As you walk through the archway and on the white carpet to the entrance of this condo sales party, you feel like you're entering the circus. Men in referee shirts are jumping on a trampoline, which gives them the power and lift to bounce off a wall at a 90-degree angle. Another man walks with stilts–he too is bouncing up and down. When a waiter offers you a fruity orange concoction, you feel like you have no choice but to accept after watching this surreal, acrobatic scene.
Your next stop is the elevator, where the doorman (who could pass for the younger brother of The Rock, the pro wrestler-turned-actor) takes you to the top floor of this 1960s-era office building, which will be torn down for–what else?–a new condo building. Inside the main room, the party's bars serve Sprite, beer, liquor, and ... oxygen.
Then there are the party-goers at this Miami event. Some are young, fit, and tan. Others are old, wealthy, and tan. And the rest are simply famous, such as Miami Dolphin football player Jason Taylor. Just what brings this diverse group of people together? South Florida's newest social phenomenon: the condo opening. This one, which features everything from cage dancers to cocktails, is for the Soleil.
The Soleil is New York-based developer Leviev Boymelgreen's third foray into the very crowded Miami market. The 41-story, 288-unit unit building is yet another addition to the cranes and conversions that dominate the South Florida real estate climate (specifically Biscayne Boulevard, where the Soleil will be located). Unlike many of these buildings, the Soleil will have a large investor contingent, says project manager Bob de la Fuente. But the party and speed at which its units are being bought is very reminiscent of the hot condo market in Miami and around the country.
"If you open up the Sunday paper, it's this opening and that opening," says Mark Sanders, CEO of The Fifteen Group, an apartment owner and manager based in Miami Beach, Fla. "In the society pages, it's all about condos. It's a crazy thing."
That it is. But while South Florida may be the center ring of the condo circus, it's certainly not the only place where people are watching–or jumping into–the greatest show in real estate. Low interest rates, rapid real estate appreciation, and a weak stock market have fueled a condo boom in places like Southern California, Washington, D.C., Las Vegas, Chicago, and, to a lesser extent, many other major metropolitan areas as investors seek a "sure thing" and renters race to buy before they're priced out of the market.
The mainstream media has been all over the real estate boom, with both magazines and newspapers reporting on the implications for consumers. But what media outlets have failed to cover is what the condominium boom has done to condo developers and apartment firms. Apartment developers and owners have been drawn to the condo market along with consumers, finding rich rewards in building, selling, or converting multifamily properties for condos. But it's not all upside. Given such demand for housing, land prices have risen to such a level that building rental markets holds little appeal, especially given weak rents. In many hot condo markets, buying a property that pencils out as an apartment is little more than a circus fantasy.
Incomparable Returns
When you walk amongst the sand-colored, garden-style buildings at Colonnades in Plantation, Fla., you see a well-maintained property in a solid suburban neighborhood sitting halfway between Miami and Fort Lauderdale. It's a very nice apartment community. And that's exactly what Tom Bartelmo, president and CEO of J.I. Kislak, an apartment owner and manager based in Miami, intended for the property when he bought it two years ago.
But things started changing. Bartelmo noticed condo converters swarming to grab any available property in the area. With each buy, the converters paid progressively more for garden-style properties, like Colonnades, but the returns they got more than justify the price. So Bartelmo, a former accountant, began to crunch the numbers. He looked at the price he could make by selling the property to converters. He computed what he could earn converting it to condos. And, he compared this to the rents he would earn holding the properties. The decision was a no-brainer.
In Kislak's one year of operating the property, it earned a robust 10 percent return on investment in a shaky market. But, if the company converted the apartments into condos itself, Kislak would earn a 150 percent return on investment. To get that as an owner, the apartment firm would need numerous years of double-digit returns at Colonnades, while keeping expenses to a minimum.
"We looked at the landscape of what was happening in the marketplace, and we saw that the value as a condo conversion was so dramatic compared to operating it as an apartment that we decided to stick our foot in the water and do a conversion on our own," Bartelmo says. "That's enough of a return to get now, and there's no guarantee that you won't have to replace the roof or [that] there won't be a downturn in the market."
