Hot Spot: South Florida

Thanks to the robust housing demand driven by favorable demographic trends, condo conversions are the big story in the South Florida market and are capturing much of the area's attention. The Fort Lauderdale, Miami, and West Palm Beach metros have a population exceeding 5.3 million people, and households are expanding by 2.7 percent annually–a trend that pushed vacancy rates down and rents up in 2005. This growth, along with a positive economic outlook for South Florida, is attracting real estate investment capital from both local and out-of-state buyers, whose keen interest in the area continues to drive prices higher. So long as these trends continue with both owners and developers, it will help smooth out the apartment market's supply/demand balance over the long term.

Conversion Rate

Strong job and population growth make South Florida a highly attractive market for investors, renters, and condo buyers. In Aventura, Fla., the 20-story tower (below) now known as Parc Central East was acquired in 2005 for converting to condos.

The condo conversion trend remains rampant in South Florida, where a potent combination of low interest rates and the widening affordability gap between rents and mortgage payments helps maintain condos' popularity with both owners and investors.

First-time homebuyers clamor for condos as an accessible way to enter the market. Luxury condos attract well-paid, young professionals who desire an urban lifestyle as well as retirees seeking to downsize. The weakened dollar also attracts foreign investors to U.S. real estate, including condos, for both investment and personal use.

On the investment front, the condo trend allows long-time apartment owners to cash out at high returns, but condo converters are pushing prices on targeted assets out of the range of income-oriented investors. Once interest rates trend up, the condo play will be less desirable for both developers and prospective home buyers.

Troy Campbell

Credit: Corbis

Contrary to initial impressions, the onslaught of condo conversions will not have dire consequences for local owners and investors. While renters who take the plunge into homeownership do drain the tenant pool, properties being converted will reduce the apartment inventory. For example, more than 10,700 South Florida apartments were removed from stock in 2005, and a significant portion–if not all–of the amount is attributable to condo conversions. In Miami alone, approximately 5,400 units were removed from the apartment market, including 1,845 units in North Miami Beach. Fort Lauderdale lost more than 2,500 rental units to conversion. It leaves fewer apartments in South Florida for more renters, a supply-and-demand situation that should result in higher rents for owners and managers.

In terms of property sales, conversion deals accounted for a larger portion of transactions in West Palm Beach as the dollar volume of deals in West Palm Beach soared in 2005. The current median price of $151,000 per unit for condo deals represents a 60 percent premium for the West Palm Beach submarket to the median price for all transactions in the county. Demographically, West Palm Beach appears to be a prime condo market as the rate of homeownership and median household income are the highest among the three South Florida metros. For these reasons, conversion deals may become an even larger share of the West Palm Beach submarket in 2006.

Beach Appeal

Credit: Roy Wiemann

Employment growth continues to drive demand for multifamily housing in South Florida. Fort Lauderdale is expected to gain 32,000 positions in 2006, a 4.2 percent increase. Gains will be led by the construction and professional and business services sectors.

In West Palm Beach, forecasts call for 3.8 percent employment growth, with strong gains in the educational and health services sector, which will boost demand for apartments. Miami's employment is forecast to grow 2 percent, or 21,000 positions.

Credit: Ted Rausch

Several South Florida markets are attracting capital from both local and out-of-state investors. A large share of multifamily construction is in Palm Beach County, due to the availability of land and the area's prospects for growth. The West Palm Beach metro has become a hub for cutting-edge bioscience and medical technology industries, which will attract well educated, higher-paid workers. Asset prices reflect this investor demand: Sales prices in West Palm Beach were up by more than 20 percent in 2005.

Hollywood, in Broward County, also has attracted investor interest. This market boasts strong rental demand and population in an area that is forecast to increase by 20,000 residents during the next five years. Investors like the relative affordability of this market: The median price per unit is roughly 20 percent lower than the rest of the Fort Lauderdale region.

The Flagler Village area in Fort Lauderdale, which has endured decades of crime and blight, is part of the city's downtown master plan to redevelop the area into a vibrant live/work district. Developers are scrambling to acquire land and obtain approvals for their projects. Meanwhile, the city is motivated to allocate housing units to the area.

Recent sales in Fort Lauderdale included 1.25 acres on Broward Boulevard for $10.53 million to Groupe Pacific, which plans to build a 48-story high-rise mixed-use project, and a three-story office building at 33 N.E. Second St. to Claridge Homes, a large Canadian developer, for $5.25 million. Claridge plans to construct a 40-story condo tower on the one-acre site.

