Jul282015

Why are condo prices so volatile?

Condo prices remain low until better alternatives are removed from the market and people are forced to compete for lower quality digs.

Condo prices are notoriously volatile, far more volatile than house prices. But why is that? Is it because nobody wants to live in a condo? There’s something special about a detached house on a clearly defined lot that a person can point to and say, “that’s mine.” But why should that matter to the volatility of condo prices?caddyshack_turd_ihb

When you look at the cities where prices are most volatile, and when you look at the type of housing that’s most volatile, one common element stands out: the less desirable a housing alternative is, the more volatile its price, particularly in Coastal California where growth restrictions limit the inventory.

Undesirable communities, neighborhoods, or housing types only gain buying interest when better alternatives are not available. In areas where supply is perpetually in short supply, the value of undesirable properties gets bid up to prices nobody would otherwise pay if they had a better alternative.

During housing busts when supply is abundant, people shun the undesirable supply, and prices get pounded back to the stone ages. Any time there is a change in supply, eventually it works its way down to condo prices that either rise or fall significantly depending on whether the supply is short or abundant. It’s the substitution effect combined with changes in supply that create enormous volatility in condos.rare condo

Condos will be the last class of housing to recover because it is the least desirable. Once all the single-family homes have been absorbed by the market, people will be forced to substitute to lower quality housing, and when they do, condo prices will soar.

Condos Left Behind in Housing Rebound

By Kris Hudson, Updated July 21, 2015

…With the housing market in its fourth year of recovery, construction of single-family homes and multifamily rentals is rebounding.Not so for condo construction, which has been slammed by tough rules on condo mortgages enacted after the housing bust as well as stronger demand among young people for rentals and tight lending conditions for builders.

Condos haven’t come back because better alternatives are still relatively affordable in many markets. The condo market here rebounded sharply already due to the lack of supply prevalent in Coastal California. This is illustrated by the Irvine community of Orangetree, which is nearly all condos. The report from December 2013 shows a 48% y-o-y increase in price.

OCHN_OC_Housing_Market_Report_2013-12

In the first quarter, condo construction accounted for just 5.5% of all construction of multifamily housing in the U.S. That was the lowest ratio since the Commerce Department started tracking the figures in 1974, and far below the 24% average.

The condo market will remain moribund in Florida and other states where prices are still well below the peak.great condos

That poses a dilemma for developers, who often reap better returns from building condos than from rental apartments. That is because condo prices are far more responsive to market moves than rents are, so in a strong market a developer can sell out of condos at rising prices faster than it would take to lease up an entire apartment building and sell it. …

Responsiveness to the market is wonderful when prices are going up, but when prices are crashing, not so much.

Condos also play a critical role in the broader housing market. While some are bought by investors and second-home buyers, many serve as entry-level housing for young buyers, who use them to start building equity they can use toward later home purchases. The National Association of Home Builders estimates that first-time home buyers will account for just 18% of new-home purchases this year, well below the 27% rate logged in the more normal market of 2001 to 2003. …

(See: First-time homebuyer participation hits three-decade low)nuclear_condos

Since the downturn, condo prices have lagged those of single-family homes in bouncing back. The median condo resale price in May, $216,400, remains $15,400 less than its pre-downturn peak set in June 2005, without adjusting for inflation. Meanwhile, the median resale price for single-family homes in May, $230,300, is only $600 less than its pre-downturn peak set in July 2006.

Condos are the first to crash and the last to recover due to their lack of desirability.

the Federal Housing Administration, which backs mortgages made to low-wealth buyers, tightened its lending standards in a series of moves from 2008 to 2012. Under the new rules, in order for the FHA to insure mortgages in a given condo complex, at least half of the units must be owner-occupied and no more than half can be FHA-insured, among other requirements. For condo projects under development, at least 30% of units must be under contract for sale before the FHA will start backing mortgages there. Mortgage giants Fannie Mae and Freddie Mac tightened their standards as well.Some observers worry the stricter rules are constraining buying. “All of these things were undertaken during the throes of the crisis,” said Steve O’Connor, senior vice president of public policy and industry relations for the Mortgage Bankers Association. “At that time, we supported many of these changes. But the environment has changed.”

The answer to every problem in housing is to relax standards, right?obvious_choice

Some developers now see hints of a condo revival on the horizon. Rising apartment rents provide renters more reason to buy instead of renting. Job growth is improving for young would-be buyers. And real-estate lobbyists say they are making inroads in Washington to build support for easing the FHA restrictions on condo mortgages.For condo construction to revive, “the millennials need to start buying,” Mr. Lev said.

Are Millennial first-time homebuyers finally active? Unfortunately, not yet.

First-time homebuyers are absent due to high debt levels with student loans and credit cards, and move-up markets are hampered by the fact that more than a quarter of borrowers are underwater. The housing market will not recover until first-time homebuyers come back in large numbers at price points high enough to lift existing loanowners above water.

The federal reserve and the banks are doing their part. The federal reserve has lowered interest rates to record low levels to allow buyers to bid up prices, and the banks stopped foreclosures to restrict MLS inventory to force the few active buyers to pay more thus raising neighborhood comps. Now all they need is an improving economy and a flood of first-time homebuyers to get the housing market moving again.

When first-time homebuyers do start buying, expect the condo market to really take off.

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