For Austin Condo Investors, the Math Doesn't Add Up

It is a fact: there has not been much investment activity in the downtown Austin condo market. Most of the buyers plan to occupy their units. As we reported last week, this is one of the reasons why Austin is less likely to see a Miami-style bubble explosion anytime soon.

There are lots of reasons why investors have stayed away: anti-flip provisions in contracts, credit issues in the mortgage markets, special deed requirements for renting, etc. One likely reason that has not received much attention is that investors may not stand to earn much money in the current condo market.

Let's say that you purchase a 1,200 square foot unit in a new building for $400 per square foot. Your unit would cost $480,000 and you would likely need to put up at least 10% -- $48,000 -- early in the construction process. If you are like many real estate investors, you would likely finance 80% of the purchase price to take advantage of cheap real estate financing. By taking loans, you can increase your total return by buy speading your cash across multiple properties .

Since restrictions would likely prevent you from flipping the unit until after construction is complete, you would have two choices: either trying to earn money by flipping the unit once no-flip provisions have expired, or by holding the unit for a longer period of time. By holding the unit, an investor would hope to capture rental income during the short term and capital appreciation over the long term.

Here is the problem, downtown Austin rental rates won't cover the costs of the unit. Let's review the math:

Monthly Revenue Received From Renter
$2,700 (Rent @ $2.25 / SF)
- $ 540 (20% Allowance for unrented months / leasing costs)
$2,160 Total Income

Monthly Costs Paid by Owner:
$1,920 (Interest-Only Mortgage @ 6%)
$ 504 (Condo Association Fee @ $0.42 / SF)
$ 878 (Monthly Property Taxes @ $2.20 / $100 Assessed Value)
$3,302 Total Costs

Monthly Loss from Renting: - $1,142

So, on a $480,000 unit, an invest-and-rent strategy would likely loose $13,704 per year on a $96,000 (plus fees) cash investment: a rate of return of (-)14.3%. In order to break-even on paper, a unit would need to appreciate at 2.5% per year. While this is possible, that just gets the investor to break-even, which is not a very exciting return. One important thing to note is that the economics change over time for investors that plan to hold for a decade or more. While mortgage payments stay level, and may even go down if the owner refinances, rents will likely continue to rise over time. Although property taxes and condo association fees also rise, they are only 40% of the cost equation in the first year.

But that's not all! If you are buying a unit in a new project, you will likely have to put money down --$48,000 in this case -- at least a year before project completion and sometimes even earlier. This money doesn't begin earning a return until a renter occupies the unit, adding to the start-up costs required to invest in a downtown condo.

Finally, one more issue for investors is that the Austin condo market is new. Nobody knows what the demand will be for the planned supply of units. It is a market that doesn't exist today, and there is always a risk of under or over-building. For investors, returns must be weighed against the risks of the individual investment. Since market uncertainty raises the perceived risk, investors will only put money on the table if they believe that they can achieve an appropriately high return.

These economics explain why there has not been much of an investor market for downtown condos. At this time, it is important to note that these economics don't really apply to buyer who plan to live in their units. For one, the economics of buying are very different as mortgage interest and property taxes are fully tax deductible. In addition, buyers get value out of their owner-occupied unit every month that they live there without the costs of finding and keeping renters.

These economics are not permanent, three variables can change the math at any time. If prices go down, rental rates go up, or interest rates go down, the economics can look very different. In the current market, rental rates are going up as interest rates continue to drop, making investor returns more attractive everyday. While construction costs are unlikely to drop significantly, oversupply could possibly lead to a drop in purchase prices. More likely, new unit costs will continue to inch upward. So if you are thinking of investing and can get the right deal, it may be possible to make the numbers work.

The Scary "B" Word: Will Investors Create a Downtown Austin Condo Bubble?

