Nearly 22,000 condominiums are going up and planned in South Florida, and the appetite for pre-construction condos is pushing sale prices to pre-recession heights. The history of Florida real estate booms proves that this surge of activity will inevitably end. The question is how damaging a market correction would be this time around. Real estate is one of our region’s main economy drivers, and the answer to that question has a bearing on all businesses tied to the real estate industry – from general contractors and architects, to furniture companies and home décor stores.

Fortunately, market dynamics this cycle indicate that local businesses will experience a softer landing when this boom comes to a close.

The last market correction obliterated some businesses – including developers, construction trades and real estate brokerage companies — and depressed property values to unthinkable levels. Once buyers disappeared from the marketplace, many developers lost their newly built towers to their construction lenders. This time around a large majority of condo buyers are foreigners so their ability to invest money in South Florida is directly related to their country’s economy. That factor makes our condo market riskier and more unpredictable when it comes to their ability to continue making future deposit payments to sustain completion of construction. But having said that, a market correction this time around shouldn’t be as destructive as it was in the last bust.

The upside about this cycle is that developers are financing the bulk of their condo construction with buyer deposits, which amount to about 50 percent of the purchase price. The buyers are required to pay portions of the deposits as the construction progresses. As a result, the first sign of a market correction would appear when buyers begin missing deposit payments.  When that happens, an important source of construction financing will dry up. Yet, developers will have choices to cure the problem, unlike most of them in the last cycle. This time, thanks to the fat deposits, developers should have enough equity built into their projects to be able to secure a construction loan from a conventional or hard money lender to compensate for the lost deposits. They would also have the option to stop or slow down the construction, unlike in the last cycle when developers had to adhere to a construction schedule to meet loan payment deadlines required by their lenders. 

If deposits begin to dry up, lenders would be motivated to finance the balance of the construction cost because of the equity in the projects. On the down side, that equity could become an incentive for non-institutional construction lenders, such as hedge funds or hard money lenders, to foreclose faster than in the last cycle. To them, the equity-rich projects could be viewed as a loan to own windfall. They would force a sale of the project that would result in the lender taking title or recovering payment of all of its loan, including default interest and fees.

But the best option developers will have this time around is the opportunity to seek protection in the bankruptcy court to block foreclosure and obtain financing to complete construction.

Don’t get me wrong. In the event of a foreclosure, condo buyers will have the right to assert liens for their deposits. But most likely, they would not be as organized as a traditional construction lender to voice their claims in a bankruptcy. For that reason, projects would be perceived to have enough equity to attract lenders willing to restructure a project’s construction debt by making loans in the Chapter 11 or by providing financing for the developer to exit bankruptcy.  In the last bust, condo projects were mostly built with debt and any equity the developer had in the project was quickly wiped out by a drastic drop in property values, leaving little or no room for debt restructuring in a bankruptcy.

In my view, the new wave of condo construction, especially in Miami’s urban core and along the South Florida’s shores, may bring back memories – and fears – of the last boom-and-bust. However, the consequences of a market correction won’t be as paralyzing for businesses tied to the real estate and construction industries as it was from 2007 to 2012. Thanks to the new condo deposit structure, developers will have ways to cure any absence of deposit payments.