Condos Continue to Capture Investor Interest
Condos Continue to Capture Investor Interest
By Teresa O'Dea Hein, Senior Writer
NOVEMBER 01, 2005 --Washington, D.C. -- Condo-mania continues virtually unabated in many U.S. markets. "The condominium boom is really spread out around the country -- it's no longer predominantly on the East Coast and West Coast markets," says Robert Sheehan, consulting economist for the National Apartment Association (NAA).
While local condo markets vary, investment activity in all of them is predicated on interest rates, job growth and worry of possible over-supply. A big factor in the increased popularity of condominiums has been lifestyle changes," believes Richard B. Swartz, managing director and principal at Sonnenblick-Goldman Co., N.Y.
Empty nesters who sell homes in high-end suburbs are moving into high-rise, downtown condo buildings to enjoy the low maintenance as well as the amenities and services of urban living, as are young professionals. For this reason, experts report, even downtown Orlando, Fla. has taken off, with a recent development selling out in days on a pre-construction basis.
Indeed, this lifestyle trend is even showing up in secondary and tertiary marketplaces, according to another national industry observer. For example, Chattanooga, Tenn. is seeing significant revitalization along its riverfront that has generated demand in downtown condos.
Sheehan notes that in this current development cycle, there is even some condo activity in markets like Oklahoma City, Okla., Louisville, Ky., Indianapolis, Dayton, Ohio, and Kansas City. And this high-density, urban-style development is being seen both in typical city areas and in suburban downtowns in northern Virginia cities like Reston, Rockville, Tysons Corner and Shirlington, many of which are also convenient to mass transit. Even once-suburban southern California cities like Santa Ana and Anaheim are considering planning applications for high-rises.
Investor Demand
"Investors, not resident-owners, are driving the condo market today," points out Richard Campo, chairman and CEO of Camden Property Trust, Houston. Some reportedly even purchase condos they haven't seen, or ones that are only in the design stage. Furthermore, a number of analysts divide those investors between long-term investors and speculators interested in quickly flipping a property, even before it's built.
Compounding this is the fact that more and more unsophisticated property owners have gotten into the condo market, report a number of observers. They are not experienced landlords and may not have adequately capitalized themselves in case they cannot rent a unit(s) or can't rent it for the amount they'd planned on. "A lot of people don't really understand the true costs of owning property," Campo explains.
Are we at the peak of the market? "While we're definitely not at the bottom, it's a question of how late in the day it is for new investors," Campo notes. He figures that the market in general is perhaps in the 9 to 11 PM timeframe. "People can still make money, but it's risky."
Both Campo and Zanda Lynn, a managing director at Fitch Ratings, New York, point out that markets where it's difficult to build -- known as "high-barrier markets," such as Washington, D.C., New York, southern California and Boston -- are a little less vulnerable to market declines because condo inventories are tighter.
Market Forecasts
David Seiders, chief economist with the National Association of Home Builders (NAHB), says, "Overall, there currently does seem to be good momentum in the condo market." However, Seiders predicts that the Federal Reserve's ongoing increases in the federal funds rate will start flattening out housing activity in all sectors in 2006.
Both the homeownership rate and the rental vacancy rates peaked in the first half of last year, Seiders reports, so he's seeing an improvement in the multifamily rental sector. In fact, he expects to see a change in the balance of condo units vs. rental properties. Seiders thinks that repeated interest rate hikes as well as pricing pressures could take a toll on condo markets in some areas in 2006. However, he adds, locational advantages and strong regional economies can override those concerns.
Where risk shows up on the demand side is on the lower-priced condos, says Ron Witten, president of Witten Advisors LLC, Dallas. He believes this is due to a slowdown in buying by low-end renters as interest rates hit 6 percent.
Analysts at Fitch Ratings do not believe that the current pace of condo conversions is sustainable, especially if and when interest rates rise and markets become overbuilt. A June 2005 Fitch Ratings report, entitled, "The Condo Conversion Market: Heating Up or Over-Heated," predicted that about 10 percent of all condo conversion loans originated this year will ultimately default over the next three to five years.
This compares poorly to a default rate of only two percent of all multifamily loans originated this year (though as interest rates rise, Fitch expects that rate to go up as well).