Much has been written about the condo bubble in southern Florida, especially the dramatic rise and fall of the Miami condo market. Between 2004 and 2006, condos were being snapped up by investors and quickly flipped for a profit long before buildings were completed. As more and more investors joined the fun, condo units would often change hands like pork bellies -- and other dangerously volatile commodities -- many times before construction was complete. For a couple of years, condo investments seemed to have no where to go but up.

In the 10-years prior to the Miami condo boom, 7,000 condo units were built. At the peak of the boom, a total of 55,000 new units were announced. This is a LOT of units: enough apartments to fill 275 separate buildings with 200 units each for a city about twice the size of Austin. When the bubble burst, 22,000 were still under construction. The bubble ended badly with steep price declines, a lack of market liquidity for condo owners, and bankruptcy for some large-scale projects.

Will the same thing happen in Austin? The answer is that it is very unlikely. While future condo demand, prices, and appreciation (or depreciation) remain an absolute mystery, the market forces in Austin are very different from the market forces that drove the Miami condo bubble.

The problem in Miami was that prices were driven up by speculators who had no intent to live in the units they owned. Their hope was to sell the contract for a profit as soon as possible to another buyer. With too many investors and not enough real buyers, the cycle eventually ended. As investors pulled out and prices started to drop, speculators stopped investing in condos, significantly lowering demand. With a large supply of units and relatively few real buyers, prices continue to drop today. Like all declining real estate markets, many real buyers wait out the fall, waiting for the bottom to buy again.

So why won't the same thing happen in Austin? Developers have learned from the Miami example and put significant protections in place to protect themselves from speculators. When someone buys multiple units and goes bankrupt, developers are often left to pay the price -- as a result, they have a strong incentive to carefully screen investors.

For example, most major projects in Austin include the following investor safeguards:

- No flip provisions that prohibit owners from selling their contracts or units until after construction is completed. At projects like 360, some contracts limit owners from selling until 6 months after closing.

- Limitations on leasing units: Many projects require special deeds for investors who plan to rent their units to others. In some projects, these deeds are limited to 25% of the buildings units.

- Most projects that offer special deeds for investors that permit renting also require higher deposit requirements. Often, initial deposits are twice as high for investors as they are for owner occupants.

Together, these requirements make it less attractive for investors to speculatively invest on downtown Austin condo units in the same way that they did during the southern Florida condo bubble. In addition, the condo financing market has also changed significantly in the last 6 months, making it much harder for investors to borrow money for speculative units that they do not intend to occupy. Finally, while the rate of condo development in Austin is unprecedented by historical standards, it is far below the rate of development in Miami. During he Miami boom, 24.4 units were planned per 1,000 population. In Austin, the equivalent rate is 5.6 per 1,000 population, including thousands of units in projects that may never be built.

While nobody knows if Austin condo units will be a good or a bad investment, it's a healthy fact that many of the larger projects have protections in place to protect against Miami-style speculation.

How easy is it to sell a downtown condo?


The market for downtown condos is very active but quite different from the single family home market in two key facets.

First, downtown condo owners who want to sell are currently competing with new units entering the market. If too many units come on at once, downward pricing pressure may ensue. That said, developers are very good at controlling prices and surprisingly patient. However, it's important to note that condo projects are more commodity-like than single family houses in established downtown neighborhoods.

Second, units for sale within a building compete directly, and brutally, with other units within the same building. As we have written before, If you buy a house in central Austin, the odds are that it is different -- in one way or another -- from every other house in central Austin. When it comes time to sell your unique house, you may get lucky and sell for more than it's worth, or you may be unlucky and have it sit on the market for a long time. Setting a price is a key variable, but pricing a unique house is as much art as science.

The issue is that the value of unique single family homes is subjective and highly personal. Every house, every street, and every aesthetic is valued differently. The single family home market, as one would expect, is very different from the downtown austin condo market.

Every high-rise condo project has a large number -- sometimes hundreds -- of interchangeable commodity-like units. Unit 16B is essentially identical to unit 17B. The result is a much more efficient resale market. When it comes time to sell a downtown condo, there will likely be similar units on the market. If they are cheaper, they will sell faster. If they are more expensive, the may never sell at all.

