COVER STORY, JANUARY 2006

CURRENCY CONVERSION
Multifamily developers are changing rental dollars to for-sale profit through condominium conversions.
Patti Connor

Florida is the hottest condominium conversion market in the country and it includes MCZ/Centrum Developers' Parc Central East in Aventura.

From the Sunshine State to the nation's capital, multifamily developers, eager to capitalize on factors such as low interest rates, a swell in first-time homebuyers and the growing popularity of urban living, are wasting little time in buying all of the high-end rental communities they can get their hands on and converting them to pricey condominiums, complete with all the latest bells and whistles.

The rental-to-conversion trend appears unlikely to taper off anytime soon. Already, the Washington, D.C., metro area is experiencing a housing shortage of more than 43,000 units, according to George Mason University's Center for Regional Analysis. Furthermore, if current job and population growth continue as expected, by 2025 the area could come up short by a whopping 200,000 units.

Needless to say, area developers are hustling to do their part to fill the void. In the D.C. metro area alone, thousands of units are in the process of undergoing conversion and renovation. Some 47,000 condo units are in the pipeline to begin sales over the next 3 years.

What accounts for the huge demand for new and converted condos in D.C. and its surroundings? Along with the fact that the city boasts the lowest unemployment rate of any major metropolitan market in the country (3.5 percent in August 2005), the conversions' popularity can be traced to two equally significant factors: the availability of low-cost and creative financing, and a belief that real estate is a sound long-term investment, says Steve Schwat, principal of Urban Investment Partners/Drummond Development in Washington.

When it comes to creating the new dwellings, D.C. developers are pulling out all the stops. Although most of the conversion activity focuses on the older rental properties, developers are expanding their offerings to include former schools, hospitals, museums, hotels and industrial properties — just to name a few. Drummond Development is converting a former dormitory at American University, while Abdo Development is converting the historic former Capital Children's Museum into almost 100 luxury lofts.

Significant properties in the D.C. area that have undergone conversion during the past year include:

• Parkside at Alexandria, originally a rental community, by Mid-City Urban: 378 one- and two-level condominiums

• Parkside at Germantown, a former rental community, in Montgomery County, Maryland, also by Mid-City Urban

• 363 former garden apartments in Reston, Virginia, by WCI Communities and The Athena Group

How are conversions affecting the rental markets? According to Delta Associates, a Transwestern company that provides research for the commercial real estate industry, the sharp decrease in vacancy rates in the Class A apartment market in the D.C. metropolitan area has helped prevent apartment oversupply. To wit: vacancy rates were below 2 percent in mid-2005, lower than the previous year, the company reports.

In Middle Tennessee, condo conversions are enjoying moderate popularity, according to Scott Tyrone, leader of the multifamily division of Colliers Turley Martin Tucker in Nashville. "In the CBD, we're seeing older office, and in some cases, industrial buildings [undergoing conversion],” he says. "As you move away from the CBD, they're more likely to be either rental unit conversions or ground-up construction."

Most of the conversions are occurring within Nashville's inner core, also known as the West End/Downtown submarket. What accounts for the area's popularity? "State government, the growing number of students at Vanderbilt and Belmont universities, consumers looking for second homes, demand for urban living — all those factors have contributed," Tyrone says.

Three factors will contribute to the conversions' success, according to Tyrone: high barriers to entry, close proximity to a major employer and the price of surrounding single-family properties. "Ideally, you want to be in a neighborhood with high barriers to entry in terms of available reasonably priced land or the high cost of prospective conversion properties. You also want to be within a nominal commute to work. Lastly, you want to be surrounded by single-family homes with values in excess of what you're selling so as to not compete with the neighborhood while at the same time providing an affordable alternative," he explains.

As long as baby boomers continue to look for ways to simplify and downsize, he is confident that the condo market will remain strong. In Nashville, new conversions over the past year include:

• Fairsted Park: 37,215, 46 units

• Hillmont: 37,215, 120 units

• Montview: 37,221, 102 units

• Bennie Dillon: 86 units

• Werthan Lofts: renovation of manufacturing facility

• Kress Lofts: renovation of former retail building

• Exchange Lofts: renovation of an historic building

While some cities may expect to experience condo market saturation in the next year or two, D.C. and cities of comparable size should expect the high demand to continue for the next few years. Nowhere is that more true than Florida.

