Who will be hurt most?
During the boom, condos were catnip for would-be tycoons. Now investors are bolting, developers are slashing prices, and unsold units are piling up.
NEW YORK (FORTUNE) - The most troubled sector of the housing market, the one that will fall first and fastest, is the condominium market. Typically cheaper than houses and easier to buy, sell or rent out, condos are catnip for investors.
"I estimate that 80 percent of the sales in Miami went to investors at the peak of the market," says Lewis Goodkin, a consultant to condo developers. The problem is that investors tend to bolt when trouble looms.
Gary Bahadur, 32, who owns a computer networking company in Los Angeles, bought six condos in California over the past few years. Now he's putting them all up for sale.
"I'm getting out of California because it's topped out," he says, "The prices are so high that investors can no longer buy a condo and rent it to cover the mortgage."
Yet even as speculators flee, developers keep throwing up condos at a breakneck pace, in part because if they have already bought the land and poured the foundation, they have no choice but to finish the project.
Unsold condos are piling up. In the Miami area 25,000 new units are under construction, and another 25,000 are approved. Yet the Miami market absorbed only 10,500 new condos in the past decade. (See a gallery of more markets in trouble.)
Tanya Wagner, a South African who worked as a food and beverage manager at the Four Seasons hotel, is caught in the squeeze. She paid $335,000 for a two-bedroom condo when she moved to Miami in 2004. Now she wants to start her own consulting business in Europe. In November she put her unit on the market for $485,000, the price that apartments in her building had sold for a few months earlier.
But Wagner missed the peak. She's now dropped her price to $415,000, and she still hasn't had an offer. Holding the unit and renting it out doesn't appeal to her. "My belief is that prices will drop even more," she says.
Builders are in a bind
When two-bedroom condos get discounted from $350,000 to $300,000, developers in the neighborhood drop their prices on $400,000 starter homes.
Builders don't have the luxury of waiting out a slump; they need to sell for what they can get. At first they hold the line on base prices by offering incentives, from free pools to flat-screen TVs. Then, as unsold units collect, they move merchandise with huge discounts.
Builders also pitch in when potential customers are having trouble unloading their current home. A typical example is the help Pedro Kritselis is getting. He had to sell his house to afford to buy a new one in Bristow, Va. But the market is so soft that he couldn't get the price he needed, so he told the builder he'd have to walk away. To keep the sale, the developer shaved $25,000 from the price of the new house. That enabled Kritselis to sell his house for $25,000 less and still afford the new home.
One northern Virginia realtor is doing good business assisting homebuyers who need to sell a house to buy a new one. Ashley Leigh, among the region's most successful independent brokers, offers the following deal: If he can't sell the old house in 120 days, he'll buy it himself at a fixed price. Leigh is trumpeting the guarantee in an ad that appears on area billboards and grocery carts at the local Safeway.
These days his services are a godsend to developers. When they get customers who want to buy but need a minimum price for their existing house, the builders call Leigh. In return, he typically gets a 3 percent commission from the developer on the new sale and an exclusive listing on the old house that gives him a minimum of 3 percent on that sale.
So far he has granted over 100 guarantees and been forced to buy ten houses himself. Even when he sells them at a small loss, he still makes money overall. "I have the cushion of the commission on both ends," he says. "On houses priced $600,000 or more, I make the guarantee less than today's market price, because I'm pretty sure prices will be lower when I sell."
Most homeowners don't have to sell; the new, lower prices will be set by those who have to bail out. They include not just investors but also owners who stretched their finances to buy a house. This year, no less than 22 percent of Americans' $8.7 trillion in mortgages will reset rates - and the extra burden will be big.
A typical three-year ARM will go from 3.6 percent to 5.6 percent, forcing a borrower with a $500,000 mortgage to pay an extra $800 a month in interest. Delinquencies are already rising rapidly. Since early 2005, delinquency rates have jumped almost 14 percent, to 2.5 percent for prime mortgage loans.
"The banks will be forced to take back a lot of properties and sell them for the amount of the loan," says Mark Zandi of Moody's Economy.com. "That will add to the already huge supply on the market."
As painful as it will be for many people, the looming correction may turn out to be welcome news for house-hungry Americans. Young couples now priced out of the market will once again be able to buy a ranch or colonial without forking over half their income for mortgage payments. Growing families will be able to trade up for more living space without raiding the kids' college funds.
Lauris Lambergs and his wife, Ginta, want to move from a condo in South Boston to a single family home. But until recently they were appalled at the exorbitant prices. Suddenly the power is shifting to the shoppers, and the Lambergs love it.
"Up until last summer, going back five years, it was a ridiculous seller's market," says Lauris. "Now the buyers have some leverage." The Lambergs relish spending Sundays house hunting. "When we go to open houses, we're the only ones all day!" exults Lauris.
It's the bright side of our gloomy outlook: The bargains are coming.
Additional reporting by Matthew Boyle, Nadira A. Hira, Julie Schlosser, Christopher Tkaczyk and Jia Lynn Yang.