Lynn points out that while they are concerned about the condo market across the U.S. in general, it is different issues from market to market that trouble Fitch Ratings in particular. For example, Lynn says, "We wonder if all the supply coming into the south Florida market is sustainable over time."
"We approach the condo conversion market with caution," warns Dina Treanor, director. In the Fitch report, Treanor and Lynn pointed out that there are three types of risk that Fitch assesses when evaluating a condo conversion project. These are condo/renovation risk, conversion stage risk and market risk.
Hot U.S. markets like Washington, D.C., south Florida and Las Vegas continue to report a high level of activity. However, industry observers state that some price retrenchment is beginning to be felt in the still-active Washington, D.C. region.
Due to the limited supply of land and continuing job growth and immigration, Witten doesn't see a huge overhang from condo product that's actually started construction. "The risk is in the deals that are in pre-sales," he believes. "Condos have more or less squeezed out the rental market."
Capital Results
"The D.C. market is absolutely booming," reports Witten, who's less concerned about the D.C. metro market because the multi-family building rate there has stayed relatively consistent. Also, he adds, the market is the number-one job producer in the country, with professional and business serves spurred on by government spending and high prices for single-family homes.
With its ongoing rise in the number of new residents, activity in the Washington, D.C. condo market has been just "capital." Observers add that Washington has been the darling of institutional investors and the capital markets.
However, "while the Washington, D.C. market has a very strong economy and continued job growth, there are concerns regarding the level of supply in the pipeline," reports Swartz. He believes investors and lenders will stick it out in the D.C. market, though perhaps not for the profit levels they'd expected.
"It there's a perception of abundant supply, buyers are more likely to wait to see the finished condominium rather than committing before it's built," adds Swartz. "You see pre-sales drop off in a slowing market."
An October 2005 report on the metro D.C. apartment market by Marcus & Millichap revealed that in the first half of 2005, 943 units were purchased for conversion to condominium. They joined another 378 units that were similarly removed from the rental market in 2004. In the last month or two, Sheehan adds, "the greater Washington D.C. area market has shown signs of beginning to cool, but there are a lot of properties in the pipeline.
"Over the last two years, prices here went up by 250 percent," Sheehan reports, "and are now starting to back off. Condos are staying on the market longer and we're seeing listings that are now priced off the peak prices," he says. "And investors aren't able to rent their units for what they expected, so they're not necessarily covering their costs. They're relying on appreciation."
Half or more of the recent condo sales were to investors, according to Sheehan. Washington, D.C. is a very strong economy, being a leader in job creation with many people moving in every month. "There was a bust before, but it won't happen again," Sheehan believes, "because there are too many jobs being created and too many people moving in. The federal government is pumping money into defense spending and disaster relief, spurring on business services." Sheehan predicts, "The market may flatten out for a while but ultimately it will adjust itself."
In the next three years, about 47,000 units in dozens of projects are slated to hit the market in the D.C. area, according to a report from Delta Associates, an Alexandria, Va. real estate firm. Furthermore, Delta says, this amount is five times as many units as were sold last year.
Betting on the Vegas Market
Real estate experts believe the usual economic concerns are mitigated in Las Vegas and south Florida by the steady influx of international buyers, whose purchases are made more attractive by the dollar's current weakness. Judging from its unprecedented population growth over the past two decades that continues to escalate, the Vegas housing market might seem like a safe bet.
"Vegas is a very misunderstood market," Campo maintains. "Of course, the tourism market is huge there," he continues. "People buy a condo to put in a rental or time share pool and use a few times a year. Lots of Asians and Europeans buy there, along with people priced out of the California market or Californians who want to get away from that state's traffic-clogged freeways."
While Vegas is definitely casino-driven, Campo notes that a little over 60 percent of the city's economy is involved in other businesses. And since Vegas has a better road infrastructure than Phoenix and more favorable tax laws, Campo says that Western distribution center and credit card calling operations, for example, find it a good base for their operations.
What's happening in Vegas is that the prices of single-family homes have doubled in the last three years. Even though there is a lot of land in the desert, there is not much infrastructure, such as water pipelines and treatment plants, Campo points out. Consequently, the inventory of buildable land has declined.
