COVER STORY, SEPTEMBER 2005

RENTAL INVENTORY DWINDLES IN A SELLERS’ MARKET
Changes in the multifamily residential management industry provide new opportunities for property managers.
Patti Harris

Harris

Through April 2005, sales of apartment communities totaled more than $20 billion nationally, 64 percent ahead of last year’s pace, which was a record year. Approximately 30 percent of apartment development sales were to condominium converters across the country.

South Florida — a Supercharged Example for the Southeast

In South Florida, approximately 90 percent of apartment development sales were to condominium converters. These conversions have caused the existing inventory of apartments to drop, with about 37,800 multifamily units removed from the rental pool since 2002. Miami-Dade County, for example, suffered the greatest loss with 12,150 units converted to condos in 2004.

The leading multifamily buyers in South Florida — Monroe, Miami-Dade, Broward and Palm Beach counties — are Crescent Height Investments, The Chetrit Group, Prestige Builders, The Related Companies and The Bradford Group.  Leading sellers are Archstone-Smith, Fairfield Residential, Altman Development and the Fifteen Group.

Naturally, this sales environment has created a dwindling supply of rental communities, affecting management and service-related companies, which derive their revenues from providing management services for owners and investors. This declining level of business activity and related revenues for the apartment management industry will lead to company re-organization. This unfortunately includes “right” sizing overhead management structures and layoffs of on-site personnel when apartment rental communities are sold and converted to condominium properties.

One thing is apparent — just as the number of apartment units is declining, the number of condominium units are on the rise proportionately. Companies that are able to embrace the changing real estate market and modify the product type that they manage will be able to ride the wave and potentially capitalize on new business opportunities.

It is easy to understand why rental property owners are ready and willing to sell to converters and why converters sell to individual condominium owners. The rental property owners make substantial capital gains on projects that they couldn’t duplicate in 5 years or more of continued rental operations. Converters can make more than 50 percent gross gains by selling off the individual apartments, even over the enhanced prices that they have to pay the rental property owners.

So far the transactions appear to be win-win situations as the buyers have purchased the converted units in droves. This could change as the affordable conversion market has had two main characteristics — low interest rate mortgages for buyers and investors seeking tenants in rental-carry-over situations. Higher interest rates, increasing real estate taxes based upon the current values and climbing condo maintenance fees could serve to decrease the investor mania. Many developers will be deterred by the bidding wars on the few good properties left for conversion.

Investors Looking to Shelter Investments

The continuing volatile and unpredictable stock market conditions previously had forced the larger institutional investors to place larger amounts of capital into real estate investment portfolios rather than taking risks with stock investment strategies. This investment strategy was sound until the condo converters started to pay unprecedented prices for typical garden-style apartment communities. The multifamily sellers have included the entire gambit of owners. The typical  “institutional” owners, such as life insurance companies, pension funds, capital advisors, and smaller, private developers and owners all have followed the trend in selling their rental property developments to condominium converters for better than anticipated returns.

Continuing low interest rate environments and plentiful bank loans have spurred first-time homebuyers into buying rather than renting. These low mortgage rates allow robust residential sales to continue and have an overall positive affect on the economy. However, this has continued to produce a negative affect upon the multifamily industry. The lower interest rate environments coupled with unprecedented real estate appreciation, in key markets, have spurred investors to purchase condominium units. Investors now represent close to 23 percent of the home-buying public, about two times the historical average. Residential investments, according to Business Week, absorbed 5.8 percent of the gross domestic product, the highest level since the 1940s.

Consumer-Friendly Mortgages Help Landlords Cash Out

Lenders are fueling the home buying with an array of lending products that call for lower down payments. In 2001, just 1.6 percent of new U.S. mortgages were interest-only loans. In 2004, 34 percent were interest-only loans. In hot condo markets, banks are issuing letters of credit to high-income buyers and investors are using letters of credit for down payments on un-built condos.

Buyers and investors are attracted to conversions because they’re freed from tying up cash reserves for an extended period of time. Developers embrace conversions as they enable developers to meet the requirements of construction financing of having pre-sold 60 percent of the units prior to construction.

Traditional apartment developers are having a difficult time getting their apartment deals to underwrite, as the land costs are too high. The land costs are being inflated by condominium developers, which are paying top dollar for land knowing that the sales price of their condominium units will justify their increased land cost. Therefore, new rental community development is at an all-time low; very few units are being introduced into the marketplace.

Where is the Market Heading?

The downside of this conversion trend is: What happens if values decline, the economy recedes further and the housing bubble bursts?

Such an occurrence conceivably could send the economy into a tailspin. The shock waves would ripple across all sectors of the economy. So, the most important question is: Are there enough end users for the number of condominiums that are being sold? The answer to this will determine if hot markets, such as South Florida, are facing an upcoming oversupply of condominiums. There are a lot of investors placing deposits and strategizing on flipping the units quickly for a profit. With the large supply of condominiums entering the market, as either new construction or as conversions, the big question will be if there are enough end users that can afford the unit’s total expense, either as owners or renters. 

How are Property Management Companies Adapting?

After the condominium craze has crested, developers and investors again will look to long-term rental communities to provide long-term stable investment growth and diversification of real estate product type. The management companies that have survived will again be presented with opportunity.

Change in the real estate market is inevitable and has demonstrated over time that it will ebb and flow in various cycles. The ability to recognize market trends and to adapt your company to reap the potential benefits and increased opportunity is key. Today and tomorrow’s opportunities will be realized by visionary executives and artful management teams who can make an ally and commit to designing a creative and targeted strategy to maximize the benefits of adapting to change. 

Factors that should be considered when designing a company’s plan to evolve with change are: current and upcoming market demands, company’s strengths and weaknesses, the competition and the company’s limitations including capital constraints, personnel and company diversity, and flexibility. The creative change process includes:

• Acceptance that change is appropriate and necessary for the company to thrive (remain competitive, productive and profitable).

• Development of a strategic business plan that outlines the evolutionary steps.

• Definition of what your company will look like, who you will be when you get there.

• Getting everyone on board, belief in the plan, measures of success and commitment.

• A evolutionary “Miller Time” where the key facilitators of change get to celebrate and participate in the financial rewards of successful organizational change.

Generally, challenging times like these afford opportunities for those property managers willing to retrofit and refine service modules to suit shifting market trends. Carpe Diem and keep ahead of the curve.

Patti Harris is executive vice president of operations with The Altman Management.

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