By Daniela Deane
Washington Post Staff Writer
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.
On the positive side, investor buyers definitely help create a buzz around a project because they can add significantly to the number of people interested in purchasing, especially now when there are so many of them. When hundreds of people line up the morning that unbuilt condos go up for sale, creating a buying frenzy, it's likely that a significant portion of them are investors, developers said.
"Investors are absolutely a positive for developers," Montagne said. "I think I'd have bigger problems if people didn't want to invest in my buildings than I have when they do."
So developers need investor buyers, but are also wary of them.
"On the one hand, you don't want to discourage so many people from buying that you can't meet your bank requirements," said Tom Bozzuto, chief executive of Greenbelt-based Bozzuto Group, a builder of single-family houses, townhouses and condominiums. "But on the other hand, when you're doing new construction, I'd rather not have a lot of investor sales, because if I'm fooling the bank, I'm only fooling myself." Bozzuto, like other developers, said if he could have his way, he would sell all his homes to people who planned to live in them.
Bozzuto said the problem now is that with so many investors shopping, it has become harder and harder to distinguish between speculators and owner-occupants.
"It used to be that you could limit investor buyers simply by saying it, and generally people would be straight with you," Bozzuto said. "But now, a lot of people do lie to you. So we need to devote more energy to culling through our customers to make sure we have legitimate home buyers."
A buyer's personal situation can also change. That means someone who really intended to live in a unit could, for instance, face a job transfer that turns him into an investor.
A recent study by the Washington-based National Association of Home Builders found that in "hot metro markets" -- and the Washington area is considered one of those -- investment buyers now account for 11 percent of purchasers of new single-family homes. For multi-family condominium projects, investors made up 15 percent of all buyers.
It's not clear how many of those investors plan to sell quickly; there are also many real estate investors who believe in holding property for the long-term.
The survey found that many builders in these "hot metro markets" have taken concrete steps to reduce investor sales. Among them: selling only to owner-occupants (52 percent); prohibiting renting during the first year after settlement (33 percent); not selling more than one home to buyers with the same last name (29 percent); retaining the right to buy the unit back at the same price if the owner tries to sell within the first year (28 percent).
Local investor Arthur Dubin said that he, like many others, would love to buy pre-construction, if only he could. "I've let about a half-dozen of these pre-construction deals get past me over the past few years," he said. "Sometimes I questioned the high initial prices and then they went up $200 a square foot in two months. Or I sneezed and they were all gone. They go that fast. And now it's become really hard."
District-based condo developer PN Hoffman Inc. has taken steps to limit exposure to investors. The company tries to sell 25 percent of the units in a project before construction begins, according to Steve Earl, the company's chief operating officer. The aim is to "confirm their market and their price points." The company tries to sell the remaining 75 percent of a project during construction.
Earl said his firm requires higher down payments for investor buyers, typically 10 percent rather than 7 percent. It also requires investors to be pre-approved for financing at 2 percentage points above the current market rate, as a hedge against interest rates rising before construction is complete.
Montagne said his firm has also increased deposit amounts over the past six months, now requiring 5 percent down, and another 5 percent when the roof goes on the building.
Investor Dubin said one developer he knows is asking for 5 percent of the gross sales price if a buyer sells a home within two years of signing the purchase contract.
Bozzuto said his firm tries to limit the number of investors in a project to 15 percent of all buyers. He said Bozzuto Homes has begun putting a clause in its purchase contracts that says that Bozzuto can buy back a unit at the same sales price if a buyer attempts to sell the home prior to the second anniversary of the date of the purchase agreement. (Usually that's sometime during construction.) His company is also requiring buyers to sign a document that states they will go to closing.
"We always worry how legally enforceable any document like that is, though," Bozzuto said. The legality of most of these restrictions has largely not yet been tested.
Besides relying on those formal barriers, developers have also developed a nose for sniffing out investors.
"They're always the first in line," said Montagne. "They always want to buy the least expensive units. You've often seen their names before on other jobs."
However, he said, if buyers agree to all his conditions, and provide pre-approval letters and statements saying they will be owner-occupants, "You basically end up signing the contract anyway. Because really, what are you going to do?"