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March 8, 2007

Soured condo market in Seattle? Think again

  • Even Portland has delivered more housing units in a market that’s half our size.

    In 1995, I relocated to Seattle from Vancouver, B.C., convinced that downtown Seattle would soon simulate the explosion of residential development that I witnessed in my hometown. After all, the markets share similar characteristics: strong economies, healthy population growth, relatively compact downtown cores, growth-management boundaries, unbearable suburban commutes and beautiful natural surroundings.

    Seattle’s three urban
    condo markets
    A few years ago downtown Seattle was viewed as one marketplace and condominiums were considered merely an alternative to apartments. Today, in-city neighborhoods are redefining themselves with individual identities and condos have become segmented into three primary product categories.

    While not inexpensive, this segment consists mostly of older resale properties and apartment conversions that generally range from below $200,000 to $400,000 ($350-$550 per square foot). Options for new construction are limited at these attractive price points due to construction costs and land values. Typically these projects are wood-frame construction located in peripheral neighborhoods. The most common home buyers are first-timers who have been renting in the city and newbie urbanites relocating from outlying areas. They’re attracted to the shorter commute, simplified lifestyle and the opportunity to build equity in a rising market.

    This segment is mostly new construction, with condo prices typically from $400,000 to $1.5 million ($450-$800 per square foot). Most of the concrete construction mid-rises in popular neighborhoods such as Belltown occupy this segment, as do an increasing number of resales within recently completed buildings. This segment is very popular with in-city professionals and move-up buyers that commonly buy, build equity, sell and then move every two or three years. The newer buildings offer enhanced features such as taller ceilings, five-piece bathrooms and air-conditioning. They are also tied to more comprehensive amenities such as full-service concierge, access to guest suites and expansive rooftop terraces.

    The emergence of more inspired condo developments, which are often associated with hotels (two such projects are open and four more are on the books), have created a new product category priced from $750,000 to more than $5 million ($700-$1,500-plus per square foot). Some condo estates have recently pre-sold for more than $10 million at rates in excess of $2,000 per square foot. Located in the most preferred infill locations closer to the city core, this segment takes advantage of taller zoning, impressive views and enhanced amenities that rival five-star resorts such as private social clubs, subterranean wine caves and valet parking. These new offerings have attracted a new cohort of downsizing empty-nesters, retirees and second homeowners, 20 percent of whom are of out-of-state owners.

    Interestingly, market demands are driving more segmented development practices. Developers are less inclined to represent all markets within one building, which was commonplace in the past. And affluent buyers are less likely to opt for a premium unit in a moderate building than they are to buy a moderate unit in a premium building. Demographic targeting, branding and distinctive product offerings have helped new projects compete in an increasingly noisy marketplace. This diversity of inventory helps ensure that the market isn’t flooded with “same-same” product, targeting the same buyers at the same time. Competition breeds product evolution, which provides for a more dynamic, well-rounded marketplace for all home buyers.

    — Dean Jones, Realogics

    Over the past decade, downtown Seattle has experienced a 67 percent population surge, the second-fastest urban growth rate in the nation. Seattle was voted the nation’s most livable city by the 2005 Conference of Mayors and, just last year, residential zoning downtown was changed to encourage our city’s emergence as a 24/7, high-rise metropolis.

    Today, downtown Seattle is a bright spot in the national landscape, with enviable demand for new retail, office, industrial, biotech and residential development. Still, our condo boom is in its infancy, lagging behind West Coast markets like Vancouver, San Francisco and San Diego. Even Portland has delivered more housing units in a market that’s half the size. Seattle is just starting to catch up.

    While headlines are beginning to recognize our promise, local home buyers have been confused by all the national press touting gloom and doom for the U.S. housing market. That perspective, in part, could explain the last quarter of 2006, when local media pronounced that in Seattle sales were down and inventory was up. These reports, however, neglected to identify one very important aspect: new construction condos were grossly underrepresented in the data. Typical reports, based on the Northwest Multiple Listing Service (MLS), overlook the fact that less than 10 percent of the new construction inventory is posted on the MLS and, given the very nature of pre-sales, there are no closings on which to report.

    As in most growth markets, new construction inventory has become a much larger category than resales. Right now there are three times the number of pre-completion units available than there are MLS listings downtown — and they’re selling twice as fast. Despite some deceleration in appreciation market-wide, pricing is still up overall.

