Developers and owners of residential condominiums for sale in overbuilt markets would be wise to cut their losses and sell before a wave of construction adds another 100,000 units to the national inventory of this year, experts say.

“People don’t realize that prices are going to be trailing the market down,” says Gene A. Berman, managing director of broker Marcus & Millichap’s Florida offices. “Smart lenders and smart owners are cleaning up the books [to sell] now because they know that in the next six months to a year, it’s not going to get better for them.”

Nationwide, the supply of condos for sale totaled 604,000 units in February, according to the National Association of Realtors (NAR). That number is down 1.8% from the inventory a year ago and well below the peak inventory of 731,000 units measured last July. Due to a slower pace of sales this year, however, February’s inventory equates to a 13-month supply, an all-time high.

Overbuilding is concentrated in specific markets. Chicago, for example, will add 16,000 condos this year; 14,600 are slated for completion in New York and another 13,000 are coming online in Phoenix, according to Josh Scoville, director of strategic research at Property & Portfolio Research. “These are just being added to the glut of empty units in the markets.”
 
The oversupply will worsen this year with the delivery of new projects that started construction before the credit crunch hit last August, according to Matt Anderson, a partner at Foresight Analytics LLC. Of 120,000 units under construction at the end of 2007, the company expects approximately 100,000 to reach completion this year and another 77,000 to break ground.

The oversupply and its diluting effect on sales have been accompanied by soaring delinquency rates on condo construction loans. Of the $42.3 billion in construction loans outstanding for condos at the end of the fourth quarter last year, a whopping 10.1% were behind on payments by 30 days or more, according to Foresight Analytics, a real estate and economic research firm in Oakland, Calif. That’s up from 2.6% a year earlier and nearly double the delinquency rate of 6% in the third quarter of 2007.

“It’s striking how rapidly the market has deteriorated, but at the same time it’s not surprising given the general residential downturn across the U.S.,” Anderson says. Indeed, the inventory for single-family homes in February exceeded 3.4 million, an unhealthy 9.2 months of supply, NAR reported.

While Anderson expects construction on about 10% of the condos under construction to be halted before completion, most projects are barreling ahead. The large number of units in the pipeline is due in part to the all-or-nothing nature of condo development, which requires completion of an entire project in order to close the sales on even a fraction of units.

Developers midway through a project have few good options. Some are falling back on conversion of completed projects to rental units, but the more substantial building materials and luxury fixtures that go into most condominiums today come with a high cost of construction, making rental income a poor substitute for sales. “It doesn’t recoup all of the money they’ve put in,” Anderson says.

In markets like San Diego, Las Vegas, San Francisco and South Florida that experienced some of the largest residential construction bubbles, new units will find few interested buyers upon completion, according to Berman of Marcus & Millichap. That’s because potential buyers at this point in the cycle are more likely to be investors than residents, and investors will wait to see prices bottom out before they buy rather than risk purchasing an asset that may continue to decline in value.

Vulture funds are already hovering in overbuilt markets like Miami, which has 50,000 to 70,000 condominiums either under construction or completed and empty, according to a Marcus & Millichap estimate.

Since late February, condos in downtown Miami have gone to auction without a minimum bid requirement, a sure sign that some investors believe the time to hold out for a specific price point has passed. Investors who want to snap up some of those deals appearing at auction will need cash resources, Berman says, because sellers aren’t going to allow time for a buyer to line up third-party financing.

Having experienced the price declines and lengthy recovery of commercial real estate in the days of the Resolution Trust Corp., Berman believes investors that continue to hold out for better prices on their condo units are setting themselves up for more painful losses down the road.

“A lot of developers or people who have bought really nice units on spec are holding onto them and renting them out for next to nothing in hopes that the market will come back,” Berman says. “But there’s really no market for seven-figure condos.”