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The Great (Condo) Depression

Condos

This past week I attended another real estate auction with a client who was interested in purchasing a condo that was being sold. I was very familiar with many of the condo complexes that had units on the auction block and it stunned me to see the final bids for many of the units.  This got me thinking about a generalization that I’ve heard many times over the years.  It goes something like this: “Condos tend to appreciate slower in a rising market, and depreciate faster in a declining market.”  I don’t know if I agree with the appreciation part, and I haven’t done the actual analysis so I can’t state for a fact that this dictum rings true, but I have seen the declining side of the market and can state (at least anecdotally), that this part appears true.

Are Condos Selling At The Same Pace As Homes On The Open Market?

There were 80 properties being sold at this recent auction.  Of those 80 properties, 39 were houses, 38 were condos, and 1 was a vacant lot.  I don’t know if the percentage of condos relative to the total number of properties sold is statistically significant, but I just wanted to present this data as food for thought.  Some data points for comparison:

In King County, WA

  • There were 4093 single family properties sold in the last 3 months vs. 1012 condos sold in that same period (4:1 ratio).
  • There are 3840 homes currently PENDing vs. 998 condos (4:1 ratio).
  • Of those units PENDing, 672 (or 18%) of homes are bank-owned vs. 221 (or 22%) of condos.
  • There are 8109 homes vs. 2992 condos currently for sale (just above a 3:1 ratio)

Condos vs. Single Family Homes

Getting back to the main question of whether condos depreciate faster than single family homes, I think we first need to discuss the main differences between the two in order to better understand how those differences might influence things financially.

Condo

House

Price Less Expensive More Expensive
Location Higher Density Population Lower Density Population
Ownership Co-ownership of entire complex Single ownership
Buyer Profile Younger, Single Older, Family
Financing Restrictive Non-Restrictive

Are These Differences Meaningful?

I realize that there are many more differences (and many similarities as well), and of course, these are generalizations. These are just a few of my observations over the 15 years that I’ve been helping buyers and sellers in real estate.  Some of the differences I think can be interpreted in a meaningful way that gives insight to why the initial statement might be right.

Price – Condos tend to be less expensive than homes because of their size ($/sqft). I think that on an absolute dollar basis, the drop would be less, but as a percentage of value (sales price : original purchase price ratio), the decline rate could be similar.  Overall, I’m not sure that price is a determining factor in the depreciation rate.

Location – “No man is an island”, and no condo stands alone. While a home may have competition from other homes in a neighborhood, the competition might have more differences than similarities.  In a condo complex, the competition is likely to be very similar (if not identical) in layout, amenities, view,etc. Therefore if two units are selling at the same time in a declining market, I believe that there is greater downward pressure on the prices. Many buyers looking at several condos for sale in the same complex will play the price card, pitting desperate unit owners against one another.

Ownership – Management by Consensus is a term in business that describes a leadership style whereby a manager tries to involve all parties before making decisions.  The ultimate goal is to seek harmony.  It doesn’t work.  Condo ownership is similar in that as a unit owner, you do not have final say in what happens in the complex. All decisions require a vote from the other condo owners. If you have neighbors who are short-sighted and don’t understand the big picture of condo ownership, and an association manager who doesn’t know which end is up, the complex could end up in serious financial trouble.  Here is a real-life example:

Back in the 1970’s, there were several condo complexes built in the Bellevue and Redmond areas of Washington. The owners of these condo units had the opinion of “Why should we pay money into a reserve fund that won’t be needed for many years? We won’t be living here that long.” This was the mentality back then.  As a result, these complexes didn’t collect appropriate funds to manage the complex. When repairs were ultimately needed, Special Assessments were issued, but that was only the beginning. HOA dues were raised significantly to build up the reserves, and many owners could no longer afford to live there. These complexes now have HOA dues close to $500/month with units selling for under $200,000 and no amenities!

When purchasing into a condo complex, it is very important to understand and investigate how the complex is managed.  If the complex is not managed well, the outcome will be disastrous!

Buyer Profile – Condo owners tend to be young, first time home buyers making the transition from apartment living or a parent’s home.  This is a great first step for them to reap the benefits of home ownership without all of the complications of maintenance issues. As first time home buyers, they probably made a minimal down payment (5% or less), might also be on a shoestring budget and stretching to make their monthly payments. At the first sign of financial difficulty, many of these new homeowners either strategically bailed or had to sell short.

Financing – When purchasing a home, the bank looks only at the home before deciding on whether they will lend the money.  When purchasing a condo, the bank not only looks at the unit you are purchasing, but the complex as well.  They will look at the overall financial health of the project which includes the financial reserves and the occupancy status.  Additionally, if the complex is involved in any legal action, they will not finance the purchase.

Back To The Auction

So, how does all of the above tie into the premise of faster condo depreciation? And what does any of this have to do with the auction I attended last week?  Most of the factors mentioned above could just as easily be said about single family home ownership as well except for the HOA participation.  However, all of the above factors combine to create extreme downward pressure on condo prices in our current housing climate. Why? Population density! Condos are just mini-homes but what happens to them becomes magnified and accelerated because there is more direct competition in a very small area.

As a result, even though the overall ratio of homes to condos sold for the past 3 months is 4:1, the current inventory ratio is just above 3:1, and the auction showed a 1:1 ratio. Remember that all of the properties being sold at auction are bank-owned.  The numbers tell me that the banks are getting tired of holding on to the condos.  They are not selling on the open market (MLS) and continue to accrue ongoing HOA fees while they sit in inventory.  Banks are desperately wanting to dump these units back into the hands of the public and are willing to sell them for much less than advertised.

Their Loss Can Be Your Gain

Many of the condo units sold at auction went for 50¢ on the dollar. If you had only one unit in a complex of 100 units sell for 50% less, this would be considered an anomaly.  But when you have 10 or 20 units sell at that price, then every other unit will feel the effects (see my previous post about a Lynnwood complex that has this problem HERE).  This is what causes the accelerated depreciation and decline in condo prices…

However, it is the perfect time to buy! Many of the auction attendees were investors.  A gentleman sitting directly behind me purchased 7 properties. He intends to fix them up and flip them for a quick profit.  He believes that even after fixing the properties up and selling them for a bit less than market value, there is still room for profit after his expenses.  If you would like to become a real estate investor, give me a call. I’d be happy to assist you!

What are your thoughts? Do you agree with me on this topic or do you think they are just the ramblings of a crazy person? Let me know!

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  1. rob yano

    Nice piece. Will try to keep up on your newsletter and when I find/make time, will gladly contribute.

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