Why no new condos? Why no apartment conversions?

It's nearly impossible to drive through any neighborhood in Seattle today without seeing a construction crane. You can count over a dozen just driving over the ship canal bridge. But why are so few condo buildings? That's the recent conversation with Erik Mehr, of Erik Mehr and Associates. Full disclosure, Erik is our managing broker, and a new development expert. Erik has been working closely with the areas top residential developers for over 20 years. He knows real estate and this is what he had to say: There are many contributing factors that are driving developers to build rental buildings rather then condominium projects.

1. High demand for rental units in Seattle.
Seattle is the fastest growing city in the nation right now and many of the new residents are not ready or willing to make a long-term commitment to purchase just after relocating to a new area. Many have just a two or three year job contract and may want to relocate again if other opportunities arise.

2. Demographics.
Many new residents are young millennials that are not interested in being tied down to one area. They want flexibility to pursue jobs and a lifestyle wherever they can. Additionally, millennials have developed a fear of real estate ownership since most witnessed their parents or other family members suffer losses, short sales or foreclosure during the economic downturn that began in 2007.

3. Valuations.
Currently, new rental buildings are appraising for more money than a new condominium project. Developers are in the business of making money while minimizing risk. Since rental buildings typically cost less to build because finish levels are lower and future liability due to HOA litigation is eliminated, rental projects are just more profitable right now. Several recent Seattle apartment buildings have sold for record prices per unit and their price per square foot was greater then the market would accept with the needed absorption level as a condominium.

4. Construction financing.
Lenders are still reluctant to provide financing for condominium projects as they consider them to be much riskier than rental developments. Only developers with long and successful track records in multifamily, for-sale product are able to acquire proper financing today.

5. Institutional investors.
Large rental buildings are typically owned by large institutional investors seeking long-term steady returns. These institutions include REIT, Pension funds, Insurance companies and very wealthy individual family investment trust. The common denominators among all of these groups in long term income, long term asset allocation with limited risk, aversion to capital gain taxation. These investors are not looking for a one time, short term, heavily taxed investment with years of future liability risk from defect claims.

6. Regulation and liability.
The state legislature has made the requirements for apartment conversion costly and complex for developers. Additionally, the long term risk from an HOA makes converting costly and legally hazardous. Bottom line, no one will convert an apartment to a condo if it’s worth more as a rental and with minimal risk.