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Apartment sales slow as condo conversions cool

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With investors waiting on the sidelines, apartment sales activity continues to struggle. But with a fundamentally strong market, a turnaround may be just a matter of time.

Burnham Real Estate reports condominium conversions have dropped to a trickle, and San Diego County apartment sales activity slowed for the sixth-consecutive quarter from April through June. George Carlson, vice president and apartment specialist with Burnham, doesn't seem too worried.

"This slowdown in apartment sales comes as no surprise given the 2004 and 2005 record years for conversion activity," Carlson said. "We expect sales to continue to slow as investors wait for prices to reach levels that are more in line with conventional apartment dynamics.

"Apartment properties had been in high demand by investors, particularly by those looking to convert them to condominiums to meet the high demand for more affordable San Diego housing."

Now, however, with the high prices and condominium conversion activity having pretty much run its course, Carlson said the dynamics have changed.

"As a result, following a decade-long run-up in pricing that was matched by record-high sales volumes, investment activity has cooled with potential buyers waiting on the sidelines for prices to adjust. How long this buyer's market will last remains to be seen, and certainly potentially higher interest rates will be a factor," he added.

A July Marcus & Millichap report reached similar conclusions, saying investors have generally been staying away and that high prices, relatively stagnant rents and high interest rates are obstacles to acquisition. That report also indicated some local apartment investors are looking outside this area in search of better returns.

According to the Burnham study, the sales of 186 apartment properties totaling 2,279 units during the second quarter 2006 were down 29.8 and 35.9 percent, respectively, from the 265 transactions totaling 3,557 units during the like period in 2005. Year-to-date, the 340 sales transferring 5,360 apartment units reflect similar decreases, declining 33.2 and 28.9, respectively, from 509 sales totaling 7,541 units in the comparable period a year ago.

Carlson says the slowdown in sales activity is the result of increasing investor concerns over cash flows due to high selling prices that are not supported by rental rates.

"The increasing municipal restrictions on conversions, coupled with higher interest rates that make first-time ownership more challenging for many would-be buyers, mean that more investors are looking at purchasing properties for longer-term investments and for achieving basic apartment investment fundamentals," he said. "However, until prices fall enough for these transactions to pencil out, sales activity will continue to slow.

"Generally, investors recognize San Diego as a very strong apartment market due to its low vacancy rates and continuing shortage of affordable housing. As a result, conventional apartment investment activity will continue to be stable."

The Burnham report showed three second-quarter sales involving 100 units or more: Regency Park La Mesa, a 188-unit community in La Mesa that sold for $27.5 million, or $146,276 per unit, to Ferber Properties of Solana Beach; Spring Villa Apartments, a 136-unit community in Spring Valley that sold for $18.5 million, or $136,029 per unit, to an entity of Hearthstone Housing Foundation of Mission Viejo; and Creekside Meadows Apartments, a 144-unit community in Alpine that sold for $16.14 million, or $112,083 per unit, to A.C. Limited Partnership of Eden Prairie, Minn.

"All three of these transactions were senior projects, which is an indirect indicator that major condo conversions may have run its course, at least for now," Carlson said.

One big transaction has happened since then.

Earlier this month the Transcript reported the sale of the 668-unit Villa Dorado at Mission Valley Apartments to The Irvine Co. for $182.5 million. Entities controlled by ING Clarion Partners were the sellers.

That property includes two spas, two resort-size swimming pools, a fitness and business center, a residents' lounge, a sand volleyball court and a movie theater.

The luxury units range from 610 square feet to 1,356 square feet in one- to three-bedroom floor plans. Rents range from about $1,200 to $2,300 per month.

Carlson said this tells him "that somebody is willing to pay a king's ransom for apartments here."

Leading San Diego County in second-quarter transactions was Inland North, with 30 sales of 302 units; followed by North Park with 21 sales of 115 units; and Golden Hill/Southeast San Diego with 17 sales of 158 units.

The numbers for the first half of 2006 reflect similar results: Inland North was the leader with 39 sales of 403 units; Hillcrest followed with 33 sales of 305 units; and North Park reported 31 sales of 168 units.

As for rents, the San Diego County Apartment Association reported the average rent in its spring vacancy survey was $1,147 per month, compared with $1,460 for Los Angeles and $1,390 for Orange County.

MarketPointe Realty Advisors, which limits its biannual surveys to complexes with 25 or more units, placed the average monthly rental rate in the county at $1,211 per month in March.

The average apartment vacancy was still only 3.4 percent in the spring, according to the SDCAA. MarketPointe had a 3.05 vacancy factor in its survey. Given that a 5 percent vacancy is the industry standard for balance, these figures show that the apartment market that remains quite tight.

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