As a result of the high job growth and high demand, prices have gone up, Campo reports, in the classic equation of supply and demand. While that rapid price escalation may make people worry, Campo says, it is still low compared to neighboring California, so residents of the Golden State who cannot afford to enter their own high-priced California housing market continue to move in.
In Las Vegas, Witten is seeing a build-up of inventory in owner-occupied property.
"It's hard to predict the depth of the Las Vegas condo market," notes Swartz, "because who could have ever predicted the huge levels of the current tourism economy there?"
International Buyers
International buyers are a wild card in the Las Vegas market as they are in the Florida market. Besides Asians and Europeans, Australians are also big spenders. In fact, Australians were the largest foreign investors in the U.S. in 2004-05, spending $6.8 billion (U.S.) on American real estate, according to the research firm, Real Capital Analytics.
Since there is not a lot of research and years' worth of data on the subject of international buying patterns, "the levels of buyer demand from markets from Europe and Asia are hard to predict," reports Swartz. Plus, many buyers also come from other states, especially California.
Within the last six months, nearly 4,000 units in Las Vegas were purchased to convert to condos at a median price of over $100,000 per unit, according to an October 2005 report from Marcus & Millichap.
Speculating on the Future
"South Florida marches to the beat of a different drummer," Campo notes. "Miami is the capital of South America, with Latin American investors escaping volatile Latin American economies and/or governments.
"Miami is very hot, with the international buyers coming again, Sheehan agrees. [For more on the Miami market, see the Market Report: Forecast Remains Sunny for Florida Markets.]
A lot of what will happen in the south Florida market depends on investor sentiment, adds one industry observer. A new real estate web site, CondoFlip.com, estimates 80 percent of buyers of the 65,000 new condo units currently in development in the Miami area are likely to be investors or speculators, which raises eyebrows among some industry experts.
CondoFlip.com was developed by Mark Zilbert, president and managing broker of Zilbert Realty Group, Miami Beach, Fla. He recently was interviewed on a national TV news magazine about this patent-pending web site, designed to help buyers flip pre-construction condos. While he's first launching it for Florida markets, Zilbert hopes to have a Las Vegas edition up and running by early 2006, and then take it national.
Flipping is one of the warning signs of an overheated market, warns a real estate veteran. To deal with speculative activity, developers and banks are now trying to limit, for example, how many condos an investor can buy in a specific building.
Supply in general is "probably the most finicky part of the market's health," says Campo. How many condos can the investor-owners buy and hold? There's a huge number of transactions in the pipeline in a number of markets. For example, the Miami Downtown Development Authority reports that 60 construction projects, comprising about 14,134 residential units, were under construction as of July 31.
And when do rising interest rates drive investors out of the condo market? A danger sign, Campo reports, is the fact that there are a lot of inexperienced condo investors. A lot of them are not sophisticated landlords, he adds, and may not be able to lease the units they own or to lease them for the results they'd hoped for, creating negative cash flows. Furthermore, Campo adds, not every condo investor may have adequately factored in all the carrying costs associated with the units. "A lot of people do not really understand the costs of owning and maintaining investment property or cannot really afford it."
Weaker Markets
Areas where the price of a single-family home is lower in price make it tougher for condominiums to compete in general. Developments that find success in those markets, experts report, usually offer some distinctive advantages in lifestyle or amenities.
Witten sees a greater supply risk overall in Atlanta than in south Florida, and points out that the Atlanta economy is growing more slowly than it had in past years -- job losses from 2002 and 2003 haven't been reversed as quickly. There also continues to be an above-average vacancy rate in Atlanta's apartment market, he adds. Specifically, while Atlanta saw a 2 percent vacancy rate over the last 10 years, that rate has jumped up to 3 and 3.5 percent in the last few quarters. "The Atlanta market has firmed up a bit but is not all the way back."
Sheehan sees market weakness in Minneapolis, where both rentals and condos were slow last year. It's now strengthening slightly, he says. "There had been a lot of activity there and then it cooled as the growth rate slowed."
Fitch Ratings' Lynn reports that, generally, they are more concerned about condos in tertiary markets like Columbus, Ohio and Kansas City, Mo. But, the housing industry has proven resilient in the face of recent increases in interest rates, so it remains to be seen how the next round of anticipated hikes will impact it.