If apartment owners haven't cashed in on condos by converting their own properties, then they let the converters take the risk and still earned staggering profits. "It has enabled us to realize significant amounts of profit and benefit as these properties are valued in excess of what they would be valued as if they were simply viewed as income properties," says David Neithercut, president of Equity Residential, the large Chicago-based REIT. "We believe that we're realizing 25 [percent] or 30 percent extra profit per unit than if these deals were sold as income-producing [rental] properties."
Nationally, the volume of apartment deals soared from $30 billion in 2003 to $50 billion in 2004, according to Real Capital Analytics, a firm that provides real estate market information. As of June 1 of this year, that figure was $24 billion. While more institutional and tenant-in-common interest in real estate (as the stock market staggered) plays a role in this spike in prices, condos remain the biggest individual driver. In fact, Real Capital Analytics reports that condo conversions now account for 21 percent of the total value of garden-style deals bought and 42 percent of the value of all high-rise deals.
The rapid appreciation spurred by condo conversions means apartment owners have essentially been sitting on gold mines. While many owners would like to hold their assets, the condo conversion market presents too much temptation. Sanders capitalized on the condo boom by selling about 1,500 units to converters, including all of his South Florida properties except for one. "We had resisted it for a while," Sanders says. "Guys would submit unsolicited offers and we'd say no. Then they'd go higher and we'd say no. They'd keep doing it and keep doing it and finally it would get to a level where I'd go into my brother [his partner] and say, 'I think we should do this. I don't think it's going to be worth this five years from now.' I don't think you ever say you wouldn't sell. Once you get too emotional, that's when you get hurt."
If private owners aren't getting emotional about properties, REITs aren't either. Archstone-Smith in Littleton, Colo., which owns significant numbers of apartment properties in hot condo markets, sold $600 million worth of assets in just the last two months of 2004, allowing it to give investors a special dividend of $1 per share. "The vast majority of what we've sold we've redeployed into core assets in our core markets," says Jack Callison, senior vice president of national operations for the REIT. "We financed virtually all of that activity with 1031 [exchange] proceeds, and much of that was condo [sales] activity."
Other REITs, such as Equity Residential and Post Properties in Atlanta, have begun converting some of their own stock. Equity built a condo conversion business group to serve Chicago, Florida, Phoenix, and Seattle, while it does conversions with partners in Southern California and Washington, D.C. As a general rule, Equity prefers to sell its more expensive properties to converters and keep the more moderate product for itself, believing the middle market to be more sustainable. "We felt more comfortable operating with the starter home demographic," Neithercut says. "We've been doing stuff in the $150,000 to $200,000 range and have been realizing 15 [percent] to 20 percent margins on those transactions."
Moody's Investors Service thinks that REITs have been fairly responsible through the condo boom so far. "For the most part, the REITs haven't let it become a significant part of their business," says Christopher A. Wimmer, a chartered financial analyst and assistant vice president for real estate finance at Moody's. "Some are sticking their feet in the water and some are taking it up to 5 [percent] or 10 percent of their business. Once you reach that 10 percent threshold, we might start to take issue."
Moody's and other industry watchers are also watching public and private apartment owners to see what they are selling. With today's sales prices and construction costs, it may be difficult for apartment owners to replace the units they sell to converters or end users. "Are they selling assets that are slated for sale anyway, or are they selling some of their core assets in their portfolio and capitalizing on the market?" asks Maria Maslovsky, an associate analyst for Moody's. "On one hand, it's nice to sell at a lower cap rate, but we don't want the companies to be selling their better core properties. If they're doing that, how do they replace that cash flow?"
Multifamily leaders are paying attention to the same issues, carefully choosing what to sell and what to keep. Although Tom Bozzuto, president and CEO of The Bozzuto Group, an apartment owner and condo developer in Greenbelt, Md., sold some apartments to converters, his entire portfolio isn't for sale. "We have some apartment properties that are in irreplaceable locations that will be good forever," he says. "Those are ones that we'll never sell."
