WESTERN SNAPSHOT, OCTOBER 2005

San Diego Multifamily Market

Low

The SDCAA reported that the average rent for a two-bedroom unit was $1,058 in the county and $1,112 in the city of San Diego, up 0.5 percent and 1.6 percent, respectively, from fall 2004. Average two-bedroom rent in downtown was $1,365, down 9.3 percent from fall 2004 and down 15 percent from 2003.

The flatness of the rental market is reflected in the multifamily sales through August. Based on apartment sales reported by Costar Comps for sales of properties with 10 or more units not sold for condo conversion, the average price per unit was $134,000, unchanged from fourth quarter 2004. The average cap rate through August was 5.26 percent versus 5.05 percent at the end of 2004, and still way below the national average of 6.25 percent. (See Table 1.)

As long as the economy and job supply remain robust, it is unlikely that demand for housing (evidenced by projected need for 20,000 new units a year) will surpass the limited supply and development of available housing. The enormous gap between housing supply and demand has created the ongoing affordability crisis, which means that only 9 percent of households can afford a median-priced home of $614,000. This affordability crisis gave birth to the condo conversion craze about 3 years ago, and the condo converters quest for apartments suitable for conversion has in turn helped fuel price escalation in the multifamily market. (See Table 2.)

Through August, 48 properties representing 8,854 units were sold for conversion to condo units. The average price of the condo conversion units was $179,505. This is about $45,000 per unit, or 33 percent, above the average price of an apartment income, and is referred to as the “condo premium.” The average price for a conversion unit in San Diego County is about 15 percent higher than the national average acquisition price of $155,400 as reported by Real Capital Analytics. The prices paid for units that will be converted to condos is driven by the expected sales prices of those units and expected costs of adding the condo touches, which normally include a new roof, landscaping, granite countertops, new appliances, etc. Given that condo converters paid close to $180,000 per unit for the stock they acquired so far this year, the ultimate homebuyers of these units can expect to pay around $310,000 to $330,000 on average.

Since 89 percent of the population cannot afford a median-priced home, which would require an annual income of about $140,000, buying a condo conversion unit has become virtually the only entrance to home ownership for first-time buyers. Sales of attached homes, of condos are running at twice the volume of detached homes in the San Diego area. According to MarketPointe Realty Advisors, condo conversion units made up 57 percent of all attached sales in second quarter 2005.

Although conversion units are typically in older buildings, by the time the converters finish sprucing them up they appear fresh and virtually brand new to buyers. Accordingly, these units sell at a premium to the typical resale condo unit, but are still a bargain compared to newly constructed units. Conversion units averaged $340,303 in the second quarter compared to $502,869 for new construction according to MarketPointe. On a per-square-foot basis, converted units sold for an average $392 and new units went for $412 per square foot.

Condo converters have become more cautious in their acquisitions of late. Concerned about recent price declines, longer market times, the potential of rising interest rates and the growing inventory of available product, it is not uncommon for converters to project further declines in retail sales prices — this translates into lower prices paid to acquire apartments for conversion. Attached inventory reached the highest level ever in the second quarter at 8,054 units, including 2,521 units immediately available as reported by MarketPointe. The largest segment of the current inventory is priced between $400,000 and $500,000. Geographically, almost half of all available condos are in the central San Diego region.

Much attention is focused on downtown San Diego, which is experiencing tremendous growth in construction of condo projects. There is concern about absorption rates for these higher priced units, many of which are being purchased by investors who may not be able to cover costs if rents soften more. As of Labor Day weekend, there were 596 condos listed for sale in the downtown 92101 ZIP code, compared to 71 closed sales in the month of August.

Will the condo craze last? As long as the housing shortage lasts, there will be demand for more affordable housing and condo conversions offer the best alternative. There has been some decline in the premium for condo-mapped properties, reflecting greater caution, but the demand for condo-mapped property is expected to remain strong. The wild card is the political climate. If local municipalities impose greater restrictions on conversions, it could become more difficult to supply the affordable housing that buyers are looking for. The city of San Diego is considering proposals to tighten parking and other restrictions, which would make many apartment properties ineligible for conversion within the city.

Cathryn Low is a vice president with Burnham Real Estate's Multifamily Services Group and is a founding partner of Langston & Low Real Estate Advisors.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.