San Diego – Developer Leo Frey did something pretty extraordinary: He built a new apartment project when much of the multifamily industry here has focused on condominiums.
He joked that he might be a little crazy because apartments are tougher to pencil out than condo developments these days due to high land and construction costs. Still, Frey stuck with his vision of building a high-end rental project, believing he had the right location and product.
It might be a good move as San Diego is expected to be one of the top apartment markets in the nation in 2006. Condominium sales have also cooled down, which may help rental properties.
Frey’s new development is Allegro Towers, a stylish 201-unit mixed-use development in the Little Italy neighborhood of San Diego that boasts panoramic views of the city and the bay.
Allegro Towers features one- and two-bedroom apartments as well as penthouse units. Rents are about $2 to $3.50 a square foot. Units have granite countertops, high-end cabinetry, fireplaces and tile and marble floors. The roughly $80 million development also includes a fitness center and infinity pool on an eighth-floor deck.
The commercial tenants include a Rite Aid, a pet store, a dry cleaner and a communications business.
The development company, Allegro Ventures, even added a touch of flair with a decorative “fin” that tops the 29-story building.
Apartment developers like Frey have faced intense competition from the for-sale market recently. Frey, however, has no plans for converting Allegro Towers, which has leased all of its 85 one-bedroom units, into condominiums.
His decision comes at a time when many market experts predict a strong year for San Diego. Healthy renter demand and expanding job growth will keep the city a top performer in 2006, according to Marcus & Millichap Real Estate Investment Brokerage Co., which ranked San Diego fourth in its national apartment index.
Overall, developers are expected to add 2,600 units in 2006, reversing a trend of declining completions, said the real estate brokerage firm. About 2,100 units were delivered in 2005. Employers are predicted to add 36,000 jobs this year.
Several leading multifamily residential firms, including JPI, see San Diego as a key market.
“JPI is actively pursuing investment opportunities in downtown San Diego as part of their urban infill investment strategy throughout California and its other core markets in its West division (Seattle, Phoenix, and Denver),” said Stephen Dominiak, JPI divisional president and managing partner. “JPI’s depth of experience in developing and constructing high-density urban infill projects, including high-rise, lends itself to the opportunities in downtown San Diego. Additionally, JPI’s Western division is based in San Diego, making it a very important market for growth.”
The San Diego County Apartment Association (SDCAA) reports that the vacancy rate is about 4.4%. The countywide average rent was $1,063 for all unit types, according to SDCAA’s most recent survey.
“The demand for rental housing will remain strong relative to other markets around the nation,” said SDCAA Executive Director Robert Pinnegar. “The rental market will continue to see a cooling in the overall housing demand, holding rent growth to the rate of inflation. However, operating expenses will continue to increase annually beyond the consumer price index.”
Marcus & Millichap forecasts San Diego rents to grow by about 5.5% in 2006.
Riding the condo wave
The San Diego market has been so hot recently that the Hard Rock Hotel organization is developing its first branded condo-hotel in the Gaslamp Quarter.
It’s not yet completed, but the project is already showing plenty of attitude. The construction site boosts edgy banners reflective of the company’s image.
“Hard Rock Hotels selected San Diego as the site for its first condo-hotel project, first and foremost, because it’s one of the most vital urban real estate markets in the country and we are eager to have our brand represented there,” said Trevor Horwell, vice president, Hard Rock Hotels. “Furthermore, the region where our property will be located, the Gaslamp Quarter, is ideal for a condo-hotel due to its energy and proximity to the heart of the city’s offerings.”
Scheduled to open in spring 2007, the Hard Rock will feature 420 rooms and suites. The units will range from 320-square-foot studios to 1,500-square-foot “rock star” suites, with prices starting in the $400,000 range.
Aimed at a hip, urban crowd, the suites will have modern furniture, an entertainment center, CD/DVD and iPod connections and a martini bar, according to a recent press release.
The tide, however, appears to be turning in the coastal town.
“We’re seeing things change rapidly,” said Jim Taylor, senior vice president at Sperry Van Ness, noting that cap rates that were about 5.42% in early 2005 dropped to 4.82% by the end of the year.
Taylor also noted that the “feeding frenzy” of condo converters began cooling last fall. A slowdown in the condo market could have implications for rental property owners and developers.
“The condo converters are moving on to those other markets that still have an ample supply of low-lying fruit to pick from,” said SDCAA’s Pinnegar. “The resulting slowdown in the condo-conversion market will have its most immediate short-range impact on the value of multifamily housing. The current return on investment on the average priced rental unit is in the range of 2% or 3% annually. To encourage investment, something has to give, so at least in the short run we expect some cooling until the market adjusts to normal conditions.”
