The gloom in the housing and credit markets is seeping into commercial real estate, challenging the conventional wisdom that luxury condominiums can better withstand a sluggish economy. Luxury condo developers today face tougher underwriting standards, higher capital costs and generally skittish lenders.

In many cases, developers are shelving ambitious proposals as supply outstrips demand and prices fall, particularly in the once-hot condo markets of Chicago, Tampa, Fla., Phoenix and Las Vegas. But other markets are suffering, too.

In Atlanta, for example, home builder John Wieland has delayed construction of a $350 million, 96-unit luxury condo development in the hot Midtown district.

In Jacksonville, Fla., Houston-based Hines is shelving plans for the 300-unit St. John luxury condo project for 24 months. Delays and outright cancellations also are occurring in Baltimore, the Minneapolis metro area and other cities.

Yet many developers are already in construction mode. “This is going to be an interesting year because a lot of projects are going to be delivered to the market,” says Michael Stein, an executive vice president with Chicago-based Corus Bank. A major condo construction lender, Corus Bank originated about $2.5 billion in loans in 2007 compared with nearly $4 billion in 2006.

“If developers sell only 5% or 10% [of their units], then it will be a disaster,” says Stein. “If they sell half, there will be a lot of pain, but not necessarily a disaster.”

Highly selective crowd

The definition of luxury condos varies by market, and those in the business describe it as attitude over necessity. The homes befit an elegant lifestyle that's far removed from the hoi polloi. Luxury residences typically feature Class-A locations, high-end interior finishes and appliances, and amenities and services such as gyms, pools, and a concierge and valet.

Prices for the product vary by market, too. In Manhattan, Miami Beach and Los Angeles — arguably three of the strongest cities in which to build luxury condos currently — such upscale residences fetch $2,000 per sq. ft. and often much more. In Phoenix, the average price is around $800 per sq. ft.; in Tampa about $600 per sq. ft.

For those reasons, condo experts anticipate the luxury niche will weather housing's downturn far better than single-family housing or conventional condos. Luxury condo purchasers, however, are increasingly becoming more discriminating about where and what they'll buy.

“No one is going to say that the velocity of sales is not down; there's certainly more caution among buyers,” says Leonard O'Donnell, president and CEO of Houston-based Patrinely Group, a luxury condo and commercial property developer focused on the Mid-Atlantic, Southeast and West. “High-end buyers want to make sure they're buying a home that's going to appreciate in value.”

Glut worries

A chief concern across the industry is the potential for overbuilding, and luxury condo experts say that developers will likely be stuck with many more unsold units than a few years ago.

In those heady times, speculators fueled a buying spree that sold out projects in mere days. Residential values escalated 30% or more annually in some markets, and luxury condo yields soared past their typical target of more than 20%.

But as of October, existing condo sales were on pace to hit 600,000 this year, down nearly 300,000 from 2005, according to the National Association of Realtors. Meanwhile, the average condo price climbed 4.5% to $662,000 year-over-year in October.

Prices in some markets are falling. The average price for a condo in the Miami area dropped to $362 a sq. ft. in October from $435 a sq. ft. in May, according to Miami-based Macdonald West Co., a commercial real estate brokerage. Supply is still coming, too. Some 26,000 existing condos are for sale and about 25,000 are under construction. A good number of those are luxury condos, says Macdonald West, principal of the firm. “The reality that we've got a huge inventory of unsold properties is finally setting in,” he says.

In Chicago, 58% of 1,500 luxury condos in all stages of development — from pre-construction sales to nearing delivery — are under contract, says Gail Lissner, vice president of Appraisal Research Counselors in Chicago. But in January 2008, Irish developer Shelbourne Development Ltd. will begin to market 1,200 more luxury condos at its proposed $1.5 billion Chicago Spire, which at 150 stories is being billed as the tallest residential building in the world.

Choked capital

Luxury condo developers pursuing construction are having a tougher time securing loans than they were just five or six months ago, thanks largely to a rise in subprime residential mortgage defaults.

Condo lenders will typically provide senior financing for up to 65% to 70% of a project's cost today compared with 75% to 80% midway through 2007, says Steven Kohn, president of real estate investment bank Sonnenblick Goldman. Lenders are also syndicating larger construction loans among other banks to reduce risk.

“It's much more difficult for projects in a marginal location or that involve less-experienced developers to get financing,” says Kohn, whose firm arranged a $27 million acquisition and construction loan for a luxury condo development in New York's West Village in 2007. “That wasn't the case 12 months ago.”

