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Investors Still Seeking Good Apartment Deals
By: Jennifer LeClaire

A soft condo conversion market is wreaking havoc on the apartment investment climate - at least in some regions of Florida.

Marcus & Millichap’s 2007 National Apartment Report cited declines in Fort Lauderdale, Miami and West Palm Beach. The bright spot: Even with declines, the trio of South Florida cities still ranks in the top 15 nationwide. Elsewhere across the state, Orlando should continue to perform well this year, despite slower renter demand, and Tampa is entering a transitional phase as growth begins to slow in the months ahead.

“The condo conversion craze has calmed, and the apartment market is getting back to business as usual,” said Bob Goldfinger, principal broker at Tampa’s Goldfinger Group at Marcus & Millichap, a real estate investment services firm. “Apartments are still a popular choice for investors, but there is a bit of a disconnect between conversion craze pricing and current pricing.”

Value-added opportunities

There may be a disconnect, but there is no lack of investment capital flowing into Florida’s apartment market, said Garard Yetming, vice president of investment properties in the Multi-Housing Group for the Miami office of CB Richard Ellis. Institutional and private investors are still bullish on the state’s opportunities. However, it’s the value-added deals that are getting the most attention.

“There has been somewhat of a shift. Many buyers are focusing more on opportunities that allow them to take an apartment community with in-place rents, do some improvements, and increase rental rates,” Yetming said, noting that there are two reasons for this strategy that is prevalent in Miami.

First, he explained, Miami has a tight supply. Purchasing land at prices that make for attractive investment opportunities is challenging. Escalating construction costs offer a second obstacle. New apartment communities that do come online during the next two years would have to charge rents that are significantly higher than what the market currently bears, Yetming said. Savvy investors are doing rehabs today, knowing there will be headroom in rents in the coming years.

Talking cap rates

Cap rates have remained relatively stable in the multifamily market across the nation - except in Florida, said Sam Chandan, chief economist and senior vice president of economic research for REIS, a multifamily and commercial real estate information provider based in New York City. Over the last two quarters, Chandan has witnessed declines in both cap rate and average prices per unit. He blames the deterioration in fundamentals in key markets like Fort Lauderdale and Orlando.

“We are concerned that there is still some room on the downside for the prices to fall a bit and for cap rates to keep climbing,” Chandan observed. “There’s a lot of pressure from condos for rent. Condos are competing aggressively and directly with the mainstream multifamily supply, and the investment market is pricing some downside risk into current acquisitions.”

What’s more, transaction activity in Florida has weakened substantially over the last three months because investors are uncertain, Chandan explained. Apartment vacancy rates are up from 3% to 5% in most Florida markets, thanks, in part, to condo reversions. Condo reversions occur when too many condos are built too quickly, and South Florida is the nation’s prime example. The condos, then, go back into the rental market.

“Some properties were emptied out. The renters had to leave so the apartments could be converted to condominiums,” said Andrew Bauman, a managing director in the Fort Myers office of Sperry Van Ness, a commercial real estate advisory firm. “Now, they are coming back online, but they are not selling because there’s a glut. So they are leasing up from ground zero again to renters.”

The widely publicized slowdown in the real estate market doesn’t seem to have made its way to sellers, though, Bauman noted. He cited a “disconnect” between asking prices and market prices that is stalling sales in the apartment market.

“There is still an appetite for rental properties, but some sellers can’t get the last three years out of their minds,” Bauman said. “You try to talk economics with the seller, but they want low, single-digit cap rates and that absolutely won’t happen. The market is adjusting, and it’s challenging to bridge the gap between what the seller expects to get and what the buyer is willing to pay.”

Long-term outlook

Despite overbuilding, high insurance costs and escalating property taxes, Florida offers apartment investors strong demand drivers. Overall, the state’s growth in population and jobs are positive long-term trends that directly impact the housing market. With the promise of continued appreciation over time, the market for more affordable rental properties looks bright in the future, experts agreed.

Indeed, there is every reason for apartment investors to be bullish on Florida. With estimates pointing to 1,000 people moving into Florida every day, the state will work off its condo inventory. The overbuilding will be absorbed as it has been in past down cycles.

That will take the condo converters out of competition with apartments, and vacancy rates should decline once again, Bauman said. He also predicted some compromise on land prices that could allow new apartment complexes to rise from the dirt in the coming months in Southwest Florida.

The big question, said Yetming, is how long it will take to absorb the condos that are already on the market - and the ones that are still under construction. It’s possible, he said, that Miami might see a repeat of the 1980s, when condos remained dark for months before willing buyers stepped in with cash to purchase them.

That bodes well for the apartment market because these million-dollar condos come with carrying costs that make rental rates non-competitive with existing apartment complexes.

“The underlying immigration patterns are very strong for investors looking to Florida,” Chandan concluded.

“There is a deterioration on the supply side across the board, so the focus is on markets that have stronger medium-term demand fundamentals and stronger demographics, like Miami. These factors mitigate the extent of the slowdown, and that’s where we’ll see a reacceleration sooner.”

Article From Florida Real Estate Journal