The Condo Game

Published Sunday, July 04, 2004 Mobile Press Register

By RYAN DEZEMBER

Staff Reporter

GULF SHORES -- On the beaches of south Baldwin County , a growing number of wealthy investors are bolstering their fortunes by rapidly buying and selling unbuilt condominium units. It's called "flipping," and the investors are using very little of their own money to do it.

According to local real estate agent Bob Shallow, the strategy involves buying a condo worth hundreds of thousands of dollars for 20 percent down -- though, in many cases, the investor actually parts with as little as 1 percent of the down payment -- and quickly marketing it and selling it for vast thousands of dollars more.

Shallow, a 23-year veteran of south Baldwin County's real estate scene, is a major player in the condo market, which he described as "without a doubt the best market ever -- nowhere in the country is it so stable and flush."

Unlike a false market in the 1980s that led to a bust, Shallow said, this one is driven by a real demand that stems from the desire of millions to own a well-appointed, waterfront home.

As a result, condos from the Fort Morgan peninsula to Orange Beach are selling in volumes and at prices previously unheard of on Alabama 's beaches.

Nearly 30 percent more condos -- 312 units -- sold in Baldwin County during the first three months of this year than during the same period in 2003, according to data from Metro Market Trends Inc., a Pensacola firm that compiles real estate sales records. A similar analysis shows that the dollar volume of sales is up nearly 72 percent over last year.

What these statistics don't reflect is the number of sales prior to closings, when condo "end-buyers" would presumably be ready to take occupancy. Closing is the point when sales records are filed in Probate Court and become public.

Though the frequency of flipping is hard to nail down, interviews with buyers, builders, brokers and bankers reveal that condos now commonly change hands -- even several times -- before being built.

Amy Stehmeyer, director of real estate sales at The Beach Club resort on the Fort Morgan peninsula, said that flipping "seems to be more the norm than the exception." Shallow said he knows cases in which condos have been sold seven times before anyone got a set of keys.

This booming market is propelled by the ever-increasing number of Americans who want a place on the beach -- particularly the 76 million baby boomers who are at or approaching their peak wealth. But the investors who are flipping units are giving the market a strong push.

Flippers, while they can come from anywhere, are typically well-financed and well-connected to local real estate agents, who are known to reserve portions of projects for these regular buyers.

Shallow has an affectionate nickname for his cadre of profit-minded clients, or flippers. He calls them "the Dolphin Club."

Like cocoa, cotton or crude oil, Gulf Coast condos have become a commodity in the sense that investors are buying and reselling the rights to an anticipated finished product long before it ever arrives, assuring producers of a demand.

Within commodities markets, there are those -- be they confectioners, clothiers, refiners or, in this case, retiring baby boomers -- who covet the finished product, and those who seek to profit by skimming the supply and hanging on to their holdings until unsatisfied demand jacks up the value.

In this context, the high-stakes condo game involves relatively simple economics: There are too few upscale units to feed the demand of the second-home market.

With little raw land left on Baldwin 's beaches, developers are doing what they can to enlarge the condo stock. In the past year, homes have been moved off the beach by barge and truck to non-Gulf-front lots, hotels have been demolished and, in one case, an entire low-rise condominium, Sandy Shores West, was carted across Alabama 182 on equipment that typically transports industrial-sized loads. In their place are signs heralding planned condo towers.

In 2003, the value of condos with a Gulf view rose an average of 30-35 percent, said Shallow, who oversaw $497 million in sales last year as the owner of a RMAX agency on the coast.

Despite this escalation, Baldwin's beaches are still a "pretty good deal" for regional buyers, said Chuck Norwood, a RMAX associate broker in Gulf Shores .

These buyers might be used to modest homes along Atlanta 's manmade Lake Lanier selling for $600,000, Norwood said. Or maybe they are familiar with condos on Florida 's east and west coasts, he said, which still cost 25 percent to 40 percent more than those in Alabama .

As interest rates have fallen and word has spread of the healthy returns reaped by those investing in south Baldwin, the prices that people are willing to pay there have greatly increased.

Consider this: In 1991, it took four months for the 48 units in Surfside Shores , then priced at about $95,000 to sell out, Shallow said. In January 2003, he said, it took less than an hour for the 66 units of the 26-story Island Tower -- situated on West Beach Boulevard just a short walk from the older development -- to sell for an average price of about $430,000.

Though Island Tower is still under construction, its units are already reselling at an average price above $700,000, Shallow said. Surfside Shores units, he said, are fetching $395,000 these days.

