Low Interest Rates Driving Condo Conversion Market

"Apartment owners, struggling with less than stellar rental increases and [also with] increasing operating expenses of real estate taxes and property insurance, are finding it much easier to sell to a condo converter, or convert themselves to take advantage of the higher profits," Todd F. Cohen, manager, Income Property Capital Group in the local office of Atlanta-based Primary Capital Advisors, tells GlobeSt.com.

Cohen has arranged financing for about $100 million in condo conversion in the past 12 months, he says. He has three pending deals, all expected to close by year end--a 200-unit class A luxury apartment property; a 250-unit class B apartment property; and a 225-unit class C multifamily property.

"All are being financed at very attractive rates which make the projects feasible to sell quick and cheap," Cohen says. "For condo conversions, we are able to obtain financing starting at around 3.75%, depending on the leverage and equity coming into the deal. And with 30-year mortgage rates still very much below 6%, or 4.5% for a five-year balloon, all things come together to be able to sell the units at an affordable price."

A failure in the 1970s and 1980s, largely because of 15% mortgage rates, condo conversions in Florida have shot up from 848 units in 2000 to 7,304 units so far in 2004, an 862% increase, according to new data from locally based Smith Equities Corp., a statewide multifamily property brokerage.

"The movement to convert newer class A and B units in the past two years" is evident in Smith Equities' numbers for 2003 and 2004, broker Michael Deree, who has converted apartment units in Michigan and Florida over the past 25 years, tells GlobeSt.com.

In 2003, of the 213 apartment properties sold statewide, 19 condo conversions contained 3,961 total units; 38% were older units, 62% newer units. In 2004, of the 113 apartment complexes sold to date, 7,304 units were converted at 25 properties; 29% were older units, 71% newer units.

"Some developers are even converting units as they come out of the ground at construction, after anticipating renting them in their original plans," Deree says. "Many older properties in prime locations have been converted already if the economics are workable."

In some instances, however, they are not. "Many of these [apartment] properties are REIT-owned which are precluded from converting to condos because of their funding structures," Tony Martin, vice president at Tarragon South Development in Orlando, tells GlobeSt.com. "However, they can sell for a substantial profit, which is what they are doing on behalf of their investors."

Martin adds, "The condo conversion craze has hit Florida because this is where people are moving to find work. The younger generation works and plays hard and finds the 'urban lifestyle' attractive. They don't want to take time to garden, deal with the roof when a storm hits, meet service people during office hours and so on. There is no one at home, so the busy professional finds condo living a great answer."But how does a condo converter value an existing apartment property?

"Condo converters are under-air, price-per-sf-driven and rely primarily on the current for-sale market in the immediate area of the property," Sean Williams, vice president, Apartment Realty Advisors, Boca Raton, FL, tells GlobeSt.com.

"Once the 'sell-out' per-air-conditioned-sf-price is determined, converters will apply their profit margin, taking into consideration any capital expenditures that may be required for the property," Williams says. "This dependency on air-conditioned-sf is why we always encourage our clients to have their units professionally measured."

The broker says "any deviation in size can result in significant price adjustments during the due diligence phase." Additionally, "converters apply a rent-versus-buy analysis as sort of a checks and balance to their market underwriting," Williams says. "Typically, a converter will target a sale price where the end user's mortgage payment, including taxes and insurance, is within $100 of their current rent net of any rental concessions."

He adds, "a converter can expect between 10% to 20% of the rental pool to buy a unit." Other physical considerations include the unit mix, total number of units, and unit and property amenities.

From 2003 through year-to-date 2004, Apartment Realty Advisors has closed or has pending over $700 million in transaction volume to 13 condo converters representing 16 properties totaling over 5,000 units, according to Williams.

"In today's rate environment, condo conversions make plenty of sense," Primary Capital's Cohen says. "First and foremost is the still very low-end user mortgage rates under 6% for a 30-year mortgage. Fannie [Mae] and Freddie [Mac] keep on raising their conventional mortgage limits, which now, at around $340,000, include some of the more expensive condos that previously had to have the premium rate quotes."

Cohen adds "the biggest challenge for most first-time home/condo buyers is saving up enough money for a down payment." But "due to newer financing options, it's possible to find mortgages for as much as 97% loan to value."

A successful tool Primary Capital has found for converters is refinancing existing apartment loans to condo loans simultaneously with the conversion to condominiums. "That saves closing and transfer costs," Cohen says.

Additionally, "a refinance allows the owner to stay in the deal and bring in partners with the experience to maximize the profits for a piece of the deal," the mortgage banker tells GlobeSt.com.

For example, Cohen says, "with an apartment that is generating $250,000 in net cash flow annually after payment of expenses and debt services, and worth around $10 million to an apartment owner on the open market--if that property was a condo conversion candidate, and he sold the condos for, say $20 million, he would pocket a significant amount of profits."

Smith Equities' Deree concludes, "In all cases, the surge in household formations and population growth in Florida provides a strong market for condos at low and high-end pricing. As always, location is paramount."

Deree notes "the strength of the conversion business has even shown a shift in the past two years from the major metro markets into the secondary markets, away from the coasts. Condos are becoming desirable anywhere housing arts are growing in the state, not just in the traditional high-density cities."