An informal, on line survey of Nashville Business Journal Readers posed the question: Who is most responsible for the condo crisis where slow sales have sparked lawsuits between developers and buyers?  I have taken the liberty of producing the results in chart form above.  (I thought the little spikes were especially symbolic!) In the “blame game,” several things need to be pointed out.  First, this questionnaire leaves out one glaring participant in all this: the government.  As I posted earlier, even the Congress is finally starting to catch on that their attempts at social engineering created disastrous consequences.  More on that anon, but first a defense of my trade – that of the evil and despised “real estate DEVILOPER” (misspelled for effect!).

Developers are creatures who crawl out from under rocks in response to the market.  They are motivated by profit, as are all small businesses.  They read a lot of information, digest it, and attempt to make all the data points actionable.  So, when the collective wisdom of the market was telling them that two large demographic segments of the population (empty nesters and young urban professionals) wanted to live downtown in condominiums that afforded them the amenity of the neighborhood and the convenience of not having to mow a lawn, we responded.  And across the United States, numerous high-quality homes have been delivered – in many instances cleaning up formerly blighted areas.  The problem comes from the nature of real estate itself – it is a time consuming business!

From the point that the trend is identified to when a project can actually open its doors, the time lags can be enormous.  Site selection can take anywhere from 1 week to 2 years.  Developing the drawings to build the project can take anywhere from 90 days to 1 year.  Getting financing for the development can add months onto a deal…then you have the whole issue of trying to build it on time.  Depending on the size of the project and the type of construction, that can take from 9 months to 3 years.  Now guess what’s happening the entire time the developer is engaged in this process?  Every other developer is doing the same thing!  The result is that a large number of units come on line at the same time, dampening prices and causing an absorption nightmare.

Now what I have just described is the normal real estate cycle.  Compound this relatively normal pattern with market distoring incentives from the Federal Government and you have a bubble.  From Invsestor’s Business Daily:

With an implicit subsidy to American homeowners in the form of reduced mortgage rates, Fannie Mae and its sister government sponsored enterprise, Freddie Mac, squeezed out their competition and cornered the secondary mortgage market. They took advantage of a $2.25 billion line of credit from the U.S. Treasury.

Bottom line is there was a LOT of cheap money and egged on by Congressional threats, lenders were willing to dispense the funds without so much as checking for a pulse.  (The “fog the mirror” test wasn’t even applied!  Years ago, when I managed a large portfolio of apartments in Central Florida, one of my property managers used to tell her staff that if the prospect could “fog a mirror held under his nose, lease it!”)  Investors, lured by the easy, low risk, low down payment schemes and cheap funds caught on fast too.  A local development here that offered to “reserve” units for $2500 for a 1 bedroom, famously sold out in 48 hours.  Three years later, they are sitting on 10% sold and a huge note.

But the cheap money and “exotic” lending products would not have been available if the lenders didn’t have Fannie and Freddie to back them up.  Remember, when studying people’s behavior, it is important to remember how they are compensated.  How do bankers get bonuses?  By getting the money out!  Sure helps if you’ve got your loans back-stopped with Federal insurance.

Good developers saw what was happening and began pulling back in 2007 (sooner in some markets that were further along.)  Others did not parse their data very well and took the surge of investor/flippers to mean that a whole new demographic was chasing the product.  To respond, they built more towers and chased more exotic locations. From that angle, the development community is clearly to blame…as a group, we lost our common sense.  But then, the construction money was available and it was dirt cheap…and then there are the fees…

The real estate business is about running a marathon – well maybe a triathlon if you’re a developer – it is not a wind sprint.  When we absorb these units, which if you live in healthy cities with good climate and a diverse economy, we will, we will build again.  Let us hope that we all approach this next cycle with some sobriety and common sense.  Let us also hope that we have a government that, chastened by their failures in social engineering, will get out of the way instead of attempt to steer markets.