While the floor (the higher the better, stay away from the ground floor) matters and in some buildings the view can vary greatly from side to side, the effect on value is not as dramatic as one might think. Our ongoing analysis of Nokonah values and appreciation confirms this: units on floor 11, the top floor, are valued at just 11% more than units on the second floor. Buyers seem to pick a building first, and then look for the right unit weighing size and price. This approach leaves very little room for creative pricing.

Yet, it's amazing how differently sellers price similar units. The AustinTowers listings pages provide a few great examples of this. For example, there are two units currently for sale in the Nokonah: a 670 SF 1/1 for $450K and a 1,225 SF 2/2 for $550K -- the smaller unit is almost certainly overpriced.

Because it so easy to compare prices, downtown condo values will be efficiently set by the market. The building will make a huge difference, but actual prices will be set by your neighbors. This has some benefits and drawbacks. On the positive side, accurate comparables make it easy to set the right price and correctly priced units should sell quickly. On the downside, pricing may fluctuate more widely with supply and demand: when there are lots of people selling at the same time, it's likely that prices will drop. And there is very little chance to get lucky and sell your unit for above market value --- if a unit doesn't sell, the most likely reason is that it is overpriced.

Strong Job Growth = Price Appreciation


It's no secret that housing prices are strongly correlated with employment growth. Demand for homes increases when jobs are created and this demand pushes housing prices up. It's no the only factor -- interest rates are very important as well. But, all things created equal, when new jobs come to town, housing prices go up.

Today, the Texas Workforce Employment released the latest unemployment statistics for the state. The news: unemployment dropped to 4.1%. This is very low. In fact, it's lower than the peak of the dot com boom. It's also lower than the peak of the wall street boom of the early 90's. It's even lower than the peak of the Texas oil boom of the 1980s. Believe it or not, the current rate of Texas unemployment is the lowest reading since 1976. And in Austin, the unemployment rate is 3.2%: nearly a full point lower than the rest of the state.

Over the last year, 240,000 new jobs were created in Texas. If interest rates were lower, price appreciation would likely be very strong. With the uncertainty around rates and weak appreciation around the rest of the country, the strong Texas job numbers should help support continued market appreciation throughout the rest of the year.


The Efficient Condo Market


If you buy a house in central Austin, the odds are that it is different -- in one way or another -- from every other house in central Austin. When it comes time to sell your unique house, you may get lucky and sell for more than it's worth, or you may be unlucky and have it sit on the market for a long time. Setting a price is a key variable, but pricing a unique house is as much art as science.

The issue is that the value of unique single family homes is subjective and highly personal. Every house, every street, and every aesthetic is valued differently. The single family home market, as one would expect, is very different from the downtown austin condo market.

Every high-rise condo project has a large number -- sometimes hundreds -- of interchangeable commodity-like units. Unit 16B is essentially identical to unit 17B. The result is a much more efficient resale market. When it comes time to sell a downtown condo, there will likely be similar units on the market. If they are cheaper, they will sell faster. If they are more expensive, the may never sell at all.

While the floor (the higher the better, stay away from the ground floor) matters and in some buildings the view can vary greatly from side to side, the effect on value is not as dramatic as one might think. Our ongoing analysis of Nokonah values and appreciation confirms this: units on floor 11, the top floor, are valued at just 11% more than units on the second floor. Buyers seem to pick a building first, and then look for the right unit weighing size and price. This approach leaves very little room for creative pricing.

Yet, it's amazing how differently sellers price similar units. The AustinTowers listings pages provide a few great examples of this. For example, there are two units currently for sale in the Nokonah: a 670 SF 1/1 for $450K and a 1,225 SF 2/2 for $550K -- the smaller unit is almost certainly overpriced.

