When Wood Partners was founded in 1998, we were a firm dedicated to the development of high-quality apartments. We still are–but today the percentage of rental apartments in our development portfolio has dropped from 90 percent to 30 percent, with the other 70 percent focused on for-sale condos.
Our business strategy started to change in 2002, as we approached the leasing phase of the Metropolis, a 498-unit high-rise in Atlanta's Midtown. We found ourselves in the middle of a soft market with concessions running as high as three months' free rent. We began to test-market the units as condos and suddenly had 100 reservations in less than a month. We were sold out in 10 months–at list price. Just as importantly, our sales people said that there were still many more buyers out there. So our venture into the for-sale multifamily business was off and running.
As we all know, condos have become the hot properties in the multifamily market. Just five short years ago, condos represented less than 18 percent of multifamily starts. Today, condo starts run closer to 40 percent, and that doesn't take into account the thousands of apartments that have been converted from rental into for-sale units by multifamily firms and condo converters.
Such trends have been quite profitable for developers and condo converters (and those firms that sell their properties to them), but they are creating challenge upon challenge for market-rate rental apartments. Such apartment projects have always comprised the majority of multifamily starts in the past, but today, this segment of multifamily housing lags behind the activity in the condo and affordable housing sectors, which have been able to attract a steady flow of capital in the form of investors (condos) and low-income housing tax credits (affordable housing).
As a result, market-rate rentals suddenly seem to be the incredibly shrinking segment of the market, with potentially disastrous consequences for the industry–and the people we serve–overall.
Price Pressures
What forces are at work? Land and construction costs. Residential land prices in many areas now rival or exceed those for commercial property.
We're currently working on a site in South Florida, where we plan to build for-sale townhomes. The land is under contract for $40,000 per unit. This particular site, even two years ago, would have been considered a classic for-rent apartment location. But two years ago, we would have spent $15,000 a unit, and rentals would have been possible.
The dearth of entitled parcels and the ever-increasingly burdensome process of getting land entitled are making development more and more expensive, leaving only those companies with the deepest pockets playing the development game. And the competition for dirt is only getting more fierce. Many large single-family home builders, including the top public companies, are pursuing prime urban locations and building high-density projects. It's a big difference from the large master plan communities they've traditionally built in distant suburbs.
The construction cost situation is no better. Building materials prices are soaring. NAHB estimates that building material costs have increased an average of almost 13 percent in since year-end 2004. These types of increases change the dynamics of your deal.
We have one project in Jacksonville, Fla., where construction costs are up 35 percent, and another in Phoenix, where the costs are up 25 percent.
Given such economic pressures, the only option for many multifamily firms is to build condos, because apartment developers simply cannot make the numbers work for a market-rate rental project, no matter how hard they work.
Real Consequences
While a tighter supply of rental units would certainly lead to some much appreciated rent growth for apartment firms, all of us should be concerned about the dwindling number of new and existing apartments.
A significant portion of the American population still wants and needs to rent their homes, whether for financial or personal reasons, and the industry is struggling to produce new units for these households. For example, we have a project in Las Vegas that, a little over a year ago, we thought was going to cost us $33 million to build. With the increase in building material prices, we now believe that project is going to cost us $43 million–a figure that just can't be supported by the rents–so we've decided to make it condos. With demand on rental apartments rising, both because of a lack of new supply and the ongoing conversion of existing apartments, rents could push beyond the reach of working families, who already struggle to find affordable housing in many of our cities.
Unfortunately, in many communities across the country, rental apartments continue to be undervalued and, indeed, misunderstood. So that even when we are able to get sites that allow density, it is very difficult to get them zoned and entitled for apartments. We as an industry need to take every opportunity to educate local governments on the benefits of good rental housing and to dispel the myths often associated with renters and rental apartments.
If local officials truly understand the value of good rental housing, they can help make them happen by lowering real estate taxes and impact fees and giving density bonuses. Such incentives can make a difference to the developer trying to make the numbers work.
Even the federal government can help. Almost every year, there are new federal regulations that add additional costs to housing. As an industry, we must be part of the legislative process, so that we can ensure that any new regulations make sense from a cost-benefit standpoint.
We can also let our elected representatives know that they can help our industry by helping to make adequate supplies of building materials available at reasonable prices, even if that involves allowing more imports and lowering tariffs on wood and concrete and other building materials.
Such efforts will reap benefits for all of us in the industry. A vibrant and sizable sector of market-rate apartments is a crucial component of a healthy housing market, and we need to do our best to ensure that such a market continues to exist in coming years.