Since January,Tarragon Corporation's Florida division, an urban homebuilder specializing in the development and marketing of high-density residential communities, has purchased, at a price tag of more than $1 billion, approximately 20 apartment communities for conversion in Florida and South Carolina. “Currently, Florida's the strongest market in the country. We've done a lot of work down there, and we'll continue to do so,” says Michael Lerner, president of MCZ Development, based in Chicago.

The Condo Store is an Orlando, Florida-based specialty division that oversees condo developments from concept to closing. In Orlando alone, the company so far this year has sold out 20 condo projects, totaling about 5,800 units, for $1.5 billion, according to Mel Husney, the operation's vice president of business development.

“Condo conversions are attractive to developers because they are existing properties. All they have to do is perform a basic rehab program, execute a sales and market campaign, and sell the units. That's preferable to working through the process of new construction — purchasing land, hiring an architect to design/build, going through the zoning and permitting and the neighborhood approvals, construction bidding with contractors, constructing the buildings and then, finally, closing. Obviously, it's a lot easier to purchase an apartment complex and convert, which takes 6 to 12 months, than go through construction over a 2- to 3-year period,” Husney says.

The condo market should remain solid through the near future. “As Florida is popular both for vacation homes and resident relocation, I don't think the bubble is going to burst,” Husney says. “In light of its weather and strong economy, the (housing market) should continue to grow.”

Significant projects converted in the Orlando area in the past year include:

• Hamptons at MetroWest: a total of 752 units

• Central Park at MetroWest: 400 units

• Solaire (downtown Orlando): 306 units, 1,000 to 1,100 square feet

• Serenata-Midwest, Orlando

• Somerset Lake Mary, Sanford/Lake Mary

Richard Zahn is president of ZMG Corporation, an Orlando-based real estate company that is the development arm of Hersh Reconstruction Inc., a 20-year-old construction firm specializing in multifamily renovation. He sees the Orlando metroplex as one of the fastest-growing condo markets in the country. As reasons, he cites factors such as a diversified economy, migration into the state, and one of the lowest unemployment rates in the nation. In addition, “there [is] Orlando's central location and its accessibility to the rest of the state,” he says.

What types of properties are undergoing conversion? Most of the activity is occurring in the multifamily apartment communities, he says. As for how the conversions are affecting the rental and for-sale markets, “Due to nearly 15,000 units going through conversion, rental inventory is significantly reduced. Also, the multifamily apartment rental availability is shrinking,” he says.

When it comes to what factors help determine a particular building's suitability for conversion, a number of things come into play. First is location. “There are statutory condo requirements for structural, mechanical, electrical and plumbing as well as overall water tightness, school district and amenities,” says Zahn. Also playing a major part is a velocity, or achievable sales (weekly, monthly, etc.) projection. The properties' current net operating income and occupancy rate play heavily into the institutional lending component in the event of a possible failure of conversion.

As Steve Schwat points out, “A blank piece of paper and a shell are worth about the same since you have to do almost as much construction to complete either. The question is how many square feet you can sell, how much per square foot it will cost, and how much you can sell it for.”

In the Orlando area at least, Zahn thinks the trend over the coming year will probably flatten somewhat. “As lending institutions become more conservative, developers with less experience may fail to meet lending requirements. Overabundance of condo supply in the [market] may also contribute to the leveling-off effect.”

He is doubtful that the eventual increase in interest rates will dramatically impact future projects. “The main buyers of condominiums compare condo prices with that of entry-level single-detached home values,” Zahn explains. “As long as interest   rates increase the cost to consumers of entry-level housing, an increase in interest rates will have no effect on condominium affordability.” Eventually, of course, the two will catch up. “Once the price of condos rises to meet the price of entry-level single-family detached housing,” he says, “that's when the condo market will slow significantly.”  

What to Look Out for When Converting to Condominiums

Developers contemplating converting a project into for-sale communities should be on the lookout for the following:

• latent structural defects, water penetration issues, or wood destroying organism activity

• prior code violations or issues

• current litigation due to defects

• MEP (mechanical, electrical and plumbing) conditions

In addition, developers should have an understanding of the current owner's debt structure in order to avoid hidden buy down fees with a current lender.



©2006 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.




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