An Investor Asks: Where Is The Condo Market Headed?

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An Investor Asks: Where Is The Condo Market Headed?

By June Fletcher

Question: What information do you have about the state of the condo market and the expected trends in the next few years? This would be very helpful to me as a real-estate investor.

-- Douglas Menelly, Kew Gardens, N.Y.

Douglas: The condo market is a lot like Elton John. It cycles in and out of fashion, and about as often and as spectacularly.

And for now, condos are at center stage, springing up in places you wouldn't expect, like Omaha, Neb., and Charlotte, N.C.

Another surprise is that condo values have been outpacing single-family homes. From 2001 to 2004, prices of single-family homes rose by a quarter, but condo prices more than doubled. Last year, the National Association of Realtors reported that the national median price of a condo was $223,500, compared to $218,600 for a single-family home -- the first time that had happened since the trade group began tracking the data.

As condos grab the spotlight from traditional homes, builders who used to concentrate on single-family housing are getting into the act. For instance, KB Homes, a big builder based in Ontario, Calif., recently announced that it was forming a new division, KB Urban, to build mid-rises and high-rises. The new division will concentrate on building in city centers rather than adding to suburban sprawl, so people "can live and work in city centers while enjoying a high-quality lifestyle," says Bruce Karatz, the company's chief executive.

Demographics are behind the shift from single-family homes. The nation's 76 million baby boomers are entering into their "empty nester" phase and yearning to move into smaller digs. Meanwhile, their "millennial generation" children, now in college or in their early 20s, are just starting out in entry-level jobs, and many don't yet want the kinds of single-family homes they grew up in. These two facts are likely to keep the multifamily market healthy for at least the next five years.

But be careful where you buy. There is evidence that condos have become overbuilt in some places like Miami, where some venture capitalists have set up "vulture funds" to buy up condos cheaply should prices nosedive.

Overbuilding also seems to be the main reason why the furious pace of building seems to be abating somewhat. According to the latest statistics from the U.S. Census Bureau, starts for multifamily buildings with five units or more came in at a seasonally adjusted annual rate of 256,000 in August, down 12.3% from July and 4.5% from the year before.

That was before the hurricanes hit the Gulf Coast, of course. Because many condominiums will have to be rebuilt, the National Association of Home Builders (NAHB) has raised its forecast slightly for next year, by about 10,000 units. The effect of the hurricanes on construction will be temporary, however.

Since you plan to rent your unit out, you should also keep your eye on inflation. According to NAHB, the overall Consumer Price Index rose at 6% in August, about twice the annual rate of rent increases, eroding the real return for investors. That caused the real rent index, which adjusts for inflation, to fall to 107.3 from 107.6 the month before.

So go ahead and invest in a condo, but make sure it's in a place where there is a big population of young and old people, healthy job growth and relatively low supply.

And keep in mind that condos will no longer be star performers once the "millennials" finally start to pair off and settle down into those big McMansions their parents left behind.

-- The "House Talk" column appears most Fridays on RealEstateJournal.com. Email your questions about the residential real-estate market. Please include your name, city and state. If you don't want your name used in our column, please indicate that. Due to volume of mail received, we regret that we cannot answer every question.

Email your comments to june.fletcher@wsj.com.

-- November 11, 2005