Tuesday, May 15, 2007
Buying in a new development: risk and reward
The selection of newly developed, luxury condo homes on the market in New York City may never be better than it is right now. There is stunning new architecture being added to the skyline with buildings rising at 100 Eleventh Avenue in Chelsea by Jean Nouvel, currently one of the hottest selling properties in NYC; or 101 Warren Street in Tribeca by SOM, now about 94% sold. Even Brooklyn is being transformed by Richard Meier's project on Grand Army Plaza overlooking Prospect Park. While I believe that these are among the best being built. There are a great many more on market and coming over the next couple of years. But they are not all the same, nor for everyone. What should you should you know about closing on a new development?
"The norm in Manhattan and Brooklyn is that developers have pushed most of their closing costs to the buyer's side of the deal".
the market landscapeIn the Manhattan apartment market we have co-ops and condominiums. These have important differences in their ownership and governance structures, but I'll be focusing here on newly developed condos as a special luxury category of product developed since the new millennium. About 80% of the privately owned apartments in Manhattan are co-ops. The flavors range from the stately pre-war properties lining Park and Fifth Avenues, to the aging inventory of mid-20th century white brick buildings, to walk-up tenement houses. They are almost always converted from rental buildings and often of a more vernacular quality. Condos represent the smallest category of the housing market and are usually 1980s or later. They have risen in recent years to about a 20% share of the market. However, the current inventory on sale is evenly divided into a 50/50 split with co-ops. This is due to the rapid pace of development in town.
For those looking to buy into a newly converted or ground-up new development project, the conventional wisdom has been that its worth a premium to be the first occupant of an apartment with the latest features, amenities, appliances and designer finishes. Exactly how much of a premium, is a question that can grab you by surprise at the closing table. Its clear that newly developed homes have more expensive price tags, but they also carry considerably higher closing costs. Some differences are clear, while other risks may not be all that obvious.
buying a promiseThe most basic difference in the decision to buy when considering a home offered for re-sale or a developer's property is that one actually exists, while the other is often a promise. Truthfully, I am amazed at the number of people who commit to a multi-million dollar purchase based on a floor plan. The sponsor's sales team at the presentation center will indeed explain and show many of the planned building features with 3-D renderings, and built out examples of kitchens, bathrooms and other finishes. It is easy to get excited by the slick and sometimes even theatrical showrooms. But keep in mind that you are not actually seeing the property or finished product. Things like views, sunlight, usable square footage and how the place "feels" are important factors which are assumptions in this kind of decision. In a resale they are the most basic of considerations that customers assess from the first time they walk-in. Has anyone ever seen pictures and floor plans of an existing property, only to enter with their broker and be totally unimpressed?
Is an existing building being converted from commercial use, or is it ground-up new residential construction? The first may offer some authentic vintage details and attempt to make the most of a floor plate that was designed for another use initially, some are better than others. The latter means that an architect has been able to completely design the environment for residential purposes. Look carefully at these too, not everyone graduated first in their class. Work with your broker to know as much as you can about your options. Visit the building sites. Google the neighborhood for information, and ask questions. The builders in Manhattan are big players with experience and track records. Your broker's ability to share information about the development team's reputation is important. Customers with vision and financial wherewithal, may have the pick of the litter.
But will your expectations be met? Not every one is comfortable with this kind of purchase. As more developments come to market, they are not all selling out in pre-construction the way they did a few years ago. I'm seeing many more with units still available as the buildings are completed and occupied. Especially with conversions, where an existing building is gutted and renovated, a representative or actual apartment, may be walked through before purchase. Its a good option for some buyers; as will be re-sale units in recently developed, but fully sold-out and operating buildings. A year or two of wear and tear, can often be as good as new.
higher closing costs and risksThe second factor is the considerably higher transactional costs which come along with a new development. After consulting with their advisers, many people do make the decision to move ahead with the deal, but for others who may be pushing affordability to its limit, the financial differences between new development and going for a re-sale become amplified.
