Apartments Go Condo
As Rental Demand Falls

When Wareham Development broke ground in June 2001 on a 101-unit apartment complex in Emeryville, Calif., across the bay from San Francisco, it figured it had an economic winner on its hands: Rents in the area were steady despite the regional economic malaise. But as Wareham began putting the final touches on the project, apartment occupancy rates and rents in the area were plummeting.

Now, the developer is selling the units as condominiums.

"We didn't expect the rental market to turn as soft as it did," says Rich Robbins, owner of the San Rafael, Calif.-based development firm. "The strength in the market now is in ownership." Wareham has sold nearly two-thirds of the units in the four months since they went up for sale.

With the apartment industry in the midst of what many are calling the perfect storm -- swelling supply and dwindling demand -- apartment complexes from New York to San Diego are going condo. Weak job growth, robust home sales propelled by low interest rates and lenient down-payment terms, and too many new units coming on the market, also driven by low interest rates, have contributed to tough times for apartment owners.

The result is that developers like Wareham are taking projects that came out of the ground as apartments and topping them off as condominiums -- while units that have long existed as rentals are being converted by building owners into condos. New York-based Taconic Investment Partners LLC purchased 190 apartment units last month in a 223-unit complex in New York, called Seaview Estates, and plans to convert 152 of the units to condos.

Conversions are especially prevalent in areas where home prices have risen dramatically and land for new construction is limited. In California, some suggest conversions are being fueled by a new law aimed at reducing litigation over construction defects, which mitigates the risk both for builders of new condos and those who upgrade existing rental units to put them on sale.

The conversion trend is reminiscent of the late 1980s, another time when there was a strong market for residential sales, says Dale Anne Reiss, who heads the real-estate practice for accounting firm Ernst & Young LLP.

In that cycle, many owners and developers who were late getting into the conversion game found themselves in the unenviable position of being left with a building only partly sold. At this point in the current cycle, that doesn't appear to be a risk, as many analysts believe condo demand will remain robust despite forecasts of continued sluggish job growth and rising interest rates.

Many say the condo lifestyle has greater appeal these days. With a growing population of older couples whose children have moved away, and with more younger couples choosing not to have children, "I think there will be growing demand," says Ron Terwilliger, chief executive of Atlanta-based developer Trammell Crow Residential. "I think it's a secular, rather than cyclical, trend."

Trammell Crow is testing the waters with three apartment projects under construction in New Jersey and Virginia, by marketing a portion of the units at each project as condos. But no condos will be sold in the buildings "unless we have binding contracts with nonrefundable down payments that will pay off the construction loan," says Mr. Terwilliger, which usually means half of the units need to sell, he adds. He believes the company will hit that target.

Data on condo sales support his optimism. Sales of existing condos and cooperatives not only hit a record last year, but also showed significant price appreciation, surpassing the gains for single-family homes. According to the National Association of Realtors, 824,000 existing condos and co-ops were purchased in the U.S. last year, a 10.5% increase from the 746,000 units purchased in 2001. The median sale price for an existing condo hit $147,900 in December, a 15.6% jump from a year earlier, while the median price for an existing single-family home was $162,400, a 6.1% jump from a year earlier.

The nation's largest publicly traded apartment owner, Equity Residential Properties Trust, began experimenting with condo conversions at its 1,500-unit Four Lakes Village apartment complex in Lisle, Ill., where sales began last year. Now, the company is "teeing up" to do the same at two of its apartment properties where the rental markets are soft, says Alan George, chief investment officer at the Chicago-based company, which owns 1,100 apartment properties nationwide. A 108-unit complex in Phoenix and a 76-unit property in Redmond, Wash., are slated for conversion. "We're not necessarily trying to [convert] the high-end properties, but ones that appeal to the broadest range of people," says Mr. George.

One benefit of the conversion plan is that it bolsters Equity Residential's efforts to attract and retain renters interested in buying a home. Equity Residential offers its tenants a chance to earn a credit of up to $3,500 that can be applied toward the purchase of homes in selected developments it has agreements with. "A resident will stay about six months longer on average" with the program, says Mr. George. Now, he says, Equity Residential can offer tenants the chance to apply their credits toward its own condos.

Email your comments to rjeditor@dowjones.com.