Luxury Condos in Major Cities - LA/Miami/NYC

I am looking for more info from anyone who works on, or knows about this industry. It seems like a pretty unknown topic when I have discussed it with both RE and non industry people about Luxury Condos.


I hear all the time how their are ghost buildings in these cities, and it seems accurate that there are tons of vacant condos, and if you buy one you can almost only sell at a a loss unless you can hold it until the building is full and there is newer product on the market, but how does this effect developers and what is the goal to profitability on these?


Do developers make money if they sell only a couple and then they just survive until they sell 30% of the units and rest and it is all profit so they can sit on it?  Is this why major condo developments happen then no new product comes online for 10 years? Do HoAs actually cover unsold units? Is it a big tax credit play?


Is a condo ever a good investment as a buyer or builder? I am have difficulty understanding and most articles are hard to decipher since they are geared at talking about how condos are only for the rich and not helping the housing crisis, or one owner who bought and had to sell due to HOAs. I am really just looking for a non-bias opinion on what is going on in the condo markets and make some sense of this stuff


https://www.browardpalmbeach.com/news/south-flori…


https://therealdeal.com/issues_articles/ghost-tow…


https://la.curbed.com/2020/3/5/21079171/los-angel…



 

I've been following this topic for a couple of years now and am interested to hear what others have to say.

Some of the buyers that I have heard who buy into the luxury condos are international buyers who are looking to stash money abroad, away from their home country. Market vulnerabilities in the home country may present it less favorable for this group so they buy into condos because it's easy to maintain and can act like a "bank account" with less hassle and the fact that real estate trends with inflation as opposed to other investments like stocks and bonds. Buyers from Argentina, Venezuela, Russia, and China really view cities like New York, LA, London, and Sydney as good places to stash money. Stable banking markets, less fluctuations in currency and ease of transactions.

I think another big reason for luxury products being developed, and not more affordable products, is the cost of land and construction. Many populations were pushing themselves towards city centers in comparison to the prior decade where working and living in a suburb wasn't unusual. Land near city centers or areas becoming more highly sought after, are experiencing those increases in prices for the land alone. For the cost of construction, I'm not sure on this one. Could it be the cost of raw materials or labor itself? Potentially, both? I'm in SF, and construction labor is commuting into the city from over an hour and a half way. The pay either must be really good to justify such a commute or all the work is more concentrated closer to city centers as opposed to being spread through metro areas.

 
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Condos are a very high-risk, high reward business that increasingly are tipping towards the high risk category. If you look at the margins on a condo deal, most of the time the developer only starts generating profits in the last 15% or so of the sell-out. So, if sell-out expectations fall short and sales pace is slow or significantly below projected pricing, it becomes significantly more problematic. Other issues include:

1. Dry-up of foreign capital. You are correct, in gateway markets lots of sales are from foreign nationals seeking a legit haven for their capital. Recent restrictions on outflow of capital from countries like China in particular, Russia, etc. make sales risk for higher-end product especially more risky.

2. Warranty defect lawsuits. These days, 99%+ of new condo projects get slapped with a lawsuit for a huge range of BS/legitimate warranty defect claims 10 years and 1 day after substantial completion (expiration of warranty). Huge exposure for condo developers. There are tons of lawyers who specialize in finding problems with 10 year old condo deals. 

3. Financing. Lenders will not provide high leverage proceeds on condo deals because of the risk profile. This often leads developers to produce a high-risk capital stack to push their equity the extra mile by procuring mezz debt, EB-5 financing, complex tax structures, etc. Makes developers high susceptible to default in the event sales do not hit projections. 

 

If there is anything wrong you can sue the developer for it, stuff like noise mitigation between units or window leaks or whatever. Lawyers realized instead of suing on behalf of individual claimants and collecting only a couple thousand bucks, they can sue on behalf of the HOA and take in $5-10m per suit. That then caused insurance premiums on lawsuits to skyrocket, further disincentivizing condo development. Here is an LA Times article that was written in 1998 (!) that is still relevant today, and here's a whitepaper that was written about it. Both are based around California development, but I read a WSJ article that also talks about it being an issue in Colorado and Texas. 

 

Sham Wow

Eb-5 financing? Isn't that just a big circle then if your investors are also the target market?

I don't think this sentence says what you want it to.

But in short, the EB-5 program is a way to fast track a green card for wealthy foreigners (go figure).  You invest at least 500,000 into a qualified project, which basically means it has to create a certain number of jobs, and in return you get a conditional green card, and then eventually a normal one.  It was a huge source of really cheap financing for developers, because the terms offered to the EB5 investors were shit (and there are a fair number of lawsuits ongoing now about this stuff, in Hudson Yards I know of one) and because the primary purpose of the thing was to park capital and get a green card.  It's also cheaper than buying a 10mm pied-a-terre in NYC or London, so it was more accessible to more people, especially in China, which I believe is where a plurality of investors came from.

Functionally, it meant that you could obtain the equivalent of cheap mezz financing to take out the last couple points of equity in a capital stack, and do it cheaply.  Instead of syndicating out your GP piece to a hedge fund or something, and having to give away some upside, bring in a dozen EB-5 investors.

 

Spot on. The two owners of my company made their name in the industry doing condos. They wouldn't touch the condo world with a ten foot pole these days. Apartments make them just as much, if not more money, but with much lower risk. 

Commercial Real Estate Developer
 

Any idea what's going to happened with the XI? Bought the land for a ridiculous number and now COVID hit plus other lawsuits stemming from a few other projects.

What is the fallout from this? Let's say total project cost is $2 billion what do they do if their total sellout turns out to be $1.5 billion? Do they hold out until prices come back assuming HFZ survives what's going on right now?

 

Don’t know the numbers on that project but using your numbers for assumptions sake, if they sell for $1.5 bil at $2 bil cost, would assume that is just enough to pay off the debt at 75% LTC, but equity is all wiped out. If they want to hold and sell later, HZF will need to get an inventory loan with a lender that believes in HZF’s underwriting sales sellout ppsf.

 

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