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Market
Commentary
The
demise of condo flipping.
Over the years,
a lot of easy money has been made by flipping condos. Today, this is
behind us, and a lot of flippers will be losing money.
In the past
four years, we’ve seen condo investors make a lot of money. Known as
“flippers,” these individuals buy into new condominium buildings at an
early stage, and then sell them immediately after settlement at a hefty
profit. But as of 2006, the easy money is gone.
Here’s how the
money was made. Condominium developers often begin selling their
units to the public before construction of the condo project began.
For a $5000 to $10,000 deposit, buyers could put a unit under contract for
delivery about a year later. While locking in the price at the time
of purchase, these buyers enjoyed excellent appreciation on their
investments in the time period leading up to settlement. Here’s
why:
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To encourage
early sales and build momentum for their projects, developers usually
offer the best prices early on and increase them over time as the units
sell out. Each price increase generates instant equity for early
buyers.
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If the finished
condominium building exceeds buyer expectations (relative to its original
blueprints and drawings) additional value may be
created.
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Over the course
of the year, any increase in overall real estate prices will also generate
equity for that early buyer. In some areas, real estate prices
increased by 20% or more in each of the last two years.
So, let’s
assume that an early condominium buyer put a $5000 deposit on a $200,000
condominium for delivery 12 months later. Let’s assume that real
estate values increased by 20% during the year, but that values on units
in the building increased by an additional 5% - a total increase of
25%. So, at settlement, the buyer pays $200,000 for a property that
can now fetch $250,000 if they can quickly “flip” it. Let’s assume
that their total closing costs on both the buy and the sell are 8% or
$20,000. Their $5000 investment has generated $30,000 in value for
them – a 600% annual rate of return!
So let’s
fast-forward to 2006. There are some key differences relative to
this example:
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First, property
values are no longer increasing by 20%+ each year. It’s more likely
that values will remain flat.
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Second, a huge
number of condo investors are now playing the “flipping” game. It’s
not uncommon for a large percentage of condo units to hit the resale
market once a new building is complete. If you’re one of those
flippers, it may take you a long time to sell. Paying interest on
the unit’s mortgage during that period can be expensive.
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Also, if many
flippers are selling at once, it’s possible that one or two could become
desperate and sell for fire-sale prices. If this occurs, it will
destroy equity for the other unit owners.
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As more
condominiums are being built, an increasing number of less experienced
builders are entering the market. On some of these projects, it is
possible that the finished product will not fulfill the promise of its
original plans. If the finished product is not appealing to
prospective buyers, the value of the units originally purchased will
decline.
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Although
developers would like to increase the prices of their units as they sell
out the building, this won’t happen if sales are sluggish. We have
seen cases where the developer actually offers their best prices at the
end of the sales process. As later buyers get better deals, early
buyers lose equity.
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Finally, in
some of these buildings, investor ratios may cause problems. Many
lenders refuse to provide mortgages on buildings in which a high
percentage of the building’s units are held by investors, rather than
owner-occupants. This can limit the number of potential buyers for
the unit, further increasing the time it takes for the flipper to sell
it.
So here’s how
money gets lost. Let’s assume a buyer places the same $5000 deposit
on a $200,000 unit for delivery in a year. Let’s also assume that
the unit’s value stays flat during the course of the year (we’ll ignore
those things that can cause prices to drop.) Finally, we’ll assume
that after settlement, it takes 6 months for the flipper to successfully
find a buyer and “flip” their unit. So, there is no appreciation on
the unit, but the flipper incurs 8% in closing costs ($16,000) and about
4% in interest, taxes, and condo fees while they are trying to flip their
unit ($8,000). So, they’ve lost a total of $24,000 on a $5000
investment – a negative 480% return. If the value of the unit
declines (for reasons above) this compounds the flipper’s
loss.
Fortunately,
for those of you who are buying condos as a home, many of the risks
mentioned above are mitigated by time. Over a four or five year
period, values are more likely to increase, and the extra inventory
created by flippers will have been absorbed.
But for those
of you thinking about flipping, remember that you CAN lose money in real
estate.
Interest-only
mortgages are not evil!
We’ve heard a
lot of bad press lately about the perceived dangers of certain mortgage
programs, including interest-only mortgages. But managed wisely,
interest-only loans can be an excellent way for certain types of
homebuyers to really manage their cash flows.
In reporting on
risk in the real estate market, many analysts and reporters have pointed
to the increasing number of interest-only mortgages that have been
originated nationwide in the past two years. With this type of
mortgage, the borrower only pays interest (without principal) for the
first five, ten, or fifteen years of the mortgage. This type of loan
can keep a borrower’s initial monthly payments very low, enabling
them to afford a more expensive home than they would otherwise
purchase.
The concern
about interest-only mortgages has been the following: By not paying
monthly principal, the borrower does not build equity in their home unless
the home’s value increases. Also, there is concern that borrowers
may overextend themselves, buying too much home relative to their monthly
incomes. Finally, if the borrower owns the property for a long time,
their monthly payments will increase once the interest-only period
expires. These are legitimate concerns, but should interest-only
mortgages really be avoided?
