Condo conundrum: Lots of demand, not enough building

If only condo construction in the Twin Cities were as brisk as the demand.

While swells of baby boomers and young professionals are hankering for the ease and amenities of condominium living, the number of units for sale is strikingly low, with only three condo buildings under construction across the metro.

"I wasn't aware of how deep this market was," said Steve Bohl, a developer who is building condos in Wayzata that are selling for $450,000 to more than $2 million. "A lot of people wanted to make this lifestyle change, but didn't because the real estate market was awful. We've had five years of pent-up demand."

Even so, most developers are steering clear of condos. Prices on existing units are still far below what it costs to build new, while banks remain hesitant about providing the construction financing. Other developers are being deterred by a Minnesota law that holds builders liable for major construction defects for 10 years.

Across the region, there were 1,011 condos on the market last month, a 17 percent decline from last year and the lowest level in more than a decade. At the current pace, the inventory of condominiums would be sold out in 3½ months.

Jim Stanton, a veteran developer who has built hundreds of condos in downtown Minneapolis and thousands of houses in the suburbs, sensed the market was shifting about two years ago. He started building Stonebridge Lofts, the only new condominium building in downtown Minneapolis, at a time when some said it was too soon.

His gamble paid off. Just a year from completion, he has purchase agreements for nearly 70 percent of the nearly 164 units in the building, which is in the Mill District near the Mississippi River.

Unlike many developers who rely heavily on bank financing, he was able to use his own cash and expertise to get the project off the ground.

Buyers have been equally receptive to the ParkSide condos in St. Louis Park, where 15 of the 22 units have already sold.

Jim Seabold, the Coldwell Banker Burnet sales agent who is marketing the project, said with condo prices still slightly below peak and construction costs on the rise, the key to making money on condos is finding a site that's affordable and keeping building costs to a minimum.

"There continues to be demand there, and the demographics are there to support demand," he said.

Financing remains one of the key obstacles to a full-swing condo comeback in the Twin Cities. Lenders often want 50 to 75 percent of condo units sold before construction can even begin to ensure there is sufficient demand. That can be difficult when prospective buyers don't have a building to tour.

"For the most part, our clients have not been interested in the condo market," Besse said. "Although we stand ready to support our clients should they bring us a deal that makes sense in a market where there is demand."

Builders are also turned off by a Minnesota law that holds them responsible for defects for 10 years.

During the last condo boom, several developers were sued by powerful condominium associations alleging that the buildings had construction flaws that were covered by the state law. The law has been on the books several years, but claims escalated during the condo boom, making developers worry about potential long-term liability.

"There are law firms in this town that have filed lawsuit after lawsuit on behalf of homeowners associations alleging construction defects," said Kelly Doran, who built two condo buildings before the housing crash but is now focused on luxury rentals. "With that 10-year warranty, there's no way I would build condos."

Tom Lund, a vice president with Opus Development, agrees. "Some are frivolous, some legitimate, but just about everyone who's done a condo building has gotten into some legal entanglement … people will be very cautious."

Others say the lack of condo construction has less to do with weakness in condo sales than it does the strength in the rental market.

Michael Steinberg, a senior analyst with Reis Inc. in New York, said Minneapolis has one of the strongest rental markets in the country, meaning vacancy rates are exceptionally low. The metro's third-quarter vacancy rate was 2.2 percent, the third tightest vacancy rate of the 82 primary metros tracked by Reis.

"The condo sales market is really only now recovering," Steinberg said. "And even if prices have stabilized, appreciation has yet to reach that fevered pitch that would prompt developers to forego the development of apartment units, which continue to exhibit rent growth and vacancy declines, in favor of condo development."

Steinberg said he expects the market to eventually shift as the surge in apartment construction dilutes rent growth, encouraging developers to shift their strategies back to condo development.

That will happen naturally as condo resale prices rise, providing an incentive to developers and buyers. Developers are also watching closely for an opportunity to convert one of the existing luxury apartment buildings into condominiums.

"We're building apartments that are nicer than the condos that were built a few years ago," Lund said. "This is about just pure supply and demand, and right now there is a lot of demand, but not a lot of supply."

Jim Buchta • 612-673-7376