What was the biggest factor in these sluggish fundamentals? Executives disagree. Some point to job demand. “As entry-level jobs are created, people leave home, school, or their roommates and create demand for housing,” says Leonard Wood, director of Wood Partners in Atlanta. “The younger folks are more prone to rent.”
Others believe the low interest rates that fueled the ongoing housing boom qualified as the biggest thing affecting their occupancy rates. “We still found a strong desire for people to purchase homes in those markets where housing costs were low to moderate because the interest rates were lower than we expected,” Sentinel’s Weiner says.
But high-priced markets like the Washington, D.C., metro area, where detached homes fetch eye-popping prices, did see strong home-buying demand for multifamily product. “Housing in our market is fantastic for condos, which has taken a lot of apartments off the market,” says Bob Murray, president of KSI Management Services, a developer and owner in the D.C. area. (Of course, the apartment market in Washington also ranks among the best in the country right now.)
In markets where housing costs were more modest, single-family homes provided the stiffest competition. “From a supply-demand standpoint, we had to factor single-family home supply into the picture,” Genry says. “Home starts stayed at a high rate, and interest rates remained low. Homebuilders had aggressive pricing, and aggressive financing options were available.”
Silver Lining While low interest rates stimulated condo conversions and hurt apartment fundamentals, there was an upside to this trend. Apartment owners “were killed by condo and saved by condo,” says Peter Linneman, principal of Linneman Associates, a strategic advisory firm in Philadelphia, and the Albert Sussman Professor of real estate, finance, and public policy at the University of Pennsylvania’s Wharton School of Business. “They were killed by condo in the sense that they lost rental demand due to the condos. But for everyone who was killed by losing tenants, they were saved by somebody buying out their end of their development at twice what anyone would have paid for it as a rental.”
The numbers agree. In 2003, buyers spent $29.6 billion on 415,626 units, according to Real Capital Analytics in New York. In 2004, that number jumped to $49.4 billion on 548,009 units. Sentinel was one of many multi-family companies that profited from the high interest in buying apartment properties. “While it was a tough year operationally, we managed to close a high number of sales at unprecedented prices,” Weiner says.
Many of these sales were to condo converters, who paid good money for their new buildings. Thanks to the strong demand for condos, these converters could make more by selling the individual units than apartment owners could make by renting them out, which drove up property prices. Picerne Real Estate Group, which built 4,135 units, sold existing apartments and new product to converters in 2004—and its CEO, David R. Picerne, expects even more in 2005.
Traditionally, this had only happened with top-of-the line, Class A properties. “Not too many years ago we thought there was a difference between buildings designed for rentals and buildings designed for condos,” Weiner says. “What the conversion market showed is that if interest rates are good enough, virtually every building has potential of being sold as a condo.”
While condo converters pushed apartment prices ever higher, they weren’t the only force in the market. Institutional investors, private investors, unlisted REITs, and 1031 exchanges all joined the fray in 2004. “Apartments, compared to Treasury bills and the stock market, still look pretty good,” explains Wood, who isn’t surprised by the industry’s popularity with investors. “The cap rates historically have a 200-basis-point spread between them and 10-year T-bill [rate], and that’s about where it is.”
High-Price Properties The flip side of the high cost of apartment buildings right now is that it’s difficult to piece together a portfolio today. In fact, given the skyrocketing prices, Weiner says buying traditional apartment properties was nearly impossible in 2004. “If we bought something, it was off-market,” he says, “as opposed to going out and bidding, which turned out to be a relatively futile exercise with all of the condo converters in the market.”