Pittsburgh businessman Don Hilty discovered Alabama 's sandy vistas when he visited a Birmingham client's Gulf Shores beach house. Hilty said he was reminded of the Maryland coast he visited as a child -- a cozy area that had yet to be fully developed.

The executive vice president of New Keibler-Thompson Co., a service contractor for steel mills, also saw an area ripe for investment, with the potential for resort-style development.

Seven years ago, he bought his first Baldwin County condo and he and his wife keep a unit on Little Lagoon as a beach retreat. But Hilty has purchased several other units and predicts he'll buy into four or five more this year with an investment group consisting of a few friends.

"We've bought some preconstruction, some we closed on, some we flipped," Hilty said. "It's a little bit of an opportunity to make a couple of dollars outside of the stock market right now."

Hilty and his partners are members of Shallow's Dolphin Club.

The partners "don't want to own anything," and "we're not trying to hit a lot of home runs," Hilty said. "We're happy with a positive return to keep the money rolling forward."

Members of the Dolphin Club, as Shallow describes them, are "not emotional."

"They make decisions based on an equation. They don't care what the flooring is, they don't really care if there's an ice maker, they don't look at the plans. They're able to make a half-million dollar deal on the phone in five minutes ... all they need to know is price, square footage and location within the building," he said.

Hilty said he considers construction planned nearby, the developer's history, and, to a lesser degree, price. But in the end he'll defer to Shallow, whom he met about five years ago after seeing his name posted at a construction site.

"If he called me up and told me I need to do this, I'm in. You need to do that with someone," Hilty said.

While Shallow acknowledges that the market could swoon like any other speculative endeavor, the Dolphin Club's flipping thus far "always ends up the perfect scenario," he said.

"It's like when the NASDAQ was going crazy," Hilty said, recalling the 1990s boom in the technology-based stock index. "You couldn't lose."

Whether they are flippers seeking only financial gain or boomers who want a second home, those in the best position to profit are "first-generation buyers." That term describes people fortunate enough to snap up condos at their initial offering.

In most developments, 20-percent down payments are collected from buyers who commit to a project in the preconstruction stage. Developers use such offerings to prove the project's viability to banks that are lending them money. The institutions hold the deposits in escrow so that if anything happens to the developer, the bank can take over the project.

With 20-percent deposits, developers and their lenders receive a layer of protection: A buyer is unlikely to abandon a down payment that could exceed $100,000, said Larry Wireman, a developer.

In many cases, buyers will give the developer an irrevocable letter of credit for the 20 percent in lieu of the amount in cash. Banks typically charge between 1 percent and 2 percent of the amount that these notes represent, although institutions will sometimes issue one for free if the borrower is a good customer, Wireman said.

By using a letter of credit to buy an unbuilt condo, then selling that condo before closing, an investor can enjoy returns that far outrun stocks, bonds and mutual funds.

For example, say that an investor bought a $500,000 condominium at its initial offering two years before closing and chose to provide the 20 percent, or $100,000, down payment in the form of a letter of credit. If that investor's bank sold such notes at 1 percent a year, the investor would pay just $2,000 to control the condo for two years until the building was finished.

Then, if at some point prior to closing, the investor sold the unit for $600,000, he would reap a $98,000 profit on his $2,000 investment.

Local real estate agents are not shy about promoting this on their Web sites. Shallow walks potential investors through the presale process, offering an example in which an investment of $2,400 turns into $240,000. Wade Ward Real Estate beckons buyers with "$100,000 or a million to invest" to think about Gulf-front real estate, "an investment you can see, touch and even live in -- try that on Wall Street!"

This, however, is a game for the "well-capitalized," as Shallow describes such investors. Tough lessons learned in the 1980s taught builders and lenders to make sure that investors could actually close on a $500,000 unit.

In the 1980s, development on Baldwin's beaches stumbled when speculators who had paid as little as $2,000 for preconstruction condos walked away from their down payments at closing, Norwood said. They had gobbled up units but couldn't resell them and lacked the money themselves to pay the price at closing.

Gulf Shores Mayor David Bodenhamer, who began developing beachfront condos after Hurricane Frederic cleared the way in 1979, recalled that potential end-buyers in the 1980s were turned off by double-digit mortgage rates and by the possibility that tax changes would discontinue deductions of interest payments on second homes.

After a period of trial and error, 20 percent became the standard downpayment for preconstruction commitments.