It's really important to understand the fine print on the 'new' deals. With time-lines to delivery often a year or two away, this introduces a new risk factor. What will happen if interest rates do increase during that time? Will you still be able to borrow as much? If you cannot, you will likely need to close the gap from savings or some other source. Since most sponsors will not extend a mortgage contingency, are you in a financial position that has enough cushion in a rising interest rate environment, such that you are not risking the loss of your down payment?
When asked about closing costs, NY Real Estate Attorney John Bradbury observes that, "The norm in Manhattan and Brooklyn is that developers have pushed most of their closing costs to the buyer's side of the deal". Every deal is different. These high end projects are attractive to wealthy customers and more modestly heeled ones too. I had the perfect storm of these conditions recently influence a deal I was working on with a buyer. I'd been working with him and his partner to find a one bedroom apartment, preferably on the west side of town. We've actually seen things as high as 153rd Street, and down as far as the Battery. So he's flexible on location, but a size of about 650 to 700 square feet and bright, are must haves. He's a serious buyer, with excellent credit, but wanted to put 10% down and leaving modest but basically sufficient liquid assets and cash reserves. After consulting with a mortgage broker, we determined that the mid to high $700K range was going to be his limit. After seeing 25 or so homes, he fell in love with a property at a new development in the financial district priced at $790K. We began to look at the specific monthly costs associated with the purchase, as well as the effect of the closing costs which included paying city and state transfer taxes as well as a number of fees.
If the deal were to close today it would have been tight, but fine. In the end, the deal was scuttled not by the numbers as they might play today, but by a judicious intolerance for risk imposed by the sponsor's terms. Even though we were told by the sponsor's rep that the projected delivery would be in 4-6 months, the purchase agreement actually gave 18 months for the sponsor to deliver the unit and no mortgage contingency provision. This proved too risky for this particular buyers circumstances, as a up tick of less than a percentage point, over a possible year and a half waiting period, might mean that he would not be able to get his financing. His almost $80K deposit would be at risk, and they simply refused to negotiate any of those terms. He still pines for the one that got away, but we are now searching for a resale property where out of pocket expenses and delivery time frame are more reasonable.
on the sponsor's terms?
"Most sponsor contracts we've seen are at asking prices, but it directly reflects the robustness of sales for the property"
In new development properties, the terms will vary from project to project, but sponsor sales most often add 1.4 to +2%, to the transaction's closing costs. The biggest chunk of these will be city and state property transfer taxes (about 1.4% to 1.8% depending on price), traditionally a seller's expense, that will often be shifted in the purchase agreement to the buyer in new developments. Keep in mind that these expenses traditionally cannot be rolled into a mortgage, so buyers will be out of pocket for more money at closing. What's more is that the closing costs will looked at by the lender as something which reduces a buyer's liquid assets after closing, which may affect the principle amount of a mortgage that buyer will qualify for. Buyers should keep in mind that they will likely have to pay them again when they sell, adding significantly to the cost basis of their properties.
The sponsor's sales people will quote a projected target date for delivery of your home in their pitch. However, you should always take a closer look. Attorney John Bradbury explains, "Usually a 'wind-down date' is stated in the offering plan if possession is not taken by then". A buyer may be able to rescind a contract after the wind-down date, but that benchmark will often be 18 to 24 months out, again leaving room for a variety of scenarios to develop from the need for interim housing to rising mortgage rates as was the case with my customer.
Even with the caveats, the marketplace has clearly ratified the added costs and risks for those qualified individuals looking for the best in new properties. There is a wide variety of product available, and not all are created equally. If you are looking at buying into a new development, I'd be pleased to offer my help and expertise.
Buying in a new development: the closing costs
download: a summary of real property closing costs in New York City (pdf 324 kb)
Buying a luxury condo: the Vertical Living interview
download: Small Promises (tear sheet pdf 320 kb)