In the end, however, "good-quality product that meets the market's needs is successful in almost every market," Swartz concludes. "Developers need to build on good parcels and use conservative financing to keep themselves prepared for any market downturns."
By Teresa O'Dea Hein, Senior Writer
NOVEMBER 01, 2005 --
While local condo markets vary, investment activity in all of them is predicated on interest rates, job growth and worry of possible over-supply. A big factor in the increased popularity of condominiums has been lifestyle changes," believes Richard B. Swartz, managing director and principal at Sonnenblick-Goldman Co., N.Y.
Empty nesters who sell homes in high-end suburbs are moving into high-rise, downtown condo buildings to enjoy the low maintenance as well as the amenities and services of urban living, as are young professionals. For this reason, experts report, even downtown Orlando, Fla. has taken off, with a recent development selling out in days on a pre-construction basis.
Indeed, this lifestyle trend is even showing up in secondary and tertiary marketplaces, according to another national industry observer. For example, Chattanooga, Tenn. is seeing significant revitalization along its riverfront that has generated demand in downtown condos.
Sheehan notes that in this current development cycle, there is even some condo activity in markets like Oklahoma City, Okla., Louisville, Ky., Indianapolis, Dayton, Ohio, and Kansas City. And this high-density, urban-style development is being seen both in typical city areas and in suburban downtowns in northern Virginia cities like Reston, Rockville, Tysons Corner and Shirlington, many of which are also convenient to mass transit. Even once-suburban southern California cities like Santa Ana and Anaheim are considering planning applications for high-rises.
Investor Demand
"Investors, not resident-owners, are driving the condo market today," points out Richard Campo, chairman and CEO of Camden Property Trust, Houston. Some reportedly even purchase condos they haven't seen, or ones that are only in the design stage. Furthermore, a number of analysts divide those investors between long-term investors and speculators interested in quickly flipping a property, even before it's built.
Compounding this is the fact that more and more unsophisticated property owners have gotten into the condo market, report a number of observers. They are not experienced landlords and may not have adequately capitalized themselves in case they cannot rent a unit(s) or can't rent it for the amount they'd planned on. "A lot of people don't really understand the true costs of owning property," Campo explains.
Are we at the peak of the market? "While we're definitely not at the bottom, it's a question of how late in the day it is for new investors," Campo notes. He figures that the market in general is perhaps in the 9 to 11 PM timeframe. "People can still make money, but it's risky."
Both Campo and Zanda Lynn, a managing director at Fitch Ratings, New York, point out that markets where it's difficult to build -- known as "high-barrier markets," such as Washington, D.C., New York, southern California and Boston -- are a little less vulnerable to market declines because condo inventories are tighter.
Market Forecasts
David Seiders, chief economist with the National Association of Home Builders (NAHB), says, "Overall, there currently does seem to be good momentum in the condo market." However, Seiders predicts that the Federal Reserve's ongoing increases in the federal funds rate will start flattening out housing activity in all sectors in 2006.
Both the homeownership rate and the rental vacancy rates peaked in the first half of last year, Seiders reports, so he's seeing an improvement in the multifamily rental sector. In fact, he expects to see a change in the balance of condo units vs. rental properties. Seiders thinks that repeated interest rate hikes as well as pricing pressures could take a toll on condo markets in some areas in 2006. However, he adds, locational advantages and strong regional economies can override those concerns.
Where risk shows up on the demand side is on the lower-priced condos, says Ron Witten, president of Witten Advisors LLC, Dallas. He believes this is due to a slowdown in buying by low-end renters as interest rates hit 6 percent.
Analysts at Fitch Ratings do not believe that the current pace of condo conversions is sustainable, especially if and when interest rates rise and markets become overbuilt. A June 2005 Fitch Ratings report, entitled, "The Condo Conversion Market: Heating Up or Over-Heated," predicted that about 10 percent of all condo conversion loans originated this year will ultimately default over the next three to five years.
This compares poorly to a default rate of only two percent of all multifamily loans originated this year (though as interest rates rise, Fitch expects that rate to go up as well).
Lynn points out that while they are concerned about the condo market across the U.S. in general, it is different issues from market to market that trouble Fitch Ratings in particular. For example, Lynn says, "We wonder if all the supply coming into the south Florida market is sustainable over time."
