Monday, July 24, 2006 | A couple of weeks ago, Bob Pinnegar was discussing with his colleagues what to call the phenomenon in San Diego real estate: the condo conversions that are now reverting back to rental units.
The group toyed with a number of possibilities: condo conversion-conversions, condo reversions and even apartment conversions. Pinnegar, executive director of the San Diego County Apartment Association, isn’t sure if they ever pinned down a final moniker. But he does know that everyone in the business is asking what’s going to happen to all the people who jumped on the condo conversion bandwagon in San Diego, only to find a sinking condo market at the end of the road.
In the once red-hot housing market, owners of apartment complexes rushed to convert their units into for-sale condos. The rush, combined with the recent cooling of the condo market, has resulted in a surplus of condos countywide – a trend that has left some developers in the lurch. Many developers in the niche market of condo conversions bought apartment buildings at high costs with the hope of converting them into condos and turning a profit, but now find themselves left with little option but to put their units back into the rental market – hence conversion-conversions.
“It’s sort of a game of musical chairs, and those who were the last ones to find a seat are going to get hurt,” Pinnegar said.
In a market where the median price of a single-family home now hovers around $500,000, condos have become the new starter homes for many San Diegans. Chuck Hoffman, president of Apartment Consultants, Inc. describes condos as the new bottom rung on the San Diego property ladder.
As home prices soared in San Diego for the last few years, the demand for condos rose in response, Hoffman said. Property developers saw their niche and pounced, leading to what many experts described as a “frenzy” of converting apartments into condos.
But as more and more condo conversions and new condo projects have come on the market, developers have faced tighter competition to sell units. That’s led to falling prices in the condo market and a glut of condo conversions with fewer and fewer buyers to go around. More than one-third of the 23,221 homes currently listed for sale in the county are condos, according to ZipRealty, a real estate brokerage firm.
According to data from HomeDex, a monthly report compiled by Robert Brown, professor of economics at California State University, San Marcos, the median price of single-family attached homes in San Diego dropped 5.2 percent from June 2005 to June 2006. The median price has also dropped 5.7 percent since the beginning of the year.
“The condo market’s weak,” said Alan Gin, professor of economics at the University of San Diego’s Burnham-Moores Center for Real Estate. “On the supply side, there’s been an overdoing of the conversions – there’s probably too much out there and you see that by these people trying to pull supply off.”
Compounding the condo market’s woes, Gin said, many potential condo buyers are instead eyeing the detached home market. They see the median price of single-family homes sinking, he said, and they’re deciding to hold off from buying a condo in case prices fall enough that they can get a single-family detached home for the same price.
Gary London, president of London Group Realty Advisors, estimates that there are 7,000 to 10,000 condo conversions in the pipeline for the city of San Diego alone. He thinks many of those properties will revert to the rental market. For companies who bought into the conversion craze late, that could spell trouble.
“There was a glut of purchases of apartments over the past 36 months, in the past 18 months in particular, where the price that was paid for the building could only be justified by converting the units,” London said.
But many companies, however, simply don’t have any other option but to put the units up for rent.
Kent Williams, who manages the San Diego office of real estate brokerage firm Marcus and Millichap, said his company is being approached by many investors and companies looking to offload their planned condo-conversion properties.
“They can’t take them to the market and sell them as individual condos, so they’re coming to us and probably other brokers and saying ‘I want to sell these as a bulk condo sale.’ We’re telling them there’s really no premium for that – it’s really an apartment building.’ “
Hoffman cited as an example a small apartment building in North Park that has sold four times in six years.
The building, 4525 Florida Street, sold in March 2004 for $2.1 million to an investor who planned on converting the property to condos. The investor spent tens of thousands of dollars getting the building permitted for condos but then decided to bail on the project as the condo market slumped. He then sold the property as an apartment building in May 2006 for $1.7 million – netting a loss of at least $365,000.
Condo conversion-conversions are not a new phenomenon. Industry players said they’ve seen this happen before in response to other market shifts. In the late 1970s, fearing the imposition of rent control measures in San Diego, many apartment building owners rushed to convert their units to condos. In the resulting condo market slowdown, many of those properties ended up returning to the market as rentals.
Even as thousands and thousands of would-be condos revert to their original home on the rental market, analysts said it’s unlikely that rents will increase given the relatively small number of units involved and the current state of the housing market.
With so many buyers sitting on the fence watching to see what happens to home prices before they jump onto the property ladder, there are a lot of people out there still looking to rent. Marcus and Millichap’s quarterly Apartment Research Update, released last month, forecasts a 4.5-percent rise in asking rents over the remainder of the year.