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King Condo is dead. Long live the king. But will Condo's successor, Prince Rental, fill the gap in the multifamily housing market?

January 01, 2008 |


Delancey at Shirlington, the 241-unit apartment component of a mixed-use

development in Arlington, Va., by The Bozzuto Group, exemplifies current

mid-rise rental construction in the Washington, D.C., metro market. PHOTO: THE BOZZUTO GROUP

L et's see, anything new in the housing market since our report of a year ago? Nothing much. Just the complete collapse of the single-family market, thanks to the subprime mortgage debacle. Just hundreds of thousands of homeowners facing foreclosure. Just lenders in complete disarray, not to mention the threat of a recession.

So, where to begin this year's look at the multifamily industry? Let's start with our old friend, the condominium. With apologies to the gentleman from Hannibal, Mo., reports of the death of the condo are not greatly exaggerated. True, some condo projects already in the works are still moving ahead, particularly in pockets like Boston, Chicago, Los Angeles, New York, and Seattle. But sales velocity is slow, and the climate for condos, unlike that of the rest of the planet, has definitely cooled.

Gone are the days when a speculator could put down a pittance on a condo in Vegas or Florida, watch it rise meteorically in value, then flip it at a huge profit. Johnny-come-lately speculators are either stuck with their luxurious 2BR white elephants, or desperately trying to rent them at bargain-basement rates in the so-called “shadow market” of condo “reversions,” whose numbers may range in the hundreds of thousands nationwide.

  Delancey at Shirlington PHOTO: THE BOZZUTO GROUP  
  Delancey at Shirlington PHOTO: THE BOZZUTO GROUP  
  Delancey at Shirlington PHOTO: THE BOZZUTO GROUP  

Thus, today's reality: Any real estate developer who proposes a new condo deal to a lender is likely to be fitted for a straightjacket.

If condo development is down, that would seem to imply that rental apartment construction would be up, but that's not necessarily the case, says Rachel Drew, a researcher at Harvard's Joint Center for Housing Studies. The bulging inventory of single-family homes and condo reversions is suppressing apartment construction, over and above the usual problems developers have in obtaining land, getting entitlements, and overcoming “not in my backyard” antagonism toward apartment projects, says Drew.

Moreover, rental vacancy rates are rising, according to the JCHS's Eric Belsky. And the National Multi Housing Council's Market Tightness Index, which measures the direction of rental conditions (a reading below 50 indicates that conditions are worsening), slipped to 46 last October, the first sub-50 reading in 17 quarters.

“The underlying demand for apartment residencies has changed little over the last six months,” NMHC chief economist Mark Obrinsky stated last October 30. “As long as the job market holds up, demand conditions should remain favorable.” But Obrinsky said that the recent credit crunch had taken a toll on the apartment market. Many transactions had to be postponed, he reported, and “the volume of activity slowed.”

Despite all the cautionary signs, there are some souls out there courageous enough to give apartment development a go. Let's meet a few of them.

Rental's true believers

One such brave soul, Tom Bozzuto, is of the opinion that “the apartment side is thriving right now.” Bozzuto, CEO of The Bozzuto Group, Greenbelt, Md., does $200 million a year in housing construction (60% of it for other developers) and manages 21,000 units in the Washington, D.C., metro area. The firm has a $100 million equity fund in place with NYSTERS, the New York State teacher pension fund.

Current projects—all with NYSTERS backing—include a mixed-use development in Arlington, Va. (241 apartments above a Harris Teeter grocery store); the residential portion of a shopping center in Fairfax, Va.; and a transit-oriented development at the University of Baltimore. The Arbors at Arundel Preserve, a recently completed $65 million project in Hanover, Md., with 500 apartments, is already three-fourths leased.

Bozzuto has also gone the condo conversion route. In the fall of 2005, he launched Tuscany condominiums in Alexandria, Va.; after a year, he had only 17 buyers. He returned their deposits, found an equity partner, and completed the project as a rental last fall. The complex is 35% leased.

“The apartment market has been absolutely fantastic,” says Bozzuto, named Executive of the Year by Multifamily Executive Magazine and winner of numerous “NAHB Pillars of the Industry” Awards. “In '05 and '06, there were no new apartments being built, and home prices were going up so high that people were struggling to buy. The market has softened a bit, but we look on that as a temporary phenomenon.”

Bozzuto believes that the overall supply of housing in the D.C. area—both condos and single-family homes—will “work through” in six months or so, and metro D.C. rentals will do well. “When you look at Generation Y getting out of college, apartment market fundamentals are going to be very strong for the next decade,” he says. “Wherever there's a strong job market, there will be a strong apartment market. Long-term, apartments are a terrific business.”

Another true believer in apartments is John Christie. “I think the fundamentals for apartments are positive,” says Christie, senior director of investor relations and research for AvalonBay Communities, the nation's second-largest multifamily REIT ($1.7 billion under construction, with 52,000 units in its fold), based in Alexandria, Va. “We're seeing rental supply returning to normal levels, with no oversupply just yet.”

Christie pegs his positive outlook on several factors: “At the beginning of '07, we had expected that job growth and our rental revenue growth would decelerate somewhat, and the fundamentals would moderate over the course of the year,” he says. “That has played out, and our rental rate growth last quarter [Q3/07] was 5% year to year, which is pretty healthy.” He also sees the “echo boomer” market as ripe for apartments. “They're at an age which has the highest propensity to rent,” he says.

Growth markets for AvalonBay are Boston; California; Seattle; and Long Island City (Queens) and Brooklyn, N.Y. “We have a $5 billion investment in New York City,” he says. AvalonBay is looking for sites close to or on transit lines. On the West Coast, the REIT is partnering with Whole Foods and Safeway on mixed-use projects.

