Aftermath of the ‘Busted’ Condo Boom

Rental developers are learning that they can no longer find quality condos at discount prices.

In what became a shining example of a “busted” condo bailout done right, Wood Partners’ purchase of City Walk last summer turned an urban eyesore into a marquee apartment and retail project in the heart of downtown Oakland, Calif. It was one of a number of skillfully executed financial moves that turned stalled condo projects into promising rental properties.

Apartment developers scooped up failed condo projects one after another last year, as they looked for bargain-priced remnants of the housing boom. Most were successful, but only a handful like City Walk were stellar from a financial point-of-view.

In another deal that closed last summer, Equity Residential of Chicago, Ill., bought a 550-unit development in Washington, D.C. out of a bankruptcy proceeding. The $170 million price tag was well below the replacement cost.

At about the same time, Essex Property Trust bought two Orange County, Calif., developments for a combined $155 million—about 55 percent of the original construction costs, according to Green Street Advisors, a real estate research firm. Buying up troubled condo projects seemed an ideal way for developers to boost rental income without incurring the steep costs and the risks of a multi-year development.

The City of Oakland’s $5 million loan to Atlanta-based Wood Partners was particularly sweet, although it will cost the nation’s fifth largest multi-family developer another $55 million or so to finish City Walk. The project stood partially complete just two blocks from Oakland’s City Hall for three years before Wood Partners made its move. It took nine months of frenetic activity, but the company worked diligently to assemble the financing and regulatory approvals to complete the project.

“It’s been a long road, with a number of complex issues to resolve, so it’s very gratifying to reach this point,” says Frank Middleton, director of the West Coast division of Wood Partners, after announcing the financing approvals last year. “Now we’ll be able to fulfill the potential of this project and deliver a true asset to downtown Oakland.”

The new community will include 264 Class-A apartment homes in four six-story buildings, as well as a street-level retail component. Construction will continue through the summer of 2011.

Similarly, Equity Residential announced the acquisition of 425 Mass (formerly known as The Dumont) last April. This property was also located in a high-profile location, just blocks from the Capitol, K Street and Union Station. The company moved quickly to purchase the property—completed in 2009 as a luxury condo project—in an all-cash transaction.

The acquisition was another example of Equity Residential’s strategy to acquire high-quality assets in core markets and efficiently execute a rather complex transaction, says David J. Neithercut, president and CEO. “We are pleased to add this asset to our portfolio without construction risk and at a price well below replacement cost,” he said at the time.

Equity Residential now owns and operates 51 properties, consisting of 15,976 apartment units, in the Washington, D.C. Metro Area, including three properties consisting of 1,062 apartment units in the District of Columbia.

The company bet that its future tenants would pay a premium rent for higher-end amenities, including built-in bookshelves and a rooftop pool. A studio is being marketed for $1,785, while a two-bedroom is going for $3,685. Typically, studios within a mile radius average $1,517, while two-bedrooms go for $3,068, according to Axiometrics, an apartment data research firm.

“I don’t think they’ll have an issue leasing it up,” says Alexander Goldfarb, a REIT analyst with Sandler O’Neill + Partners. “One of the beauties of apartments is you can always cut the rent. Even if you do a month free, you’re still looking at a decent return for the current environment.”

In California, Wood Partners purchased the highly distressed property of City Walk in late 2009, and then faced the task of raising more than $30 million in construction debt.

The City of Oakland played a pivotal role in bringing the financing package together by agreeing to Wood Partners’ request for a $5 million loan. The city loan improved the project’s debt-to-equity ratio, which in turn allowed Wood Partners to secure the balance of funding.

“In this economic climate, assembling the right financial package can be difficult,” says Wood Partners’ Brian Pianca, who is overseeing the project. “The City of Oakland understands what City Walk means to downtown, and stepped in at a critical juncture to help us get it across the finish line.”

In Santa Ana, Essex Property Trust’s acquisitions of the 349-unit Skyline at MacArthur Place and 115-unit DuPont Lofts in Irvine also needed solid financial backing. The larger Skyline project cost $128 million and is a 50 percent joint venture with an undisclosed partner.

Unlike the Wood Partners and Equity Residential projects, Essex’s properties are in marginally below-average submarkets surrounded by office parks with little retail within walking distance. However, the company feels renters will choose its new high-quality, luxury units (rents will top $2,500 per month) over older apartments that may feature better locations.