Because it so easy to compare prices, downtown condo values will be efficiently set by the market. The building will make a huge difference, but actual prices will be set by your neighbors. This has some benefits and drawbacks. On the positive side, accurate comparables make it easy to set the right price and correctly priced units should sell quickly. On the downside, pricing may fluctuate more widely with supply and demand: when there are lots of people selling at the same time, it's likely that prices will drop. And there is very little chance to get lucky and sell your unit for above market value --- if a unit doesn't sell, the most likely reason is that it is overpriced.

Nokonah Analysis: Part II


Two months ago, Austin Towers initiated a comprehensive unit-by-unit analysis of appreciation in the Nokonah. The Nokonah, A luxury high-rise project completed in 2002, was one of the first successful projects that helped to ignite the current condo boom in downtown Austin. The 11-story project is located at 9th and Lamar just north of Whole Foods and on the western border of downtown. When the Nokonah was built, the real estate market in Austin was stalling as the regional economy slowed. It was not clear how well the new project would do. Five years later we know the answer: the project sold out and the buyers have seen significant appreciation in the value of their units.



As we mentioned in Part I of our analysis, In order to better understand condo values in the downtown market, we've begun a comprensive analysis of public tax records (tax records are available online through the Travis Central Appraisal District) to better understand downtown condo market values and how they have changed over the last five years. This analysis, which tracks every unit in the Nokonah, shows appraisal value and $ / SF by floor, apartment size, # of bedrooms, and year. The data is fascinating and will be a useful tool for anyone looking to purchase a downtown condo (Register for the full report).

In part two, we've further examined the tax data and have come up with some interesting results: Read More...

Flipping in Austin?


Now that it is open and available for occupancy, the 240 unit Milago is completely sold out. Despite the fact that all units have been purchased, it is curious to see 30 units -- 1 / 8th of the building -- currently listed on MLS. While some could be from people whose plans have changed between when they signed the contract and now, the most likely option is condo flippers.

It will be interesting to see what happens. While the Austin market increased by 5% last year, this is hardly the sort of growth that gets flippers excited. Now, with 30 units competing for buyers, it will be interesting to see how fast they turn and whether prices increase as the market strengthens.

75% of 360 Units Sold in 3-Weeks


An incredible 75% of the 430 units in Novare Groups' 44-story 360 project are now under contract after just 3 weeks on the market. The units, which are mostly priced between $190K and $550K, rank among the most affordable units in the current downtown condo boom. This demonstrates, once again, that there is tremendous pent-up demand for reasonably priced units in central Austin.

Today, there are only 9 listings in the Austin MLS (360 is being marketed privately and is not reflected in the MLS numbers) in all of central Austin — areas 1b. 1a, 2, 4, 6, 7. To find similarly priced homes, buyers need to look far outside the city center. In contrast to other options, central high-rise developments seem to be very attractive to buyers. As this sales rate shows, units priced under $400K will move very quickly -- there will likely be ongoing demand to fill quite a few projects like this one. Novare, in fact, is planning additional 35-story and 40-story tower on the central post office site and an adjacent lot for completion by 2010. These units will priced in a similar range to the 360 project.

AustinTowers ongoing reader survey (please take our survey if you haven't already!) has shown so far that more than 90-percent of potential downtown Austin condo buyers are looking for units priced under $400K with the median target price for buyers currently around $300K.


Why it is Hard to Track Downtown Condo Sales

One problem with analyzing the downtown austin condo market is the lack of good sales data on many of the projects currently on the market. When realtors sell traditional single family homes or resell condo units, they are listed on MLS and the actual sales price is recorded in MLS and available to any participating real estate agent. Unfortunately for buyers and sellers, many of the new downtown high-rise projects are being marketed by in-house sales teams without the assistance of realtors. As a result, these units never hit MLS, aren't included in market statistics, and the comparable sales data isn't available to realtors. The result: downtown condo buyers have very little information on sales prices and discounts in the major downtown projects.

