Denver’s Pending Condo Boom

07/13/2016

Denver’s housing market fundamentals cry out for new condo development, yet the industry remains in the doldrums. A ray of hope is on the horizon, however, that may soon open the floodgates. In many ways, Denver is enjoying some of the best economic conditions in the country, with strong job growth and in-migration, low unemployment, and rising home prices (see Mile High Rebound by our Chief Economist, Kevin Gillen). Yet the housing industry continues to under-supply market demand.  Consider the following:

Ramifications of Excess Demand: Our analysis of Denver’s population growth and building permits reveals that the new housing industry under-supplied demand by an average of 8,000 homes and apartments per year from 2013 through 2015. As a direct result of this imbalance, annual home price appreciation and apartment rent increases both averaged nearly 10% for the past two years. With similar population increases forecast, there is clearly a golden opportunity for strong growth of the new housing industry in Denver, especially at more affordable price points that could be met by condo builders. Yet condo construction remains in the doldrums, particularly at price points with the greatest demand.

Attached Housing Fails to Fill the Supply Gap: In the past, Denver’s new condo market played an integral role by helping the housing industry supply entry level buyers with homes they could afford during times of rapidly escalating home prices. The last prior such era was from 1998 through 2000, and attached housing comprised 30% of the new for-sale housing market. Over the past three years of high price appreciation, however, attached housing failed to pick up this excess demand. In fact, the share of attached housing actually declined, amounting to just 13% of new home closings in 2015. Furthermore, the attached housing now being created can no longer be characterized as affordable. Denver’s home prices rose by 21% over the past two years, leading all of the 20 top MSA’s analyzed by Case Shiller. Over these two years, the average new attached home closing price increased by a whopping 33% to an average of $466,276 – just 5% less than the average for new detached homes.

So Why Not Build Condos? Denver’s construction industry has the proven ability to produce a large volume of good quality attached housing; nearly 21,000 new units were added to the metro Denver area supply of apartments over the past three years, including suburban two- and three-story walk up buildings as well as urban towers with 10 to 20+ stories. Most of these units are considered Class A properties with high finish quality and extensive amenities that would be very suitable as for-sale condos. With capital providers now beginning to worry that Denver’s apartment demand may have peaked, the stage would seem to be set for a re-emergence of the condo market. The problem with this scenario, however, is Colorado’s construction defects litigation environment. Since 2007, directors of a Colorado condominium HOA have been able to initiate a construction defects lawsuit on behalf of the entire project without asking for approval by the other owners, thus making it much easier for plaintiff attorneys to form class action lawsuits. Mindful of the large financial awards and settlements over the past 10 years, developers, their capital partners and insurers are reluctant to move forward with projects on the drawing boards. We have identified five significant new Denver area condo developments in the planning stages. All of these are targeting luxury price points – only a few units in these projects will be priced under $500,000, and none of them have yet started presales.Condo Market Outlook: In our recent condo development studies we have documented adequate demand at the luxury price points required to justify the high costs and litigation risks associated with these new projects. However, until the defects litigation environment changes, only minimal condo development can be expected at affordable prices.

Colorado courts may one day open the floodgates: One lawsuit working its way through Colorado’s court system may ultimately provide some relief from the litigation straitjacket that currently stymies condo development. When writing the condo declarations for the Vallagio condo development, the builder included provisions to require that disputes over construction defects be resolved using an arbitration process. Although the condo declarations also stated that this provision could not be amended by a future HOA board without the builder’s approval, shortly after control was turned over to the HOA the board of directors removed the arbitration clause anyway and proceeded with a class action lawsuit. The latest chapter in this saga was a strongly worded decision in favor of the builder by the Colorado Court of Appeals. The plaintiffs appealed the decision in mid-2015, and on June 20, 2016 the Colorado Supreme Court agreed to review the core issue in the case. At best, it will now be at least until the middle of next year before either the court rules in the Vallagio builder’s favor or the 2017 state legislature finally provides some relief.

Condo market outlook: In our recent condo development studies we have documented adequate demand at the luxury price points required to justify the high costs and litigation risks associated with these new projects. However, until the defects litigation environment changes, only minimal condo development can be expected at affordable prices.

Contact us to learn how the market supply and demand forces in play for a specific submarket will affect the feasibility of your proposed condo project.

Mike Rinner, Senior Vice President
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