Though Norwood and Wireman both acknowledged that flipping is the fastest way -- at the moment -- to profit in the condo game, each said he urges buyers to close on condos, allowing the properties to appreciate for a few years before selling.

"If we've got all speculators, then we're going to have a problem," Norwood said. "Somebody's got to buy them, somebody's got to rent it, live in it, or use it as a second home."

Wireman said he reminds buyers with flipping on their minds that they pay regular income tax -- which for many high-end buyers is 42 percent -- if they don't hold their purchase for a year, after which any profits qualify for long-term capital gains tax breaks. A 42-percent levy reduces a profit of $98,000 to $56,840.

Hilty, the flipper, said he will sometimes hang on to a unit to take advantage of capital gains exceptions, and other times he'll take the hit and pay regular income tax on his profits. It all depends on the market, he said.

This long-term approach has proven lucrative, as owners of condos in Wireman's Caribe Resort can attest. "We've got units that have sold four to five times and every time people have made money," the developer said. "It's unbelievable."

Take unit 103, for example.

According to probate sales records compiled by Metro Market Trends, the completed three-bedroom, three-bathroom condo with a balcony view of Old River was sold by the developer on May 9, 2002, to a Point Clear woman for $295,000. The next day -- although the agreement could have been made months earlier, before the project was complete -- she sold it to a Baton Rouge , La. , couple for $380,000.

While the Point Clear woman pursed an $85,000 profit, the Louisiana couple, when they sold the condo four months later to another Baton Rouge couple for $475,000, reaped a profit of $95,000, according to the records.

And, as the sales history of unit 407 shows, more recent sales have yielded even greater profits:

During its initial offering in May 2002, two Gulf Shores women agreed to pay $399,000 for the northeast-facing unit. A year later the 2,102-square-foot condo was sold to an Orange Beach couple for $640,000. In mid-April, that couple resold the unit to a partnership that is registered in Georgia to members of a prominent Atmore family for $735,000.

In less than two years, unit 407 increased in value by 84 percent.

This trend has made its mark on the two unfinished Caribe towers and will likely push the price upward when condos in the fourth are offered.

Wireman said that units comparable to those that sold for about $244,000 in the first building were presold in the third -- which is more than a year away from completion -- for $550,000. All but a handful of the similar second-phase condos presold and some are reselling for $600,000.

On the Fort Morgan peninsula, values of the 656 units at The Beach Club have also soared. The average price per square foot rose 214 percent, from $176 to $552 between 1997 and June, according to the resort.

In one example culled from sales records, a 15th-floor unit in the development's Doral Tower was sold April 21 by a Birmingham couple to an Alpharetta, Ga. , couple for $554,100. The Georgia couple became the three-bedroom, three-bathroom condo's fourth owners since two men from Traverse City , Mich. , closed on it for $250,000 on Dec. 6, 1999, before it was ready to occupy. That same December day, according to records, the Michigan men sold it to a St. Louis couple for $282,400. The Michigan men, who collected a $32,400 profit, had owned the rights to the condo for about four months.

As a "realist," Norwood said, he's aware that the days of such rapid appreciation may be numbered. With several large-scale projects under way or planned, and many other smaller high-dollar developments selling out within minutes of being offered, the broker envisions values leveling off in a couple of years as supplies increase.

"It's getting pretty close because everybody's running down here talking about how much money they're making," he said.

The last time he heard so much talk about easy money was right before the bubble burst on tech stocks. The good news, Norwood said, is that with condos, unlike the stock market, "you won't wake up in the morning and lose half your value."

Later this summer, Wireman will begin selling the 400 $1-million units of his Turquoise Place project, which features two 27-story towers.

"I don't see anything but prices going up for three years," he said. "We don't average 500 new units a year, how could that catch up to demand?"

Wireman and other developers with projects on the table are banking that south Baldwin 's reputation as a diamond in the rough -- or as one banking source put it, "a fertile playground" -- continues to spread.

Escapehomes.com, an Internet firm that bills itself as a marketplace for second homes, recently ranked the Gulf Shores area as one of the top 10 waterfront second home markets in the country, alongside tony locales such as the Hamptons in New York and Maui , Hawaii .

Amanda Sturges, marketing director for the San Francisco firm, said that an increased number of inquiries about the area prompted the ranking. Among the inquisitive investors, she said, is her mother, who lives in Tampa , Fla.

Sturges said she told her mother: "You better hop on it, you're running out of time."