Condo Market Freeze Causes Multifamily Sales to Hit Brakes

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By Jillian S. Ambroz

The multifamily investment sales market is slowing down after a fierce run-up that was fueled largely by condominium converters.

But interest in rental properties remains strong and is expected to strengthen.

The month of May marked the first time in five years that the sector saw a decline in sales deals for two consecutive months. About $3.8 billion in apartment sales closed in May - a 30 percent drop from a year ago, according to Real Capital Analytics. For the year so far, the market has seen a 14 percent increase in sales. But that can be attributed to several REIT mergers and portfolio acquisitions.

The condo-conversion market has become downright frigid. The number of units selling for conversions is off by more than 90 percent from the peak in September 2005 when 111 properties totaling 27,784 units sold for a total of just over $4 billion, according to Real Capital, a New York research firm.

By comparison, May saw 19 properties with 2,706 units slated for conversion trade for a total of $334.3 million. That's a nearly 50 percent plummet from April, when 25 properties sold for a combined $655.8 million.

"The condo craze has quietly come to a virtual halt," Jay Massirman, a vice chairman with CB Richard Ellis' multifamily group in Miami, said. "There are some projects that are still viable, but many of the investors and speculators have backed off the market."

There are a lot of reasons for the sea change. Perhaps the biggest is lackluster consumer demand for units. Other reasons include higher interest rates, which have had a big impact on converters' ability to go through with their proposed projects as well as consumers' ability to finance the purchase of units; higher insurance and construction costs.

The condo craze in Florida began about five years ago. The drop-off started about five months ago in cities like Miami and Ft. Lauderdale, Rosendo Caveiro, a director with Cushman & Wakefield's Miami office, said.

The Florida market is looking at some 60,000 units statewide that are in some mode of condo conversion, Massirman said. Some of those could end up becoming for-rent apartments. Others simply won't be completed.

Lenders have become far more stringent in providing debt. "If they do loan money for building new luxury condos, the developer will not have to just provide reservations, they'll want contracts with real money," Caveiro said.

Meanwhile, high construction costs have put a damper on the development of new rental projects, in Florida and elsewehere.

In the first quarter, 11,221 units were completed, according to Reis, down from 21,637 a year ago. Meanwhile, 14,351 units were converted to condos. That compares with 25,770 units that were converted a year ago. The result is that the nationwide inventory has stayed flat at 8.9 million units.

So the national vacancy rate has improved, to 5.6 percent in the second quarter from 6.4 percent last year, according to Reis.

The average national effective rent grew to $936/unit in the second quarter, a roughly 4.5 percent increase from a year ago, according to Reis Inc.

So investors remain hot for rental properties.

Take San Francisco, which is still in recovery mode. Not too long ago, properties with condo maps in place were a hot commodity. That's no longer the case.

"The yield threshold for the converter has gone up substantially," said Phil Saglimbeni, a broker with Marcus & Millichap's Palo Alto, Calif., office. "The apartment guys are getting the deals. There's more perceived risk in selling to converters," he said.

Archstone-Smith, for example, has been among those actively pursuing rental properties. It just acquired a 322-unit complex in Fremont, Calif., for $79.6 million. It also paid $120 million for the Key West apartments in Manhattan and $165 million for the Marlborough House in Manhattan. Both New York deals were brokered by Douglas Harmon of Eastdil Secured.

"Any drift apparent in cap rates since the beginning of the year for solid conversion candidates has been almost entirely offset by increasing rental rates, and a broader and deeper worldwide appetite for large, stable, rental properties or portfolios," Harmon said. He added that high-end condo opportunities "have not lost any of their luster," while the "the condominium bloom fades from the rose of more pedestrian rental properties."

In New York, rents are higher and have increased even more than elsewhere in the country. Rents stood at $2,370/sf in the first quarter, up 6.2 percent from the same period a year earlier.

"New York rents have exploded," said Richard Bassuk, president of The Singer & Bassuk Organization, a Manhattan mortgage broker.

So lenders, which have become conservative when it comes to financing condo deals, are aggressive when courting rental transactions. "Lenders are willing to finance a much broader spectrum of developers doing residential rental development," Bassuk said. "This willingness to provide financing for rental projects has caused many developers to re-evaluate their plans to see whether once again residential rental development is attractive."