The only upside is that the lack of transparancy may help buyers get better deals. When a large project is marketed on MLS, developers are very resistent to give discounts as every future buyer will ask for the same deal. They are much more likely to stick to list price or standard discounts to protect their margins. When the sale is non-public, the developer doesn't have to worry about providing a break on an uncontested unit as nobody else will know.

This trend towards in-house marketing is one of the reasons that the current MLS statistics show a 14% year-over-year drop in February of condos and townhomes in Austin. While sales volumes of single family homes are flat amid tightening supply and quicker sales, the condo and townhome data is useless because it does not include any of the in-house sales.

Nokonah Pricing Analysis: Part I


The Nokonah, A luxury high-rise project completed in 2002, was one of the first successful projects that helped to ignite the current condo boom in downtown Austin. The 11-story project is located at 9th and Lamar just north of Whole Foods and on the western border of downtown. When the Nokonah was built, the real estate market in Austin was stalling as the regional economy slowed. It was not clear how well the new project would do. Five years later we know the answer: the project sold out and the buyers have seen significant appreciation in the value of their units.



In order to better understand condo values in the downtown market, we've begun a comprensive analysis of public tax records (tax records are available online through the Travis Central Appraisal District) to better understand downtown condo market values and how they have changed over the last five years. This analysis, which tracks every unit in the Nokonah, shows appraisal value and $ / SF by floor, apartment size, # of bedrooms, and year. The data is fascinating and will be a useful tool for anyone looking to purchase a downtown condo (Register for the full report).

For example, the analysis shows that the average appraisal value of Nokonah units rose 61% from $233 in 2003 to $376 in 2006 - a growth rate of 17% per year. This is more than trible the 5% annual growth rate in sales prices for the Austin market during the same time period. Even as other projects have hit the market, Nokonah values have continued to increase in value.

While the average appraised value is $376 / SF today, there is incredible variance. If you're trying to figure out what the right price is to pay for a new unit, the Nokonah data is very interesting: current appraised values actually range from $230 / SF to $498 / SF depending on size, floor, bedrooms, etc. In future postings, I'll dive deeper into the factors that make a unit more or less valuable.

Over the next few weeks, I plan to post more information from the Nokonah analysis in this blog. In addition, I am going to provide all registered members with direct access to the spreadsheet with all of the data. This will be a great tool for anyone who is trying to ensure they don't overpay for an Austin condo or anyone who is interested in better understanding Austin condo market dynamics. Registration is absolutely free -- just click the link on the top of the page and complete our very brief survey. The summarized data will be published in a future post, and it will help AustinTowers better understand our readers. Please register -- you'll receive a link to the full Nokonah analysis later this month!


How many buildings fit downtown?

Last June, the Austin Chronicle published a fascinating analysis of potential downtown development. The main point is simple: it is getting very difficult to assemble a downtown parcel large enough for a major project. The number of viable sites is rapidly dwindling. The mayor has set a goal of 25,000 residents downtown by 2015 -- 20,000 more than exist downtown today. While their may be enough downtown parcels to get there with very dense development, downtown capacity is very limited by the following factors:



Read More...

The Downtown Condo Market: 2003-2006

It's not easy to get a clear picture of downtown condo sales volumes. Real estate sales statistics are reported by MLS area, and the downtown area cuts across a few zones: Area 4 runs from Guadalupe to I-35. Area 1B runs from Scenic on the west to Guadalupe / Lamar. Both are bounded on the south by Town Lake and the north by 2222. There are also some projects south of town lake in Area 6. While most of the downtown units are captured in these statistics, there are also some units near the university, in Tarrytown, and in the other corners of central austin contained in area 1B and 4.

So what do the numbers show? Downtown condo sales grew from 2004-2006 by 33% while sales volumes in the larger Austin market grew by 27%. In fact, downtown condo sales as a % of all Austin condo sales actually shrunk from 31% to 25% during the same period. In 2006, a total of 619 condo units were sold in areas 1B and 4.

I draw three conclusions from the numbers: Read More...