We don’t think
so. Managed properly, interest-only loans can be beneficial for
certain borrowers. These programs keep monthly payments low, but
enable the borrower to pay back interest at his or her pace.
For example,
some borrowers may have modest monthly incomes, but may be eligible for
substantial bonuses at the end of each year. The low interest-only
payments enable the borrower to manage their monthly cash flows. But
at the end of the year, the borrower can use part of his or her bonus to
pay back principal.
Interest-only
loans also help borrowers who have limited income in the short term, but
have the potential for much higher incomes in the long term. At
Corus, we’ve known several high powered clients who have taken positions
in the public sector. But after their public sector work is
complete, they’re likely to take on much higher paying jobs in the private
sector. By utilizing interest-only loans, these individuals can
manage their short-term cash flows, but can pay back principal once their
incomes increase.
It’s true that
interest-only loans can create a high degree of risk for irresponsible
borrowers. But, this is true of all loan programs. Even with a
conventional 30 year fixed loan, if a borrower is not managing their
finances responsibly, they could encounter problems. Managed
properly, interest-only loans can be beneficial for the right
borrower.
Home
Improvement
Are
renovation costs declining?
Two weeks ago,
the Wall Street Journal reported that contractors are reducing prices,
adding perks, and providing discounts. Here’s why.
If you’ve
recently had any renovation work completed on your home, you probably have
a sense of the home improvement market. Surging demand
for renovation work has meant that costs are high, and that contracting
firms can be hard to deal with. In most markets, contractors have
been in the drivers’ seat for many years – they’ve been free to increase
prices, to choose what jobs they take, and to dictate contract terms to
their clients. But the balance of power may be
changing.
Over the past
four years, decreasing interest rates resulted in an unprecedented number
of refinances. Homeowners cashed out on their home equity, and
directed the money into renovating or improving their homes.
According to Harvard University’s Joint Center for Housing Studies,
spending on home remodeling rose 20% from 2003 to 2004.
While interest
rates still remain low, they have crept up over the last year and
refinances have dried up. From 2004 to 2005, spending on remodeling
rose just 4.3%. And during November 2005, spending actually
decreased 4.1% from one year ago.
The Wall Street
Journal reports that around the U.S., contractors are beginning to cut
prices and offer discounts. They’re also being more responsive to
clients, offering to meet on evenings and weekends, providing more
detailed estimates, and offering extra services. And shorter
backlogs mean that the jobs get completed a lot sooner.
Now, the rate
at which this occurs will vary market by market. Within the Corus
service areas, we speculate that this market change may be most evident in
the Delaware Valley / Philadelphia market. By contrast, in the
Washington D.C. area, construction remains robust and the labor pool
remains tight, potentially keeping contractors in the drivers’ seat to an
extent.
Nevertheless,
if you’ve been thinking about remodeling your home, it may be a good time
to check with a few contractors. You may be pleasantly
surprised.
If
you bought or sold this year, read this before you file your
taxes.
Did you settle
on a real estate transaction in 2005? Make sure you know what
closing costs are deductible.
In any year
that you complete a real estate transaction, you’ll find that filing your
taxes at the end of the year can get a little complicated. Taxes,
interest, and points paid or credited at settlement can all affect your
deductions. If you miss an important deduction, you might be
overpaying your taxes.
In analyzing
what’s deductible, check your HUD-1 statement. To help, Corus Home
Realty’s accounting firm, O’Connor and Desmarais, has prepared a brief
overview of what HUD-1 items may or may not be deductible. This
report is available by request. For a copy, contact us at amy@corushome.com.
Corus
News:
Corus
completes one of 2005’s top 10 transactions.
During 2005,
Corus Home Realty’s McLean team completed
one of the year’s 10 highest priced resale transactions in the
Washington,
DC metropolitan
area.
Corus Home
Realty has announced that during 2005, the firm completed one of the
year’s 10 highest priced residential resale transactions in the
Washington, DC metropolitan area. The property transacted was a
10,205 square foot Williamsburg colonial situated on 3 one acre lots in
the Langley Farms area of McLean, Virginia. The property was sold at
a price of $5.5 million. Corus Home Realty represented both the
seller and purchaser in the transaction.
According to
Michael Gorman, Corus Home Realty’s CEO, “Corus completes transactions at
all price levels. However, the luxury home segment of our business
has expanded steadily, and people are starting to notice. Additionally,
our sophisticated research and the expertise of our senior-level staff
have really made Corus an appealing choice for the high end homeowner or
purchaser.”
For additional
information on Corus’ expertise in luxury home sales in the
Delaware
Valley, contact Kathy Davila at 610-825-3225. In the Washington,
DC metropolitan
area, contact Eric Rossum at 703-827-0075 x1206.
NOTE: This
analysis is based on transactions documented on the MRIS MLS system for
Washington, DC, Northern Virginia, and suburban Maryland counties with
settlement dates occurring throughout the 2005 calendar
year.
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