A New Phase in Condo Craze

There's a new twist to the condominium development and investment boom.Single-family home builders are entering the condo arena due to changing demographics, greater difficulty finding available land on which to build single-family lots, and pressure to grow revenues.

Bruce Karatz, CEO of KB Home Inc. (NYSE: KBH), which delivered more than 37,000 homes in 2005, says this convergence of factors offers a new avenue for single-family home builders, but he advises caution. “While there are huge opportunities for us in the multifamily for-sale arena, there are lots of risks. The risk profile is very different from what we're normally used to,” says Karatz.

In January, KB Urban, a division of KB Home, announced that it was partnering with Anschutz Entertainment Group (AEG) to finance and build a 50-story, 1,100-room convention center hotel in Los Angeles budgeted at more than $600 million and offering more than 70,000 sq. ft. of banquet/ballroom space. At least 250 luxury residential condominiums will also be part of the development.

Home builders recognize demographic shifts taking place across the country. Only one-quarter of American households today are classified as traditional households that include a husband, wife, and children. That figure should serve as a wake-up call, says Karatz.

“The vast majority, and a growing percentage, of American households are something other than traditional, and most of those folks are interested in lifestyles very different from what traditionally home builders built,” says Karatz. In hot pursuit of that demographic trend, home builders such as KB Home have opted to enter the condo sector.

Aside from demographics, there is another reason single-family home builders are entering the condo market. Many home builders today are public companies looking to boost shareholder value. Condos offer an avenue for growth.

Condo starts approached 150,000 units in 2005, reports Trammell Crow Residential, up from nearly 110,000 units in 2004 and the highest level since 1985. Demand for condos has remained robust. Through 2004 (the most recent data available), roughly 75% of newly built condo units were occupied within 90 days after construction was completed, according to Trammell Crow. The median price of existing condos sold in the third quarter of 2004 was $197,000, 20% above the median price a year earlier.

Still, there is growing concern that some select condo markets have become highly speculative in nature. In the Miami Beach area, 70% to 80% of the purchases are by investors who plan to flip the properties, says Ron Terwilliger, CEO of Atlanta-based Trammell Crow Residential. Other overheated markets of concern include Las Vegas, San Diego, and to a lesser degree Washington, D.C.

But Terwilliger, whose company will undertake 6,000 rental starts and 3,000 condo starts this year, insists that the demand for condos is not a passing fad. Furthermore, he argues that the industry is much better positioned now than it was in the early 1990s when condo prices fell rather precipitously during a recession.

“The condo units in the early 1990s were not as well built as they are today, and their location wasn't as good as it is today,” says Terwilliger.

“What's also different today is that we have tremendous traffic congestion in this country,” Terwilliger adds. “We have a lot more people who want to live in locations close to urban centers and to amenities, so they're not willing to be satisfied with the suburban location that they might be able to afford.”

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