Developers and investors alike are scrambling to capture land in downtown Fort Lauderdale, especially within the parts of the area where there are no height or density restrictions. Previously, land sold in the range of $40 per square foot to $60 per square foot. That standard now has been pushed well beyond $150 per square foot.

Occupancies Improve

Completed in 2004 as a rental property, Pineapple Grove Village in Delray Beach, Fla., is now going condo, with units and townhomes priced from the $300s to the $700s.

Credit: Louis Novick

Robust demand and reduced development activity were expected to yield an 80-basis-point decline in Fort Lauderdale's vacancy rate, down to 4.5 percent by the end of 2005, and a 160-basis-point decrease to 5.8 percent in West Palm Beach. Ten of 12 Fort Lauderdale's submarkets boast vacancy rates below 5 percent. The star? The submarket of Davies, which has a vacancy rate of 3.3 percent, where it is expected to remain going into 2006. A recent measure to preserve the community's open land should limit new apartment supply in the years ahead.

With reductions in vacancy expected to persist, asking rents were forecast to climb 2.8 percent in Fort Lauderdale to $1,003 per month by the end of 2005 and 2.7 percent in West Palm Beach to $1,035 per month. Effective rents also were projected to increase in late 2005, hitting $950 monthly in Fort Lauderdale and $970 in Palm Beach County.

Not to be outdone, Miami's vacancy rate was expected to fall to 4 percent by the end of 2005, a significant drop from 2004's 5.2 percent vacancy rate. Why? Population increases, job growth, and the removal of 2,600 apartment units from the market. Strong fundamentals were expected to help owners raise monthly asking rents region-wide by 2.5 percent by year-end 2005 to $1,020, with effective rents of $970.

Price Jumps

Investors are maintaining a keen interest in apartments in the South Florida market. Median prices in Miami, West Palm Beach, and Fort Lauderdale rose 25 percent in 2005, hitting $96,500 per unit in West Palm and Fort Lauderdale and $92,000 in Miami. Predictably, as prices have soared, cap rates have declined. They now average 4 percent to 6 percent, with condo conversion deals trading in the lower end of the range.

Linwood C. Thompson is managing director of Marcus & Millichap's National Multi Housing Group. He is based in the firm's Atlanta office.

Given that South Florida's conversion buyers are motivated by the potential capital appreciation of their newly purchased assets, apartment investors will have to adjust their customary holding periods and return assumptions if they want to be in the South Florida market. Some apartment buyers may have to wait patiently for the optimal deal to materialize, but their patience should be rewarded. While shrinking competitive stock and demand driven by displaced renters will support gains in property income during the near term, the area's solid demographic profile and diverse economy portend steady property performance over the long haul.

Brownfield Boost

Ever wanted to develop that abandoned factory site so close to downtown, but were scared off by the liability of tackling a possible environmental hazard? A new rule from the Environmental Protection Agency should help, provided you follow the required steps.

The EPA's "all appropriate inquiry" rule, adopted in November 2005, spells out the steps a brownfield site buyer must take to ensure that it cannot be sued for environmental contamination under a past owner. Among the requirements from the EPA are that a buyer must have an environmental professional conduct a study of the site, and it must interview the seller of the site. "The phase one [study of the site] will cost the same, but it will bring more," says Jeffrey Hanneman, an attorney in Chicago-based AON's risk services division.

Credit: Barbara Proud

Experienced brownfield developers also see it as a positive step. "It basically tells you how to do your due diligence and, if you do your due diligence in this way, you will be protected," says Brian O'Neill, founder and chairman of O'Neill Properties Group in King of Prussia, Pa. "It's a roadmap. This is extremely clear and extremely helpful."

–Les Shaver

Tightening Trend

Multifamily revenues continued their steady uptick in the third quarter of 2005, according to Atlanta-based brokerage firm Marcus & Millichap. That's thanks, in part, to completion levels that have remained low and increased activity in the condominium market.

Many apartment projects under construction are shifting to for-sale units before they are even finished, and existing inventory continues to be converted. The result: lower vacancy rates and fewer concessions. Add to that increases in occupancy and effective rents, and you get revenues with nowhere to go but up.

Credit: Marcus & Millichap Research Services

Marcus & Millichap expects the market tightening trend to accelerate in 2006. The MFE Revenue Index for third quarter 2005 hit 94.7, considerably higher than the 89.9 for the same period a year ago. It was the highest showing since fourth quarter 2001, when the index read 96.

Completion levels, which have been on a downward trend for the past year, hovered at 43 in the third quarter, just barely higher than their all-time low reading in the previous three months.

The MFE Index, published quarterly in partnership with Marcus & Millichap, reviews the national apartment market performances and analyzes its fundamentals.

–Nichola Zaklan