A giant upright ponzi scheme?

January 25, 2007 5:49 PM

How do condo developers make their money?

I've seen a number of condo tower developments underway, throughout the Southern USA. Typically the costs on construction of the tower greatly exceed the actual revenue received from sale of the units.

For instance, the "Austonian", in Austin, TX will cost $200 million to build. There will be 195 residences, ranging from $500,000 for the smaller ones, and the larger one (penthouses) will be somewhat over $1 million.

The question is as follows:
195 condos at $1 million each = $195 million.
If total development costs are at $200 million, this seems like a hell of a shortfall.

And, of course, that's assuming that every single unit will be a million dollar penthouse. It's likely that the majority of residences will be substantially less in cost, yielding even greater shortfalls for the condo developers.

I've heard various explanations (one was that condo developers make their money up in financing the deal, leasing out lower floors to retail, and condo management fees). Does anybody know how the condo developers make their money? How is this profitable?

posted by The Giant Squid to work & money (9 comments total)

As far as I can tell, the Austonian is just a proposed project. As such, the numbers are essentially meaningless.

It isn't clear to me that the tower will cost $200 M to build, it may actually cost $50 M to build, and sell for $200 M, netting the developers $150 M.

Condo developments probably make a profit of something like 20-40%, depending on the duration. They require very high interest rate short term loans, and construction takes one to two years. If the return dropped much below 20%, the developers would be better off putting their money in stock index funds. If their profit goes much above 40%, I suspect the banks and construction companies would figure out how to squeeze more profit out for themselves.

I am not a condo developer, but I like to run the numbers when I can.
posted by b1tr0t at 6:18 PM on January 25, 2007

Recall that the condo developer (or, more likely, the company he sells out to after populating the complex) will be collecting monthly maintenance fees from each owner for maintaining the common areas. The typical agreement essentially allows the manager to set the price for this service, so a profit is nearly guaranteed.
posted by megatherium at 6:34 PM on January 25, 2007

I agree that the $200 M number is essentially meaningless--imagined up solely for the purposes of a press release.

But taking the number seriously, my first thought (like bitrot) was that the developer had included in that figure some reasonable profit for himself. The other possibility that I can think of is that this land was purchased some time ago and the developer has been struggling through the entitlement process. A break-even result may one of the few remaining options in an environment of declining condo prices and rising construction costs (neither of which I know for sure to be the case, I'm just speculating). And perhaps this developer owns some adjacent land that is being developed into office property and this just happens to be the residential portion of a larger mixed-use project. We could probably think of a hundred different possibilities but it all comes down to that $200 M probably being a child of PR.

However, I think it is very unlikely that the developer is intending to make its profit through financing. If you meant the construction loan then a large commercial bank would have access to much cheaper capital than the developer could get a hold of--plus, the developer wants to borrow outside money in order to leverage the returns on its equity position. And if you meant the mortgage financing extended to the eventually residents, that is also very unlikely as that is not the type of risk a developer normally takes on and residents are likely to find much better deals through larger players in the mortgage market. Holding a portfolio of mortgages secured by a single building is a fairly dubious position to be in unless you have an enormous diversified portfolio already.

The HOA management income stream is potential profit, but it's pretty small compared to the type of equity returns sought by real estate developers. Most developers maintain pretty lean staffs, so the HOA management will likely be outsourced, thereby cutting down the profitability.
posted by mullacc at 6:48 PM on January 25, 2007

Re the Austonian, I estimate big construction projects for a living ... I've never seen a condo tower costing 400 bucks a square foot to build, although not knowing Austin I suppose the land could be wildly expensive. Condo developers tend to build very, very (very!) cheap.
posted by jamesonandwater at 7:04 PM on January 25, 2007

Maintenance fees don't go to the developer - they go to the condo owners association (at least in Ontario). Once it's built, the developers are completely out of the picture. And the maintenance fee money... pays for maintenance.
posted by GuyZero at 7:38 PM on January 25, 2007

Austonian is mixed use. So there'll be some nice retail revenue and fees coming out of that. The retail + building itself is something the developers will hope appreciates quickly so they can sell it.
posted by birdherder at 8:05 PM on January 25, 2007

In Chicago, and this may be entirely apocryphal, I've heard that a number of the near-south-loop buildings are essentially mob fronts for money-laundering.

...if that were the case, losing a substantial percentage of the investment would be taken as merely the cost of laundering (which, as I understand it, normally involves very large losses).

This conjecture is based entirely on two anecdotes, so take it with a giant grain of salt. The first came from a real estate agent (offhand remark), and the second came from a man I know in banking (who, among other things, described a particular very friendly & pleasant condo developer as "associated with people you don't ever want to be in debt to, in any way, ever").

But hey, with a little embellishment it makes a great tale!
posted by aramaic at 8:29 PM on January 25, 2007

In los angeles the general rule of thumb for towers (or other condo developments) is that the developer and bank financing it want to have enough units sold BEFORE construction to cover the total cost of construction. This was back when the market was hot, not sure how its going now, but a tower is a huge risk to take and developers tend to like their ducks in a row.

There is no way the construction cost of that tower is $200M, that figure is probably how much all of the units together will be sold for or something. Figure half of the cost is going to construction / contractor, another 1/4 for design fees / engineering / city agency fees, and 1/4 to the developer and his agents.
posted by outsider at 6:59 AM on January 26, 2007

http://www.bizjournals.com/twincities/stories/2005/04/25/story7.html

read this for some more accurate info (just found googling...) development costs (what this includes varies but it generally means everything but profit to the developer...) to top $100 million. 50 stories, 360 units, 160 units already sold and its still not under construction.
posted by outsider at 7:04 AM on January 26, 2007