Like Bozzuto, Jeff Stack, managing director and principal of The Sares?Regis Group in Irvine, Calif., has converted some of his apartment stock into condos, but he cautions his colleagues to be thoughtful and consider the long-term consequences for their companies. "Anything you sell, you will be hard-pressed to replace," Stack warns. "We feel very lucky that we have the pipeline that we do. Two years ago, we got very aggressive buying apartments. If we had to do that today, we would be hard-pressed [because prices are so high]."
Featured Performers
While condo converters and apartment owners have benefited from the condo boom, land owners and condo developers are the ones that are really profiting. As returns from condo construction have soared in recent years, many apartment developers have turned into condo developers–at least for the time being. And they've done very well.
One of those executives is Leonard Wood, director of Wood Partners in Marietta, Ga. After he built the Dakota, a mid-rise building in Atlanta, he realized the potential of condos and met with great success. Now the company builds more condos than apartments, a strategic shift that has made Wood Partners bigger and more profitable.
"We've evolved to meet the market of renters that want to own," Wood says. "That's where the market is taking us."
While Wood was last year's most prolific multifamily builder, Jorge Perez of The Related Group of Florida may be the most creative. Related, which is known for luxurious developments such as Icon South Beach (which features a 27-foot coffee urn in its lobby and $10 million penthouses) and buildings designed by Philippe Starck and Ian Schrager, has stamped its architectural and artistic brand on the Miami condo market.
Related's high-profile high-rises catapulted Perez into the limelight in Miami, where he is a regular on the cover of the city's lifestyle magazines. It has also brought great success to the company. "Jorge is the dean of all things condo," says Sanders, one of many multifamily executives to marvel at the sheer number of deals the company does with less than a decade of experience in condos.
Of course, Perez didn't always do condos. Just under a decade ago, the company did its first condo project, when it bailed out the developer of Portofino Towers in Miami. Slowly, Related did more and more for-sale product, starting 5,054 multifamily units last year. "The condo market started, and we did fewer and fewer rentals and more condos," says Roberto Roche, executive vice president of The Related Group. "Now we don't do any rentals."
Others have taken note of the success of Perez and Wood. "Everyone wants to be a developer," Roche says. "You have electricians venturing into development. You have dentists getting into development. Whether they can do a 10-unit deal or a 100-unit deal or a 500-unit deal, everyone is getting into development because they will sell it."
Given all these people trying to develop condos, it's little wonder that land prices have increased dramatically–with serious implications for new rental production. "It's getting more and more difficult each year to find rental projects that make sense," Wood says. "Land prices are going up because condo developers are bidding for land, and they can afford to pay more."
As a result, some people wonder if this condo boom will cut renters out of high-quality locations. "Land owners are typically long-money people," says Steve Patterson, CEO of ZOM Development, a developer and apartment owner in Orlando. "Land owners have the dry powder to wait a long period of time before they start dropping prices so we can buy land again at rental economies."
Roche sees things going the opposite way. "Right now, it's a sellers' market," he says. "When there are no more buyers, they [land owners] are going to have to drop their price."
Quietly, some developers admit that they'd like to see Roche's scenario play out so that prices will come back in line. Others, particularly income-oriented owners and investors, would like to see apartment prices come back to a sustainable level, so they can enjoy the long-term returns of an apartment property versus the one-time cash-out from a condo sale.
But there are other issues under the condo circus about which even the smartest people under the real estate big top admit they can offer only educated guesses. There's the whole issue of whether the real estate and condo markets are inflated by a huge number of investors and the proliferation of interest-only mortgages. And, even if the industry weathers this storm, liability problems from all of the conversions and new starts could also be on the horizon.
Everyone's got an opinion on these issues, but no one has the answers–they just know how much money they've made in this boom. But in five years, will they look back on the condo circus with nostalgia? Or will they feel as disoriented as the trampoline jumpers at the Soleil's opening?
