Equity Residential, closed on a $96 million deal to buy a 256-unit apartment building in suburban Washington from a developer whose condo conversion plan evaporated. The REIT plans to close soon on the $200 million purchase of a 300-unit building in New York that met the same fate.

As the condo market reels, property values are falling, a double-edged sword that hurts some investors and helps others.

"A year ago, we couldn't have afforded these buildings," said David Neithercut, president and chief executive of Equity Residential, which owns 926 properties with 197,404 units that Wall Street values at about $14.4 billion.

Now that developers don't think they can make sufficiently profitable condo conversion deals, he added, "we intend to acquire several of these properties where condo conversions were planned that never happened."

Prices for these apartment buildings probably have fallen about 20 percent from their peak in the summer of 2005, said Jonathan Litt, senior real estate analyst for Citigroup Investment Research in New York.

Nationwide, profits for condo developers have fallen from 50 percent to "20 percent for some, and for many to zero or less," Litt noted.

Chicago condo developers face some rough times ahead, Litt added. "This has been on the radar screen for a couple of years because developers have brought on a lot of inventory," he said.

Speaking about Gouletas' lottery, Neithercut of Equity Residential commented, "I'm no expert, but what I hear is a savvy condo conversion guy that didn't want to get caught holding in a market he's worried about."

Equity Residential, which owns some properties in the metropolitan area but never had a strong presence in downtown Chicago, is "moving our investments to high-barrier [areas] like New York, Boston, South Florida and California," Neithercut said, meaning places where the development approval process is stringent, long and costly.

In Chicago, "this is the first time I've seen a two-hour sellout," said Gail Lissner, vice president of Appraisal Research Counselors Ltd. a Chicago-based consulting and appraisal firm. But she added: "American Invsco is a mass marketer that looks for volume sales. This is their style."

Lissner does not have third-quarter numbers for downtown condo sales but her informal tracking indicates sales are still slowing. She has yet to see prices drop, but has observed owner concessions rising and developers pulling back.

Appraisal Research predicted that approximately 10,000 condos would come on the market this year, but Lissner said, "We're definitely seeing projects delayed and units not coming on the market as fast as we anticipated."

In the second quarter, the most recent numbers available, sales contracts and reservations totaled 1,496, about one-third less than the historically strong first quarter, according to Appraisal Research.

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sdiesenhouse@tribune.com