MIAMI—There’s plenty of talk about the nearly 175 condo projects planned for South Florida. Nearly 24,000 condos are now being marketed for sale—mostly to foreign buyers. This scenario begs the question: What would happen if buyers from Brazil, Argentina and Venezuela, among other countries, begin to withdraw from our condo market in response to their country’s deteriorating economies?
Thomas R. Lehman, founding partner of Miami-based Levine Kellogg Lehman Schneider + Grossman, tells GlobeSt.com he can almost predict what would happen if the construction boom and the oversupply of condos end up in a new market correction. We caught up with Lehman to get his insights in part one of this exclusive two-part interview.
GlobeSt.com There are about 24,000 condos in the pre-sale stage in South Florida, and pre-construction prices keep going up. Are we going to see a market correction and what could cause that?
Lehman: The history of Florida real estate booms is that inevitably the boom ends. In the past, when construction loans were financed with a single source, institutional lender, the first sign of distress for a completed and sold project was the failure of sales of units to close at the pre-construction contract prices agreed to by buyers. This time around, projects are being financed by purchaser deposits as high as 70% or 80% of the purchase prices and the deposits are paid in stages as construction progresses. Purchaser-financed projects should show distress earlier.
The first stage of a slowdown in the market will occur when purchasers begin to fail to make their required additional deposits when the additional deposit payments are due. When this occurs, a developer’s source of construction financing will dry up and the developer has two choices: stop or slow construction, or get the balance of its construction financing from a conventional or hard money lender.
Alternative financing should not be difficult for the developer to get because the purchaser contracts provide that the buyer has agreed to subordinate any lien of the purchaser on the project for the amount of its deposits to a later mortgage lender. Thus, a developer may overcome a project’s initial distress resulting from a slowdown in customer deposit payments by getting the balance of its construction financing from more conventional lending sources.
GlobeSt.com: This time around, condo projects have a lot of equity on them thanks to the big deposits from foreign buyers. At the same time, construction loans represent a small percentage of the construction cost. In case of a loan default, how could bank react knowing there is so much equity invested in a project?
Lehman: If a project stalls after the developer has obtained construction loan financing through a mortgage loan, the mortgage lender will be in a better position than in previous downturns. The mortgage lender’s lien will be senior to any asserted liens of purchasers and, because of substantial initial construction financing by purchaser deposits, the project will have a market value greater than the amount of the mortgage debt.
Non-institutional construction lenders such as hedge funds or hard money lenders will be motivated to foreclose quickly, hoping to force a sale of the project that will result in the lender taking title or recovering payment of all of its loan, including default interest and fees. Institutional lenders will be motivated to exercise patience with the developer, even making additional advances under its mortgage to complete construction so units are able to be closed and the mortgage debt paid.
Be sure to come back to this afternoon’s Miami edition. Lehman will discuss how underwater condos influence lender’s decisions and the potential impact of a condo correction in this cycle.