Condo Conversions Propel
The Market in Tucson

As the Tucson area's rising population closes in on the one-million mark, investors have been snapping up apartment complexes, betting on rising demand for condominiums that offer a slice of the mountainous Sunbelt region's warm winters and laid-back lifestyle.

The economy of the visually dramatic Sonoran Desert region of Arizona has been ramping up since 2003, after it suffered job losses following the tech bust and sagging tourism after the terrorist attacks of Sept. 11, 2001. The burst of activity in the apartment sector comes as employment levels rose to a 10-year high in December after increasing at a year-to-year rate of 3.7% for the month, more than double the national rate of 1.5%, according to the Bureau of Labor Statistics.

The job growth, an above-average influx of new residents and relatively little new construction strengthened the commercial real-estate market last year. By year end, the office sector's vacancy rate had recovered to 2000 levels. Retail vacancies fell below the 2000 level, while the industrial market's improvement lagged behind, and average asking rents rose in December from a year earlier in all but the retail sector, according to Don Ahee Jr. of CB Richard Ellis Tucson.

Just over 100 miles southeast of Phoenix and a short drive north of the Mexican border, the area is known for the posh spas that dot the landscape. It is also home to defense contractor Raytheon Co.'s missile systems division, the University of Arizona, a strong optics industry, as well as many smaller service companies.

The housing market has posted the region's most impressive growth in recent years, though the pace showed signs of slowing by the end of 2005, according to the Tucson Association of Realtors. Median home prices climbed 66% from 2002 to $242,300 in the third quarter, just above the national level -- but they are still a deal compared with the Western region's median of $322,000, according to the National Association of Realtors.

The froth carried over to the apartment market last year. Aiming to offer ownership options that are more affordable than single-family homes, developers have turned to condominium conversions in Tucson as property prices in many larger cities soared out of reach, said Mike McClain, senior investment associate with real-estate investment brokerage firm Marcus & Millichap in Tucson.

The dollar volume of apartment-complex sales far outstripped all other Tucson-area commercial-property transactions last year, with nearly a half-billion dollars of apartments trading hands, more than double the year-earlier level, according to Real Capital Analytics Inc., a New York research firm.

Developers such as Terry Brown, president of Brown Cos. in San Francisco, which began purchasing Tucson apartment units last year and expects to own about 1,600 after closings within the next few months, are confident the condos will be in demand, in part because retiring baby boomers are expected to flock to the region. The metro area's population increased at an average annual rate of 1.7% over the past five years to an estimated 972,297 in January, and is expected to hit one million sometime in 2007. The population is forecast to rise at twice the national pace through 2010, according to Economy.com, a unit of Moody's Corp., and David Taylor, a Tucson city planner.

Nonetheless, the jury is still out on the condo-conversion market. "Condominiums have never been popular here because most people who move to Tucson like wide-open spaces," said Marshall Vest, director of the Economic and Business Research Center at University of Arizona's Eller College of Management in Tucson. And thousands of converted units could go up for sale this year, up from about 450 units sold last year, said Mr. McClain of Marcus & Millichap.

Email your comments to rjeditor@dowjones.com.