What Happens if a New Development Condo Building Doesn't Sell Out? We’ll demystify this topic
in the following video.
I’m Nick at Hauseit. Check out our website www.hauseit.com to learn how to save up to
6% when selling and save up to 2% when buying here in New York City. So let’s get started!
While most new development condo buildings sell out successfully, it’s a good idea
to consider what might happen if you buy into a new construction condo building in NYC which
is unable to sell all of its apartments. As we’ll explain, condo buildings with a large
number of unsold apartments can sometimes be a risky purchase.
If a condo building struggles with sales, the developer will typically seek to refinance
the construction debt as a first step. If sales continue to slump, the sponsor may be
forced to aggressively reduce prices or convert some units into rentals. A developer may also
seek to offload units in a bulk transaction to an investor. In a worst case scenario,
the developer defaults on the units and they’re taken over by the lender, who either sells
them or possibly holds onto them until market conditions improve.
How might this impact you as the owner of an individual apartment in the building? Well,
the value of your apartment will decrease if the developer cuts prices, converts to
rentals or offloads units in a bulk transaction. Unsold units can also make it harder for you
to sell or refinance, as lenders might not be willing to make loans to prospective purchasers
in the building as a result.
In a worst case scenario, you’ll face higher common charges if the developer defaults,
as the other owners including yourself will be forced to make up for the lost common charges
which the developer failed to pay on the unsold apartments.
Now let’s take a step back and start with the basics of new developments. A developer,
also known as a sponsor, typically finances a new development with a construction loan.
Construction loans usually have three year terms with two, one-year extensions. In an
ideal world, the length of the financing coincides perfectly with the complete sellout of all
apartments in the building.
If a new development experiences slower than anticipated sales, the developer will need
to refinance in order to push out the maturity date of the building’s loan obligations.
Refinancings for new development condo buildings happen all the time, and the act of refinancing
by no means a guarantee that there will be larger problems with the building in the future.
Typically, a developer who is experiencing slow sales will pay off its higher interest
rate ‘construction loan’ with ‘condominium inventory loan’ which generally offers a
lower interest rate, but more importantly, extends the maturity date of the development’s
financing by a few years.
This lower cost, longer dated financing helps the developer to better align the realistic
length of time it will take to sell the remaining units with the duration of the underlying
financing. It also gives the developer more resiliency to resist making large price cuts
and possibly ride out a soft market and wait to sell units into a stronger market.
If a new development continues to struggle with sales, the developer may elect to convert
some of the unsold units into rental apartments. The rental income helps cover some of the
carrying costs of the unsold apartments. Unfortunately, rental units can change the feel of your building
due to frequent turnover, and it may also increase wear and tear on the building as
a whole.
These apartments could remain as rentals for several years until market conditions improve,
at which point the developer may reattempt to sell them. The risk of unsold apartments
being converted into rental apartments is something which is typically outlined in the
condo’s Offering Plan.
If market conditions don’t improve, a new development with struggling sales may also
elect to slash amenities in order to conserve cash flow. A building with a large number
of unsold units may also attempt to raise revenue by raising fees (such as subletting
or alteration fees) or by implementing new fees altogether, such as a flip tax.
In the most extreme scenario, a struggling developer with a large number of unsold apartments
may stop paying common charges on those units and default on their obligations to a lender.
While the lender takes responsibility for paying unit common charges on a going forward
basis, there may not be enough cash to cover the previously unpaid common charges after
paying lender expenses. Such a scenario results in a permanent loss to the condo building’s
finances. This means that other owners would be responsible for filling any budgetary shortfall
in the building’s financials.
This additional financial strain on unit owners may also create a chain reaction of additional
defaults within the building. To make matters worse, owners under financial strain may struggle
to sell since lenders likely won’t provide financing for a purchaser if a large number
of apartments in the building are in default and/or remain unsold.
As this extreme scenario unfolds, the lender eventually forecloses on the developer. If
the lender decides not to hold onto the foreclosed units, they may be sold at auction. A prospective
purchaser, such as a large investor, may also have different end goals compared to the remaining
residents.
For example, if an investor who is looking to maximize cash flow purchases the apartments,
they may exert influence on the condo board to defer or minimize building capital improvement
projects.
While the risk of a worst case scenario with a full blown default and foreclosure remains
low, it’s a more likely outcome for smaller developers. As a purchaser, it’s a good
idea to familiarize yourself with the developer of the building you’re considering by looking
at their track record of similar buildings.
In conclusion, the primary risk of buying into a new development condo building with
a large number of unsold apartments is that the value of your apartment may decline. The
feel of your condo building may also change if unsold apartments become rental properties.
In a worst case scenario, you may also be responsible for paying higher common charges
in the event of a default by the developer.
We hope you enjoyed this video, and if you did, please like, subscribe and leave us a
comment. We’d greatly appreciate it. I’m Nick at Hauseit, and we’ll seen you on the
next video!