"We approach the condo conversion market with caution," warns Dina Treanor, director. In the Fitch report, Treanor and Lynn pointed out that there are three types of risk that Fitch assesses when evaluating a condo conversion project. These are condo/renovation risk, conversion stage risk and market risk.
Hot U.S. markets like Washington, D.C., south Florida and Las Vegas continue to report a high level of activity. However, industry observers state that some price retrenchment is beginning to be felt in the still-active Washington, D.C. region.
Due to the limited supply of land and continuing job growth and immigration, Witten doesn't see a huge overhang from condo product that's actually started construction. "The risk is in the deals that are in pre-sales," he believes. "Condos have more or less squeezed out the rental market."
Capital Results
"The D.C. market is absolutely booming," reports Witten, who's less concerned about the D.C. metro market because the multi-family building rate there has stayed relatively consistent. Also, he adds, the market is the number-one job producer in the country, with professional and business serves spurred on by government spending and high prices for single-family homes.
With its ongoing rise in the number of new residents, activity in the Washington, D.C. condo market has been just "capital." Observers add that Washington has been the darling of institutional investors and the capital markets.
However, "while the Washington, D.C. market has a very strong economy and continued job growth, there are concerns regarding the level of supply in the pipeline," reports Swartz. He believes investors and lenders will stick it out in the D.C. market, though perhaps not for the profit levels they'd expected.
"It there's a perception of abundant supply, buyers are more likely to wait to see the finished condominium rather than committing before it's built," adds Swartz. "You see pre-sales drop off in a slowing market."
An October 2005 report on the metro D.C. apartment market by Marcus & Millichap revealed that in the first half of 2005, 943 units were purchased for conversion to condominium. They joined another 378 units that were similarly removed from the rental market in 2004. In the last month or two, Sheehan adds, "the greater Washington D.C. area market has shown signs of beginning to cool, but there are a lot of properties in the pipeline.
"Over the last two years, prices here went up by 250 percent," Sheehan reports, "and are now starting to back off. Condos are staying on the market longer and we're seeing listings that are now priced off the peak prices," he says. "And investors aren't able to rent their units for what they expected, so they're not necessarily covering their costs. They're relying on appreciation."
Half or more of the recent condo sales were to investors, according to Sheehan. Washington, D.C. is a very strong economy, being a leader in job creation with many people moving in every month. "There was a bust before, but it won't happen again," Sheehan believes, "because there are too many jobs being created and too many people moving in. The federal government is pumping money into defense spending and disaster relief, spurring on business services." Sheehan predicts, "The market may flatten out for a while but ultimately it will adjust itself."
In the next three years, about 47,000 units in dozens of projects are slated to hit the market in the D.C. area, according to a report from Delta Associates, an Alexandria, Va. real estate firm. Furthermore, Delta says, this amount is five times as many units as were sold last year.
Betting on the Vegas Market
Real estate experts believe the usual economic concerns are mitigated in Las Vegas and south Florida by the steady influx of international buyers, whose purchases are made more attractive by the dollar's current weakness. Judging from its unprecedented population growth over the past two decades that continues to escalate, the Vegas housing market might seem like a safe bet.
"Vegas is a very misunderstood market," Campo maintains. "Of course, the tourism market is huge there," he continues. "People buy a condo to put in a rental or time share pool and use a few times a year. Lots of Asians and Europeans buy there, along with people priced out of the California market or Californians who want to get away from that state's traffic-clogged freeways."
While Vegas is definitely casino-driven, Campo notes that a little over 60 percent of the city's economy is involved in other businesses. And since Vegas has a better road infrastructure than Phoenix and more favorable tax laws, Campo says that Western distribution center and credit card calling operations, for example, find it a good base for their operations.
What's happening in Vegas is that the prices of single-family homes have doubled in the last three years. Even though there is a lot of land in the desert, there is not much infrastructure, such as water pipelines and treatment plants, Campo points out. Consequently, the inventory of buildable land has declined.
As a result of the high job growth and high demand, prices have gone up, Campo reports, in the classic equation of supply and demand. While that rapid price escalation may make people worry, Campo says, it is still low compared to neighboring California, so residents of the Golden State who cannot afford to enter their own high-priced California housing market continue to move in.
