Sunday, January 16, 2005

Developers cash in by converting apartments to condos

By Kristina Shevory

Seattle Times Eastside business reporter

When vacancies started rising at Equity Residential's apartments two years ago, the company decided it was time to sell.

Just not apartments.

Equity instead started converting its aging rental apartments into condominiums and selling them back to tenants. The Chicago real estate developer converted around 400 rentals nationwide in 2002, 700 last year, and expects to do 1,400 in 2005. One of the country's largest apartment owners, Equity decided it could make more money cashing in some of its rentals instead of holding on to them.

In a sluggish rental market where vacancies top 7.4 percent, a growing number of real-estate investment trusts, developers and apartment owners are remodeling apartments and selling them as condos.

As a strong housing market, boosted by decades-low interest rates and looser lending practices, has turned renters into homebuyers, it has left apartment owners with more vacancies and less income.

Conversions allow developers to avoid the skyrocketing land prices and tight building requirements associated with new condos. They also help them avoid insurance or financing problems caused by a rising number of lawsuits filed over condo defects.

The number of apartment buildings sold for conversion to condos rose from 4,445 nationwide in 2001 to 44,957 last year, according to Real Capital Analytics, a commercial real-estate research and consulting company in New York.

Most condo conversions have been limited to cities like Miami, San Diego and Boston, but the trend is spreading to other cities across the country. From October 2001 to this past October, condo conversions in the Seattle area grew 2,900 percent to 1,500 projects, according to Dupre + Scott Apartment Advisors, a Seattle market research firm that tracks rental housing.

In other parts of the country, large developers with deep cash reserves control the rental market, but in the Seattle area, small, regional developers own many of the apartment complexes. Local firms usually have focused on small conversions with less than 100 units because they don't have the financial backing to do more.

The Eastside has drawn most of King County's conversions because apartment owners there have been eager to sell: The high-tech bust and resulting layoffs hammered the area and forced vacancies up. Large developers own many of the apartment buildings on the Eastside and have the money to invest in remodeling and converting large-scale complexes.

Mosaic Homes, which builds condos and townhomes, chose a 92-unit apartment complex in Kirkland for its first conversion. The Vancouver, B.C., developer expects to make money quicker than it would by building: It expects to renovate and sell converted apartments in less than three months. Building a new development would have taken 18 to 24 months.

In July, Mosaic bought the project for $10.8 million and is spending $2.3 million upgrading the 19-year-old complex. Three months later — after Mosaic replaced roofing and installed new siding, kitchen cabinets, appliances, fixtures and carpet in half of the buildings — condos at the Gallery went on the market in mid-October starting at $202,900. So far, 46 units have sold. The rest of the condos will be put up for sale as each building is remodeled.

"It's very difficult to build brand new product that's truly affordable," said Dave Kirzinger, managing partner at Mosaic Homes. "The market would like affordable homeownership, but with the high price of land, we can't sell (new housing) and still make a profit. With conversions, we can."

Conversions don't require as much effort as new construction. Builders usually don't have to file for development or land-use permits unless they're doing major construction work, like tearing down walls. They do have to offer the converted units to renters before they put them on the market. Around 10 percent of renters usually buy units, a point that helps developers market properties to prospective buyers.

Conversions offer developers another plus: Builders are generally liable only for the upgrade work they do on a conversion, not on the building itself. In the wake of so many condo-construction lawsuits, that has huge appeal for developers.

In the past year, competition among developers has heated up for apartment buildings to convert.

Pat Leach, executive vice president of income property at Homestreet Bank in Seattle, has been fielding more calls from real-estate investors looking for low-priced apartment buildings to buy, but she doesn't have a lot of candidates.

As the local economy has improved and unemployment has dropped, out-of-state investors have started eyeing Washington state.

"Seattle is now on the radar screen for outside investors," said Walter Braun, a partner at Mosaic. "There are more rental buyers now, and you have to be creative and outsmart other developers."

Not all apartments are good candidates for conversion. The best apartments to convert are those built in the 1920s and 1930s or those less than 20 years old. Anything else has dated architecture that can be tough to freshen up, said Warren Ballard, vice president at Williams Marketing, which helps builders market and sell converted condos. The company converted five projects in 2004 and hopes to do eight this year.

"We turned down a lot of (conversion projects) last year because of their price and location," Ballard said.

Complexes in good condition near Seattle are commanding high prices, with the average price per square foot rising 17.4 percent in one year to $101.96 in 2004, according to Cain Inc., a Seattle apartment brokerage and research firm.


Condos have remained popular, especially with first-time buyers leaving apartments, because they're cheaper than houses and have lower maintenance costs. The median price of a condo in 2004 in King County was $202,000 compared with $327,000 for a house. Converted apartments are usually cheaper than new condos and can be quite a deal for budget-conscious homebuyers.

"For a person who is extremely price sensitive, neighborhood sensitive and can't afford new construction, converted condos are a fantastic alternative," Ballard said.

Low prices are fueling an increase in condo sales. In King County, condo sales rose 17 percent to 9,216 units in 2004, up from 7,877 in 2003, according to the Northwest Multiple Listing Service.

David Hewitt and his wife, Marcia Wagoner, sold their house on Bainbridge Island and were renting a two-bedroom, two-bath apartment in Belltown when their 153-unit building converted a year ago. The couple bought a roomier two-bedroom, two-bath corner penthouse for $577,150.

"It's a fabulous situation," said Hewitt, who designed the four-year-old building. "We love the views, the building, and we can walk to work. Best of all, I get to live in my own work."

Although the rising number of conversions has been a boon for apartment owners and buyers, it could threaten the area's supply of rental housing at a time when developers are not building many new apartment buildings. Builders opened 1,921 apartments last year — the lowest level since 1973, according to Dupre + Scott.

Conversions could deplete the area's apartment stock and derail the rental market when the demand for apartments increases. That would push up make renting more expensive.