Risky Business: Low Inventory Rattles Reality

As market pressures increase, buyers are well advised to double down on due diligence.
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Déjà vu All Over Again

Thanks to a shortage of inventory, Manhattan real estate may be having a George Santayana moment. Despite everything that occurred only a few years ago, buyers are beginning to revisit the bad habits that resulted in misguided real estate purchases. As sales continue the upward trend, and fewer units are available, the balance of negotiating power is quickly shifting from buyer to seller.

The Real Estate Canary in the Mine

If there is one metric more than any other that signals the beginning of an overheated real estate market, it's the pace of sales with new construction. When developers roll out the "take it or leave it" welcome mat, an artificial urgency is added to the marketplace with buyers usually getting pushed into deals that don't necessarily make financial sense. As outlined in Julie Satow's timely cover story in the New York Times on March 13th, "Developers Cease to Offer Condo Incentives," the lack of condo units in the new construction pipeline has created an environment where there are more buyers than available apartments, resulting in higher pricing and fewer incentives (like transfer taxes and attorney's fees paid by the sponsor). So despite the fact that almost all national economic indicators have remained unchanged, or may actually be deteriorating, simply changing the balance of supply and demand, can dramatically shift sales trends. Citing Noah Rosenblatt's statistics in the article, contract signings in March and April of 1,213 and 1,164, respectively, the highest in four years, occurred while inventory continued to shrink during the same periods. In fact, inventory has been decreasing for the past 18 months. The window of opportunity for buyers that opened after the Lehman debacle occurred, is closing and may, in fact, already be shut.
The Boutique Condo

Finally, the smaller developments are starting to move units. But buying in a smaller building has its own unique set of issues. Front and center is the fact that the cost of any construction problem that arises, which the sponsor refuses to handle, is spread over a smaller number of unit owners. Although any new development needs three to five years of operating history before the quality of the construction can be determined, buyers often ignore that reality in favor of emotional and sometimes irrational "wants" rather than "needs." Here's a good rule of thumb: the smaller the development, the greater the need for due diligence and research about the developer.

Is the "All Cash" Contract Making a Comeback?

If the upward sales volume continues at current levels, expect headwind about the inclusion of financing and funding contingencies. With multiple bids starting to occur, buyers will face pressure to absorb the financing risk in order to make a deal. Although sales may be improving, lending conditions have not. Underwriting guidelines continue to frustrate borrowers and slow down transactions. The buyer who requires 80 percent financing and who agrees to an "all cash" contract, is taking a substantial risk if the appraisal does not meet expectations. No matter what the circumstances may be, a buyer should avoid giving up a financing contingency, unless he or she is prepared to pay cash if financing is not available.

Back to the Future...

Walking down Lexington Avenue yesterday, my wife and I passed a somewhat beat up Delorean parked on the street. Taking a few pictures, I couldn't resist thinking that really smart people often make really bad decisions. As market pressures increase, buyers are well advised to double down on due diligence.

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