    Seattle stands out

    Seattle isn’t experiencing the same reality as soured condo markets such as Miami, Las Vegas and San Diego. These once red-hot markets were simply overbuilt as developers misread demand, which in theory should be anchored by job growth and actual end-users. Instead, most home buyers were discretional consumers (second-home buyers and overexuberant investors), which created a false sense of demand. While this buyer segment is viable in markets posting 20 to 25 percent annualized appreciation (as they had for the previous five years), it’s clear those days are over. Once supply and demand found balance, the rate of appreciation decelerated, sales slowed and inventory rose. Subsequently, discretional home buyers dried up at about the same time as a record number of projects broke ground.

    Seattle’s market is far less sensational and much more logical than these other cities. Our economy experienced a delayed recovery from the recession and, from a market perspective, we’re still in the first half of our cycle. Seattle didn’t witness the same rates or consecutive years of appreciation as headlining markets that are now digesting a market correction. It wasn’t until 2005 that downtown Seattle saw double-digit appreciation, and I believe that was brought on more by the introduction of improved product offerings than by any kind of investor ebullience. While investors may have represented 15 to 20 percent of downtown Seattle’s condo absorption in the past, new restrictions are forcing this conditional buyer segment much lower. The vast majority of home buyers today are owner-occupiers, which is a good thing.

    Meanwhile, new categories of condos have only just begun to attract new buyer profiles across the board. For instance, the luxury market segment has been patiently waiting for more evolved product offerings. That might explain why some projects are selling scores of units averaging $2 million or more while others tread water at a quarter the price. It’s a reminder that there’s no such thing as a singular housing market. Different market segments operate independently of one another — just as the national housing market doesn’t dictate what happens in the Pacific Northwest.

    Overbuilt or over-announced?

    Natural selection occurs in real estate just as in nature — only the strongest survive. Last year, there was talk that Seattle may see nearly 10,000 units added between 2005 and 2010.

    In reality, downtown Seattle may see 6,500 condos delivered in the studied 60-month term. Of this number, about 1,000 units will become apartments, leaving approximately 5,500 units of new construction condo inventory. Considering that 2,000 of those units are already pre-sold, this suggests that about 3,500 new units will need to be absorbed between now and 2010 — not a tall order, all things considered.

    Choice is key

    With increased resale inventory and new projects coming online, home buyers have more choice than ever. This is a relatively new situation for downtown Seattle, a market that has been accustomed to very limited resale inventory and perhaps two or three new construction projects within a set market window. It’s understandable if home buyers have become cautious about where and when to buy, especially with resales. They can find themselves in “analysis paralysis” and, for a short while, could actually create a self-fulfilling prophecy about a declining market. That will pass.

    Thankfully, a new year has a way of resetting things. Based on sales so far in 2007, many shy home buyers have reconciled the market truths and decided to buy. Sales are up at all price points.

    Job growth and lifestyle

    Market fundamentals support an optimistic outlook. By 2010, downtown Seattle will see another 1.5 million square feet of office space developed. The market will add 10,000 new jobs downtown, swelling an urban employment base to more than 240,000, which is half of all the jobs in Seattle. Yet for all those people working downtown, only 43,000 housing units will exist in the city center, of which 25 percent will be condos.

    While job growth is critical for housing absorption, another major component is lifestyle. This demand driver is largely comprised of downsizing baby boomers, retirees and second-home buyers — most of whom are not affected by interest rates or concerns about relative affordability. They’re choosing the lifestyle. The more residents who live in a city, the larger the consumer base to support restaurants, culture, retail, residential amenities and other attractions, which, in turn, attracts more residents of all types. For example, downtown Vancouver has twice the in-city population of downtown Seattle, yet half the employment base. So it’s not all about jobs; it’s about creating a compelling lifestyle proposition within a resort city. That’s the real opportunity.

    Downtown Seattle is well insulated from the dynamics that caused market corrections elsewhere. This industry shake up is healthy, and we are better for it. Watch for elective tightening of investor sales and more responsible marketing and sales practices, which are required to engineer condo values commensurate with today’s construction costs. Most importantly, expect greater product differentiation and a more cautious scheduling of new inventory being introduced to the market. In business, nobody likes surprises.

    There’s something to be said for being a late bloomer. Seattle can learn from other markets as we perfect our own future.

    Dean Jones is a principal of Realogics, a Seattle-based real estate consultancy specializing in market research, product development, marketing and sales solutions for high-density, infill condominium and mixed-use properties.

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