Developers Try to Limit Speculative 'Flipping'
Saturday, May 21, 2005
For the past few years, it has been a way to make easy money: Sign a contract to buy a property when it is still nothing more than a few squiggles on a builder's plans. Then, when there are four walls and a floor, or even before, flip it to another buyer, making a profit without ever moving in or even being a landlord.
With prices and demand climbing around the Washington region, such investors could make hundreds of thousands of dollars during the two years or so that it takes to build a condominium complex, townhouse or housing development, with just a small down payment at risk.
But like much of real estate investing these days, this pre-construction buying has become a lot harder, largely because builders are trying to rein in the process.
"There is a general understanding among builders that there is a lot of hot money out there, people buying for short-term capital gain purposes only," said David Seiders, chief economist of the National Association of Home Builders. "There's definitely a concern that if there's some inkling of prices flattening, or rates going up sharply, they could get a large flow of units back onto the market."
Developers have several concerns about pre-construction speculators. For one, if the market turns down, investors are considered far more likely to walk away from a deposit than are owner-occupants. And even if they don't walk, investors who plan on selling their units after the property is built can be competition with the developer's own final sales on a project.
"When you sell a unit to an investor, it's kind of a phantom sale," said Bobby Montagne, president and chief executive of Walnut Street Development, a condo development firm in Fairfax. "You've sold that unit, it's not available anymore, but in the end, you might not have sold it."
With values rising the way they have been, two years has meant huge price appreciation. It has been hard for developers to sit back and watch investors earn millions of dollars they might have kept themselves.
"Developers don't want to feel like they're leaving dollars on the table," said Jim Abdo of District-based Abdo Development, a luxury condo developer. "If absorption on a project is that intense, and it's worth so much more at the time of completion, they've let a lot of money go out the door. That's the concern I'm hearing. They want to ensure and protect themselves in a way that doesn't allow someone else to take that profit portion."
Abdo said development profits have been squeezed recently by soaring land and construction costs, which he described as a "runaway train."
He said, "Anyone who says inflation is in check is not in the construction business."
Investors can also complicate financing. Lenders often require that developers pre-sell a certain percentage of units before they can get the financing they need to build. However, particularly with condos, lenders will often put a cap on the percentage of investors in a project. If there are too many investors, it can be almost impossible for other buyers to get mortgages.
But limiting investors is a double-edged sword.