AvalonBay recently put together its first deal in Chicago, where a developer's plans to build three condo towers in the South Loop fell through. AvalonBay picked up the fully entitled land at a “significant discount” and will build 984 rental units in two towers, a $280 million job. The REIT has also purchased partially developed single-family sites from homebuilder D.R. Horton Inc. in Anaheim and San Diego and will put up 411 apartments. “We stretched a little to get in, but our strategy is to extend our penetration” into the California market, says Christie.

“Over the next 12-18 months, we probably will see construction costs starting to moderate, some continued declines in land prices, and slower job growth, but the demographics are in our favor,” he says.

Yet another disciple of the rental creed is Greg Lamb, EVP of developer and property management firm JPI, McLean, Va. With backing from General Electric Capital Services, JPI made what Lamb calls “a substantial land acquisition play” in Capitol Yards, site of the new Washington Nationals Ballpark.

JPI has four projects in Capitol Yards: The Jefferson (twin towers, 448 apartments) and the Mercury (246 units), both scheduled to open this summer; The 909, at 909 New Jersey Avenue (237 units, 6,000 sf of retail space, mid-'09 delivery); and Jefferson Half Street (421 units, 15,000 sf of retail, breaking ground this year). The level of investment, $470 million, will quickly create a critical mass that, with other office and retail development under way around the ballpark, will transform this old industrial/warehouse district into a thriving new residential neighborhood in Southeast Washington, says Lamb.

“There's a flight to quality,” he says. “Well-capitalized sponsors will succeed. It's going to require partnership, and we've got GE on our side. Well-capitalized, fact-based companies that understand what it costs to build a project are going to stick around.” JPI is even finishing a condo project, Jenkins Row in Capitol Hill, 247 units atop a Harris Teeter store, near a Metro station. “There are condo buyers out there, but they're being more selective,” he says.

“I think we're in a temporary condition [in multifamily housing] where liquidity is challenged, both equity and debt,” says Lamb. “We'll come out of it as the subprime situation is evaluated. It may be a little bit of a tough year, but there are going to be opportunities in '08, and we're looking forward to that.”

Dark shadows in the Sun Belt

Condos are “dead as a doornail” in the Sun Belt, says Steve Patterson, president/CEO of Orlando-based ZOM USA. The self-described “boutique regional merchant builder” of 15,000 multifamily units converted 3,000 apartments to for-sale units in '04-'05 but will stick to rentals for a while.

“There's already a correction taking place,” he says. “Home ownership peaked at 70% in 2006. We expect that the ratio of renters to homeowners will find equilibrium. It usually costs 20% more to own than to rent, but it's been 35%, and in some markets like D.C. it was 80%, so that will have to correct. The majority of the people [in mortgage trouble] came out of a rental scenario, and they'll go back to rental.”

But Patterson worries about the fundamentals of the rental market. “It's a narrow-margin business,” he says. “The costs to build and the operating costs are so high. Prices are going up 40% and incomes are up only 3%. That's not a good thing.”

One way to address costs is to make the units smaller: 1,000-1,100 sf may work for 1-3BR units in Washington, D.C., but make them 800-900 sf in Florida or Texas. “I can strip out the granite tops and the stainless-steel appliances, but you start hitting a wall” in how much you can cut to bring rental prices in line, he says. “You're going to see a lot of wood frame,” he adds, because heavy-frame concrete and steel structures will only work in first-tier cities, close to downtown.

Access to capital has also become a constraint. ZOM would like to ramp up in Houston, Dallas, and Austin, but “we're getting fewer deals than we want to do,” says Patterson. Still, conditions are right to forge ahead—the building trades are available, construction costs are relatively flat, and the rising cost of oil has been taken into account. “This is the time to be building,” he says.

The apartment game is getting rougher, says Tom Bartelmo, president and CEO of J.I. Kislak Inc., Miami Lakes, Fla., which owns and operates apartment projects in Florida, Texas, Arizona, and Nevada. “The rental market is terribly efficient,” he says. “There's not as many mom-and-pops as there used to be, and there's a lot of capital in the space and that has driven the cap rates way down. You have 20 people bidding on a property in a blind auction.”

Bartelmo says he has no regrets that he didn't buy any properties in '07 because “the fundamentals in Las Vegas and Florida are down.” Las Vegas has 11,000 vacant single-family homes alone, he says, while South Florida has 20,000-40,000 housing units in the pipeline for delivery in the next 12 months. “What I hear from developers is that if they get enough sales, they'll try to build out slowly and sell them over time.”

Toughing it out in condo

At least one major developer, Fifield Realty Corp., is still in the condo market. The 42-story, 428-unit Allure Las Vegas, which started construction in late 2005, is 95% sold. A 283-unit in Hallandale Beach, Fla., is 100% sold, but it's almost a year late and not all the contracts have been closed.

“Is condo dead? No, but it's hurting,” says Fifield president Rick Cavenaugh, who is reducing his firm's condo exposure. Fifield sold 1200 Club View, a 22-story “uber-luxury” project overlooking the Los Angeles Country Club, to Emaar Properties of Dubai for $100 million; word is the new owners plan to make the 35 condos even more “luxe.” Fifield is also under contract to sell its 41-story, 397-unit Californian on Rincon Hill property in San Francisco to a London firm.

For apartments, Fifield likes its home base, Chicago, where it has 2,400 apartment units planned or up and running in five “K Station” towers in trendy River North. These include the Left Bank at K Station, a 37-story, 451-unit apartment building on the Chicago River, and 353 N. Des Plaines at K Station, a 350-unit tower scheduled for completion later this year.

Looking ahead, Fifield's Cavenaugh wisely prescribes caution: “Getting deals started is harder than ever. Be selective. Focus on deals that are fundamentally sound, that can weather a potentially difficult marketplace.”

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