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Once fast-rising prices for apartments in San Diego have moderated

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Prices for multifamily units have moderated a bit in the county, but this is expected to be just a pause before they start up once more.

A Burnham Real Estate Services report for the first quarter of 2005 shows the market reflecting changes in investor expectations, with a slowdown in price increases and fewer transactions for both apartment and condominium-mapped properties.

The run-up in multifamily prices began slowly in 1995 and accelerated to a feverish pitch in the past couple of years. It has been relatively quiet in recent months, however.

"We don't see any signs of a downturn, but the market has to pause to let rents and prices of converted condos catch up to the previous increases in multifamily values, said Cathryn Low of Burnham Real Estate's Langston & Low multifamily team.

"This environment is actually creating opportunities for repositioning real estate assets, because when prices begin to stabilize, owners can sell or exchange property and capture huge appreciation gains with less concern that they are leaving money on the table in a runaway market," she said.

Some conversion transactions included the 112-unit Woodland Townhomes complex at 1401-1463 N. Broadway in Escondido sold in May for $21.8 million; and the 123-unit River Village Apartments at 1845 N. Broadway in Escondido sold for $16 million.

As evidenced by all the cranes downtown, plenty of projects are being started as condominiums. Three parcels in the East Village area totaling 55,000 square feet on the downtown block bounded by Broadway and 16th, C and 17th streets, were sold last March to Intergulf Development LLC for $14.9 million. The Canadian developer plans 500 units in a high-rise condominium project with ground floor retail that will be known as Cityscape.

As new projects continue to go up and others are converted, the per-unit prices have come down, at least for the moment. CoStar Comps reports the average price for all multifamily properties of 10 units or more was $136,557 per unit in the first quarter of 2005, down 6.9 percent from $146,778 per unit in the last quarter of 2004. Even so, first quarter 2005 prices were still 11.3 percent above the same period last year.

"Looking at average multifamily statistics can be misleading because there are really two distinct segments of the market: straight apartment properties that produce rental income, and condo-mapped apartment properties ready for condo conversion," said Low.

"Both segments have been propelled by historically low interest rates and the countywide housing shortage, which drives demand from both renters and first-time homebuyers. These same conditions have also created the demand for rental income property from investors who still fear stock market uncertainty and don't expect an end to the imbalance in regional housing supply and demand for a long time to come," she said.

Condo-mapped properties carry a sales premium anywhere from 10 percent to 30 percent more than non-mapped properties and this can distort average sales prices, reports Burnham's Mack Langston.

"Mapped properties are acquired with the intent of converting and selling the individual units to homebuyers," he said. "The developer estimates selling prices, then subtracts rehab costs and expected profit to determine the purchase price, which in this market is always higher than properties that are being acquired for rental income. On the other hand, the value of rental units depends on the expected rental income those units will generate each year."

The ability of condominium developers to outbid apartment builders almost every time has had the effect of dramatically decreasing the number of apartment projects being constructed in the county today. This is a complete reversal from the late 1980s and early 1990s when construction defect litigation made condominium construction grind to a near standstill.

Burnham notes that values of apartment properties both with and without condo maps move in the opposite direction of interest rates.

"If rates rise significantly, the same homebuyers will not be able to afford today's condo prices," Langston said. "In the developer's business model, if the units are going to sell for less, the acquisition price has to decline accordingly. Similarly, at higher interest rates apartment investors will need more cash flow to cover the mortgage payment, which will drive down the prices they can afford to pay for apartment units."

While conversion had been all the rage, this too has taken a breather. CoStar Comps reports that of the 41 sales of properties with 10 or more units during the first quarter of 2005, four involved condo-mapped properties. This compares to 25 such condo-mapped property sales in the fourth quarter of 2004 and to 18 during the first quarter of 2004.

"Condo converters appear to be exercising more caution in their acquisitions compared to a year ago which reflects speculation about the future direction of condo prices and the increased inventory of converted condos for sale," said Low.

The average sales price of these converted properties in the first quarter of 2005 was $227,437, up 23.3 percent from $184,481 the previous quarter. However, on a per square foot basis, first quarter 2005 values were essentially flat at $226, compared to $228 in the previous quarter.

MarketPointe Realty Advisors reports the inventory of all new and converted condos in San Diego County was 6,258 units at the end of the first quarter, having risen for six consecutive quarters to the highest level since 1992.

During the first quarter of 2005, the average price of apartments without a condo map fell 5 percent to $126,732 per unit, representing 12.1 times the annual rental income. In the previous quarter the average price of non-mapped apartments reached a high of $134,040 per unit, or 12.5 times the annual gross rental income per unit.

"Even though first quarter data indicates that prices for both apartment and condo-mapped properties may have reached a plateau, the desirability of the San Diego market is such that values will always appreciate over the long term," said Low.

"The current apartment climate provides an opportunity to sell property for owners who want to get rid of property management or earn a higher return. It's also a great time for owners to obtain a condo map on their apartment properties to create the 'condo premium' and maximize the value they can achieve in a sale to a developer," she said.

As for whether the condominium conversion craze will last, Low said it is likely to continue for some time to come.

"As long as there is a housing shortage, there will be demand for more affordable housing and condo conversions are the best alternative," said Low. "Even though there is some decline in the premium for condo-mapped properties, we expect the demand for condo-mapped properties to remain strong for a long time.

"The one wild card is the political climate. The city of San Diego is considering several recommendations with respect to condo conversion, including mandatory inclusionary housing (and conversion restrictions), new parking requirements and underground utilities to name a few," she continued. "With more onerous requirements for conversions, it could become more difficult to supply the affordable housing that buyers are looking for."

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