As 2004 unfolds, San Diego County remains a very attractive market for apartment investors, as a limited supply of affordable housing has created record demand for rental units. Add to that, a national economic recovery and an improving local economy seem to be increasing buyer confidence in the apartment market.

Robert Vallera

In tracking the progression of San Diego's market to date, apartment vacancy rates had been increasing 12 months ago, leading up to the war in Iraq -- in part because of layoffs in the technology sector, and partly because of troop deployments.

That trend has now reversed. The apartment vacancy rate that peaked last spring has since been on the decline, bouncing back from a springtime high of 4.5 percent (which is still considered moderate by industry standards) to its current rate of around 3.12 percent, according to the San Diego County Apartment Association. The upscale rental market has experienced the greatest softening, while the lower end "bread & butter" rental units have fared the best.

Overall, the apartment market in San Diego is thriving right now. Interest rates have remained at a low level as the economy has continued to gain strength, allowing buyers to aggressively pursue acquisitions. As evidenced by the approximately 169 apartment properties sold in the county during the third quarter of 2003, investor demand is strong. Small transactions appear to be dominating the market activity, with 155 of those properties selling for less than $5 million.

Condo conversions still red hot

In 2003, the number of condominium conversions in San Diego reached record levels. More apartments were refurbished and sold as condominiums in the first three quarters of 2003 than in each of the previous three years combined. Of all the condo conversion projects in Southern California over the last four years, 90 percent were in San Diego.

In 2004, with San Diego's affordability index for home purchases having reached a new low (the median home price stands at $388,000), the demand for more affordable housing is as strong as ever. According to the San Diego County Association of Realtors, the average price of an attached house in the region through the first 10 months of 2003 was approximately $329,099. The average converted condo sells at $229,000 -- a difference of $100,000.

Without a doubt, both the renovation and condominium conversion of existing apartment properties are creating exciting opportunities for multi-family investors throughout much of San Diego County. This trend will continue to fuel the region's apartment market in 2004.

Condominium conversions have been focused most strongly on properties that either have approved "condo maps," and/or properties with floorplans and amenities that give them greater market acceptance for resale after condo maps have been processed. Ideal candidates for condo conversions include properties of mid-1980s or newer construction, with such amenities as garages, units with two or three bedrooms and two full baths, larger square footage units, more modern floorplans, washer/dryer hookups and fireplaces.

Older neighborhoods continue to rebound

Higher rent levels established over the last five years have allowed apartment investors to justify upgrading much of the older rental housing stock in San Diego County. Increasing traffic congestion countywide has increased the desirability of living in the older neighborhoods close to the urban core. Residents in these neighborhoods can access major employment centers without losing hours each week battling traffic on congested freeways.

Emerging neighborhoods, such as North Park, Normal Heights, City Heights, Golden Hill and Sherman Heights, offer quick and easy access, requiring little or no freeway commute to major employment centers such as downtown, Kearny Mesa and Mission Valley.

San Diego still a sellers market

In the coming year, San Diego may continue to be an exceptional sellers market. This will be fueled in part by the eligibility of Tenant in Common ("TIC") properties for 1031 exchanges, which make it easier for an investor to defer paying capital gains tax on the sale of real estate.

Some owners likely will opt to sell apartment buildings and reinvest in less management-intensive investments, including TIC or fractional ownership investment properties, and triple net leased properties. Other sellers will acquire investment properties outside of Southern California. Markets in the Southwest and Pacific Northwest are among those that currently are offering enticing investment opportunities for buyers.

Overall, the region's lack of land for new development and low vacancy rates means that the demand for housing will continue to exceed supply for the foreseeable future. This has created a strong rental environment that investors find appealing.

Moreover, with condo conversions and the continued revitalization of apartment properties in our older urban neighborhoods as strong trends, San Diego's apartment market will continue to offer a number of opportunities for both investors and sellers. Working with an experienced real estate broker well-versed in all facets of the apartment market can be helpful in obtaining accurate and current information, and in executing a transaction that will yield the highest possible return on investment.

Vallera is a senior vice president with IPC Commercial Real Estate, a full-service brokerage firm specializing in the sale and leasing of commercial properties, including office, retail, industrial, land and apartment communities; as well as property management. More information about the company is available online at www.ipccommercial.com.