In Las Vegas, Witten is seeing a build-up of inventory in owner-occupied property.
"It's hard to predict the depth of the Las Vegas condo market," notes Swartz, "because who could have ever predicted the huge levels of the current tourism economy there?"
International Buyers
International buyers are a wild card in the Las Vegas market as they are in the Florida market. Besides Asians and Europeans, Australians are also big spenders. In fact, Australians were the largest foreign investors in the U.S. in 2004-05, spending $6.8 billion (U.S.) on American real estate, according to the research firm, Real Capital Analytics.
Since there is not a lot of research and years' worth of data on the subject of international buying patterns, "the levels of buyer demand from markets from Europe and Asia are hard to predict," reports Swartz. Plus, many buyers also come from other states, especially California.
Within the last six months, nearly 4,000 units in Las Vegas were purchased to convert to condos at a median price of over $100,000 per unit, according to an October 2005 report from Marcus & Millichap.
Speculating on the Future
"South Florida marches to the beat of a different drummer," Campo notes. "Miami is the capital of South America, with Latin American investors escaping volatile Latin American economies and/or governments.
"Miami is very hot, with the international buyers coming again, Sheehan agrees. [For more on the Miami market, see the Market Report: Forecast Remains Sunny for Florida Markets.]
A lot of what will happen in the south Florida market depends on investor sentiment, adds one industry observer. A new real estate web site, CondoFlip.com, estimates 80 percent of buyers of the 65,000 new condo units currently in development in the Miami area are likely to be investors or speculators, which raises eyebrows among some industry experts.
CondoFlip.com was developed by Mark Zilbert, president and managing broker of Zilbert Realty Group, Miami Beach, Fla. He recently was interviewed on a national TV news magazine about this patent-pending web site, designed to help buyers flip pre-construction condos. While he's first launching it for Florida markets, Zilbert hopes to have a Las Vegas edition up and running by early 2006, and then take it national.
Flipping is one of the warning signs of an overheated market, warns a real estate veteran. To deal with speculative activity, developers and banks are now trying to limit, for example, how many condos an investor can buy in a specific building.
Supply in general is "probably the most finicky part of the market's health," says Campo. How many condos can the investor-owners buy and hold? There's a huge number of transactions in the pipeline in a number of markets. For example, the Miami Downtown Development Authority reports that 60 construction projects, comprising about 14,134 residential units, were under construction as of July 31.
And when do rising interest rates drive investors out of the condo market? A danger sign, Campo reports, is the fact that there are a lot of inexperienced condo investors. A lot of them are not sophisticated landlords, he adds, and may not be able to lease the units they own or to lease them for the results they'd hoped for, creating negative cash flows. Furthermore, Campo adds, not every condo investor may have adequately factored in all the carrying costs associated with the units. "A lot of people do not really understand the costs of owning and maintaining investment property or cannot really afford it."
Weaker Markets
Areas where the price of a single-family home is lower in price make it tougher for condominiums to compete in general. Developments that find success in those markets, experts report, usually offer some distinctive advantages in lifestyle or amenities.
Witten sees a greater supply risk overall in Atlanta than in south Florida, and points out that the Atlanta economy is growing more slowly than it had in past years -- job losses from 2002 and 2003 haven't been reversed as quickly. There also continues to be an above-average vacancy rate in Atlanta's apartment market, he adds. Specifically, while Atlanta saw a 2 percent vacancy rate over the last 10 years, that rate has jumped up to 3 and 3.5 percent in the last few quarters. "The Atlanta market has firmed up a bit but is not all the way back."
Sheehan sees market weakness in Minneapolis, where both rentals and condos were slow last year. It's now strengthening slightly, he says. "There had been a lot of activity there and then it cooled as the growth rate slowed."
Fitch Ratings' Lynn reports that, generally, they are more concerned about condos in tertiary markets like Columbus, Ohio and Kansas City, Mo. But, the housing industry has proven resilient in the face of recent increases in interest rates, so it remains to be seen how the next round of anticipated hikes will impact it.
In the end, however, "good-quality product that meets the market's needs is successful in almost every market," Swartz concludes. "Developers need to build on good parcels and use conservative financing to keep themselves prepared for any market downturns."
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