Doomsday Scenarios: Could Condo Prices Fall to Zero?

Why not? Certainly condo prices aren’t going to approach $0 in most markets or on a national basis. But given the right set of local conditions, it is entirely possible that some condo prices could fall to a nominal value functionally equivalent to nothing.

Free condos huh? Does it sound too good to be true? That’s because it is. Costless condo purchases would be far from free, which is exactly what creates the possibility that prices could fall so low.

The first myth of homeownership in the United States is that you actually “own” your house or condo. U.S. homeowners have residual rights to their properties as long as the more senior claimants receive their recurring pound of flesh.

This concept is an obvious one for mortgage holders. “Owners” borrow a sum of money from a lender and are allowed to continue to “own” their property as long as the mortgage debt is serviced and repaid according to the terms of the borrowing agreement. We presently see large numbers of people losing houses that they supposedly “owned” because they can’t pay their mortgages. The question is why these people with little, no or negative equity actually believed that they “owned” the houses in which they lived?

Now let’s assume that a homeowner paid off his mortgage or bought his house with cash. That homeowner would truly “own” his house right? True, except that most houses are subject to property taxes. In such markets, homeowners supposedly own their houses, yet are required to cut a check to the government for the right to stay in it. And unlike a mortgage payment, this is a perpetual liability. Even worse, fickle governments can decide to increase your perpetual homeowner liability at their leisure. (As an aside, how safe is the residual equity value of your home if a government can raise taxes to a confiscatory level at their discretion?)

One of many disadvantages that condo owners have to home owners is that they are also junior in ownership rights to their condo owner associations. Condo owners must pay monthly dues for maintenance, insurance, security, etc… These fees are perpetual and contractually required.

If you don’t believe that condo owners have only residual equity rights and are fourth in line in terms of seniority, imagine what would happen if such an individual decided not to pay their mortgage, condo association fees or property taxes? How long would this owner continue to have a legal claim to the property? Not long.

How do you actually own something that can be legally taken away from you if you don’t perpetually pay for the right to keep it? In reality, homeowners more closely resemble serfs beholding to the government, condo associations and lenders who will kick them off of their land if sufficient tribute is not paid.

Additionally, houses generally have a price floor relative to condo values for a variety of reasons. Houses tend to be more heterogeneous than condos. Homeowners have exclusive property rights to their land and thus the opportunity to use the house or land for alternative purposes. A house is a single ownership unit, so if an owner wanted to sell the property to a developer or develop it himself, the process would be relatively simple.

A condo owner has rights only to a few hundred or thousand square feet of space within a building. Condo ownership doesn’t come with any claim to land, and all control of the remaining facilities are owned and controlled by the condo association. It is for this reason that, until the Housing Bubble began, condos always traded at relative discounts to equivalent houses.

This brings us to the question at hand. Could condo prices fall to zero? Given the right conditions such values could indeed fall to nothing. This does not mean that the condos would be free. Owning a condo comes with the laundry list of financial obligations and liabilities which we discussed above.

Imagine a condo with $1,000 a month in condo fees and $6,000 in annual property taxes? (these are hypothetical numbers designed to illustrate a point) If you were to purchase such a condo for $1, ownership of the unit would still be costly. The free unit would cost $1,500 a month.

Now what happens in markets with the following conditions that may come to exist in places like Miami:

• The supply of condo units dramatically outstrips demand
• A large backlog of units for sale exists
• Credit terms are tight or relatively expensive
• Property values have been falling for years, are presently falling and are expected to continue to fall

In such a market, what would happen if the cost of renting an equivalent unit falls below the $1,500 a month necessary to service condo ownership expenses? What if real estate prices are expected to continue to fall, people refuse to buy assets or borrow money due to rampant price deflation, or unemployment rises so high that there are insufficient potential buyers to assume ownership of all for sale units? Why would anyone pay for the right to purchase a condo only to be required to pay monthly taxes/maintenance expenses in excess of what it would cost to rent the same unit across the hall?

With this framework of understanding, it becomes hypothetically possible that condo prices could actually fall to less than zero. Negative real estate prices!

A potential buyer may decide that perpetually paying condo fees and taxes that are in excess of the market price of comparable rental units isn’t a good idea. Theoretically an owner might be willing to pay a potential “buyer” to take a condo off his hands simply to remove the perpetual liabilities attached to the unit. In such a case, the buyer would require compensation to assume the perpetual liabilities.

This is obviously a highly theoretical potentiality. I am not arguing that it is likely. Furthermore, there are numerous factors, such as the availability of distressed asset investors, which would likely put a floor on condo prices above $0. But if the economy gets bad enough, house prices continue to collapse, deflation becomes prevalent, unemployment expands and financing for investors dries up, the potential for condo prices to fall to previously unimaginable lows will materialize.