Over the long haul, the investment potential for San Diego rentals looks good, according to Pinnegar. “A limited supply of available land is forcing new units into highly regulated urbanized areas,” he said. “The result is higher development costs per square foot that demand rents above current levels.”
Building materials costs, and the expense of trucking materials to San Diego, have become a growing issue for developers. Some experts report the costs being 5% or more higher than other areas of Southern California.
One of the areas with the most construction activity is the downtown submarket. Petco Park, the new home of the San Diego Padres, has had a huge impact on the area.
There are more than 11,000 homes under construction or planned in the downtown area, according to the Centre City Development Corp. (CCDC), a public, nonprofit corporation created by the city to work on downtown redevelopment. Nancy Graham, former mayor of West Palm Beach, Fla., recently became the organization’s president.
CCDC reports that there are more than 9,000 condos and another 2,400 apartments under construction, approved or pending approval. About 4,100 hotel rooms are also in the works downtown.
Douglas Wilson, chairman and CEO of the Douglas Wilson Cos., is one of the key players redeveloping downtown with his residential projects.
Petco Park, he said, has spurred the revitalization of an area that needed a lift. In addition, it created interest in urban living.
Wilson estimates that there’s been about a billion and a half dollars in recent investment in the area, including housing, hotels and retail. It’s a far cry from the warehouses that Wilson remembers sitting in the area some 20 years ago.
When the ballpark designs were unveiled, Wilson noticed that the park would provide terrific views of the city as it stretched out beyond center field. He began looking for opportunities in the neighborhood. He built the nearby Parkloft, which features 111 condominium units and nine penthouses. Valued at about $60 million, the development, which was the first for-sale project in East Village, is sold out.
He is working on the $155 million The Mark, which will have 220 one- and two-bedroom condominiums, 13 penthouses and 11 townhomes. At 33 stories, it will be the tallest building in East Village and will be completed in 2007.
“Overall, the market is very good,” he said. “It began to soften around the middle of last year, but a slowdown to a more normal pace is a healthy, healthy trend.”
Despite the market adjustment, Wilson said he is still seeing good demand and absorption at his properties. “It was pretty hyperactive for the last three years, so it’s nice to press the pause button a little.”
Wilson said he is very pleased with sales at The Mark. He reports that 165 of the 200 units that have been released have been sold. Units start around $400,000 and go to a whopping $4 million.
In general, he finances his projects with the help of his equity partner, Lehman Bros. Bank financing is used for the construction loans.
Development of The Mark is under way, and Wilson locked in his construction costs about 20 months ago. But, developers who are starting projects today will find the road tougher as prices continue to rise.
One of Wilson’s concerns is financing because costs are a bit unknown today. He is starting to notice some tightening on the construction lending side. “Lenders are a little skeptical,” he said “They don’t want firm commitments up before costs are determined. But, so do I.”
While many residential developers have their sights set on downtown, developer Bruce Leidenberger has focused his attention on the Uptown neighborhood, where he will have two condo developments opening in 2006 – the 12-unit Monde and the 37-unit Deca. Some larger projects are in the pipeline.
The projects are being developed by UP, Inc., a subsidiary of his La Jolla Pacific Development Group, Inc.
Leidenberger likes the Uptown district because it already has a sense of community, with established restaurants and neighborhood services.
As the market cools, location is going to be more important in 2006, he said.
One of the touches that he likes to add to his developments is large outdoor living areas. “Our philosophy is people come to San Diego to enjoy the outdoors,” he said. As a result, he tries to provide as large a deck and balcony as possible.
Like Wilson, Leidenberger said that a market adjustment isn’t necessarily bad. There haven’t been any major price decreases, and in the long run, it makes for a better market as everyone is more careful, he said
But, when it comes to financing, developers are starting to see a change in attitude, according to Leidenberger. “There’s a more conservative approach to valuation of the projects and the underwriting standards,” he said. He also said it’s become a little more difficult to find loans that allow developers to hold a property while they are going through the entitlement process.
Conversions get tougher
San Diego officials have been working on tightening the rules for converting apartments into condominiums.
Regulations approved in January are aimed at providing full disclosure of a property’s condition. Converters would also be required to replace roofs and other “integral” components of a building if its remaining life is five or fewer years. The San Diego Union-Tribune reported in January that there are more than 270 projects accounting for 8,350 apartment units being reviewed for conversion.
City officials are expected to consider even tougher regulations this year. A lawsuit was filed against the city claiming that conversion projects had been given the go-ahead without environmental reviews.