The best deals in Miami are gone

Developers also found plenty of bargain-price condos in overbuilt Miami, Fla., last year. In October, Wood Partners and AREA Property Partners closed on the acquisition of Terrazas River Park Village, a 324-unit Class A property along the Miami River. The value of the off-market transaction was not disclosed.

Wood Partners and AREA leased the property as high-end market rate apartments. The abandoned condos offer tenants superior finishes and amenities at competitive rental price points. Almost all of the apartments were leased within a short period of time this fall.

“There was a very short gap between the find and the close on this acquisition, and the reason we were able to accelerate the process is because of our strong financial partnership with AREA,” says Jay Jacobson, national acquisition director for Wood Partners.

Terrazas River Park Village consists of two sleek, contemporary towers on a 2.15-acre site along the Miami River adjacent to E. G. Sewell Park, a 10-acre nature preserve. The community is in close proximity to downtown, the rapidly expanding Miami Medical Center and the new Florida Marlins’ baseball stadium.

The towers feature two-story soaring lobbies with open views to the park and river, a private clubhouse and a lushly landscaped pool and spa surrounded by an expansive sundeck. There is a state-of-the-art fitness center with exercise equipment and yoga/aerobic studio, along with separate men’s and women’s sauna/shower areas and a relaxing meditation garden.

“In the case of a luxury condo, the amenities package is typically bigger and better than even a high-end rental property, which is both positive and negative,” says Jacobson. “These condos are much more attractive to renters, but it will cost the owner a little more to operate. The biggest advantage is you take out two of the top three risk factors in multi-housing development—construction risk and rising cost risk—right out of the equation.”

A limited pipeline of rental inventory, coupled with improving demographic trends, has supported strong apartment fundamentals in the Miami area. However, Wood Partners left the smaller projects to other buyers, and soon the competition heated up. The Miami Beach Community Development Corp. began to snap up lesser properties, including the 35-unit Neptune Beach, one of the many failed condo conversions remaining from the housing boom, in prime South Beach.

The public housing agency paid a scant $5.7 million for the property, and renters will be paying only $500 to $650 per month. The affordable rental housing units came in at $162,000 per unit—a big discount from the original selling price of $200,000.

As the public sector moved into a market dominated by private-equity and institutional funds, the competition for failed condo projects became fierce. The rest is history.

“If I could find failed condo deals in a sub-market with good rental prospects—even with lagging construction issues—I’d buy everything I could get my hands on tomorrow,” says Jacobson. “There are not many ‘busted’ condo deals on the market right now.”

The number of good pickings peaked in January and February of last year, according to Jacobson, with most of the failed condo buying opportunities vanishing in the fall of 2010.

There are still deals available where most of a project’s condos sold at high prices and the balance is on the market or being sold at a lower price point. However, companies like Wood aren’t interested in the scraps.

Most of the “busted condo dot-com” companies came out of the woodwork looking to sell individual units or aggregate them and sell them in bulk.

“Any condo that’s in the right location and is the right size to be turned into a rental property is already in the process of conversion at this time (Dec. 2010),” says Jacobson. “And that’s great news for the industry.”

However, there are still a number of banks and equity partners that have bought “busted” condos at attractive prices with the thought of selling them when local demand returns.

“This year was the turning point in ‘busted’ condo deals,” emphasizes Jacobson. “Lenders and equity partners turned them into rentals or sold them to companies like ours. Others are hanging on to what they have and selling at lower prices.”

Jacobson notes that condo prices in South Florida have fallen about 50 percent since 2008. In the meantime, the standing inventory of unsold units continues to clear the market in significant numbers every day.

Wood Partners’ purchase of City Walk last summer turned an urban eyesore into a marquee apartment and retail project in the heart of downtown Oakland, Calif. The “busted” condo project stood partially complete just two blocks from Oakland’s City Hall for three years. (Photos courtesy of Wood Partners, Atlanta, Ga.)

Wood Partners and AREA Property Partners closed on the acquisition of Terrazas River Park Village, a 324-unit Class A property along the Miami River in Miami, Fla. The abandoned condos were leased as apartments within a short period of time this fall.