Sold on luxury

Despite the riskier climate, luxury condo developers continue to bet that well-heeled empty nesters, trust-fund babies, and buyers of second homes will keep paying top dollar for premier residences in tony locales across the U.S.

“There's a strong belief that demand for high-end condos is still out there,” says Guy Maisnik, a partner in the Global Hospitality Group of the Jeffer Mangels Butler & Marmaro law firm in Los Angeles. Last August he represented lender HSBC when the London-based bank made a $140 million acquisition and construction loan to New York-based Elad Group. Elad is developing the Wilshire Carlyle, a $330 million condo project in Los Angeles.

Patrinely Group executives share that sentiment, although they're taking a conservative approach to boost chances for success. The company is building in a few select markets, for example, and projects typically house a low number of residences — about 75 to 125, O'Donnell says.

By following those strategies, the firm is less likely to get stuck in a city that suddenly cools or that lacks sufficient depth to absorb the units, he adds. Last year, Patrinely completed and sold out the 86-unit Residences at 2211 Camelback in Phoenix, some for about $3 million.

Patrinely is putting the final touches on its 114-unit Plaza at Harbour Island project in downtown Tampa and has sold about 80% of the residences despite a well-publicized condo collapse in the city.

Price stability

Despite some evidence that New York housing demand is cooling — the New York Sun recently reported that asking prices dropped 13% in new developments in Chinatown, Central Harlem and other gentrifying neighborhoods — luxury condo developers in the metropolis remain upbeat.

In Brooklyn, N.Y., Bronx-based luxury condo developer SDS Procida has sold about 40% of its 102-unit On Prospect Park project and is hiking asking prices for a few select floor plans. The residences range from $860,000 to $6 million, and SDS Procida anticipates delivery of finished units this summer.

“Clearly, people have more choices,” says Mario Procida, principal of SDS Procida. “But if you have a true, top-of-the-market product that is one-of-a-kind, you aren't going to see much of a reduction [in demand or price].”

Apparently, top-of-the-market projects don't see a reduction in financing, either. In September, Corus Bank provided SDS Procida with $93.5 million to build an 83-unit luxury condo building at 405 W. 53rd St. in Manhattan.

Loan terms essentially remained the same, even though the deal was in the works over the summer during the capital market fallout. Procida said equity and mezzanine financing accounted for 10% to 20% of the capital stack.

“I'm not in the market [for financing] right now, but I wouldn't expect to come up with anything that's any different from what we got in September,” Procida says. “For the right project and the right team, there's still financing.”

Joe Gose is a Kansas City-based writer.

Free and easy lons a luxury no more

As luxury condo developers toil to find financing in the once-overflowing debt markets, they can at least take note of one bright spot. The scarcity of financing should minimize new construction.

Still, that might not be enough to keep developers cheery. Senior construction financing now costs about 300 basis points over the 10-year Treasury yield, an increase of 75 to 100 basis points since the summer, says Guy Maisnik, a partner in the Global Hospitality Group of the Jeffer Mangels Butler & Marmaro law firm in Los Angeles. As of mid-December, the 10-year yield hovered around 4.2%.

Additionally, lenders want to do business with proven developers with whom they already have a relationship. “Sponsorship is much more important now than it ever was,” Maisnik adds.

But lenders aren't necessarily demanding more pre-sales before providing financing for luxury condos, according to experts, and rules guiding pre-sales vary by project and market.

In New York, for example, developers typically don't sell units before going to the bank, says Mario Procida, principal of Bronx-based SDS Procida, a developer of luxury condos and other housing.

The restrained lending environment has forced a team led by commercial real estate developer Steven Poe to scale back the initial phase of a 42-acre mixed-use development emerging on the banks of the Ohio River in Louisville, Ky.

Poe, who is CEO of Louisville-based Poe Cos., a real estate investment, development and management firm, had planned to erect three luxury condo buildings in the first phase of the project, known as RiverPark Place. But late last summer he started construction on just one building.

Poe and other development partners also recently started constructing Museum Plaza, a $490 million mixed-use project in a 62-story tower complex that will include some 160 luxury condos and lofts in downtown Louisville.

As of mid-December, Poe and his development partners were seeking $45 million in public bond money to fill a financing gap. That was on top of $130 million in public funds already committed.

“There was certainly a different lending environment when we started the project,” Poe says. “But the demand for this type of housing in Louisville has increased over two-and-a-half years.”
— Joe Gose