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Commercial Real Estate Investment
Property
Indulging in Luxury Investments
Multifamily developers treat themselves to this upscale market.
by Christine Rombouts
While low interest rates and a hot home-buying market have dampened
multifamily development in recent years, select regions are experiencing
an increased demand for the deluxe from apartment dwellers. In Southern
California, the Mid-Atlantic, and South Florida, where housing is
scarce and land costs are high, some developers are fulfilling renters'
craving for quality with high-amenity multifamily complexes.
High land and construction costs and a move toward high-density
development are shaping this growing segment, along with shifting
demographics and cultural trends. As more Americans develop a taste
for the finer things in life, the challenge of marketing for-sale
and rental luxury multifamily will ease. But as demand grows, so
does competition, and smart developers and investors need to keep
their pencils sharp to create value and numbers that work.
"In the next two years or so, most markets will be healthy enough
to support new luxury multifamily construction," says Ron Witten,
president of Witten Advisors in Dallas . "I'm telling my investor
clients to buy now, while they can, because a recovery is expected.
There will be a substantial uptick as occupancy rates and rents
rise, which means bigger cash flows."
In addition, developers and investors should continue to watch
markets where job and population growth are strong, says John Burns,
president of John Burns Real Estate Consulting in Irvine, Calif.
A number of smaller markets are emerging on experts' radar screens,
including Jacksonville and Daytona Beach, Fla., Austin, Texas, Sacramento,
Calif., San Antonio, Nashville, Tenn., Indianapolis, Fayetteville,
Ark., St. Louis, and Kansas City, Mo., Burns says.
Tapping Into the Market Currently fundamentals don't support
luxury product in many secondary markets, Witten says. However,
some adventurous developers are exploring opportunities in particular
cities. For example, Turnberry Associates developed a successful
upscale condominium property near the Strip in Las Vegas , traditionally
not a luxury market, Burns says. "The same was true for San Diego
and Orange County until [recently]. Luxury condo markets are markets
of 'If you build it, you hope they'll come.'"
To ensure successful entry into new markets, developers need to
gauge pricing and timing. For instance, analyzing single-family
home prices is important, says Eric Martin, vice president of development
for Bosa Development Corp., headquartered in Burnaby , B.C. Bosa
builds U.S. high-rise luxury condominiums that cost up to $250 per
square foot and prices them between $500,000 and $2 million. "We
don't want to build in a community where our prices will result
in sticker shock to our prospective buyers," Martin says. "These
buyers are usually empty nesters seeking a simpler, hassle-free
lifestyle that a high-rise condominium can offer. We want them to
be able to cash out the equity in their [single-family] home to
purchase one of our high-rise condominiums."
Timing is another critical consideration, says Thomas P. Cox, senior
principal of Irvine, Calif.-based Thomas P. Cox: Architects. "For
a high-rise, the construction takes up to two years or more, and
60 to 80 percent of the units have to be pre-sold before the developer
can secure financing. It's a whole new mind-set."
Holding the Line on Costs While a slowly improving economy
holds promise for future luxury multifamily, today's developers
struggle to manage construction costs for both luxury rental and
for-sale properties. While building-supply costs skyrocket based
on global and national demand, housing prices are constrained by
local economic factors.
In some cases this pricing dichotomy has forced developers into
building a higher-priced product. "Construction and land costs have
played a huge role, especially in areas where there is so much competition
for building product," says Mark Cassidy, president of Pacific Properties
in Las Vegas . "Our total project costs have gone up about 12 percent
over the last 18 months. We tried to build a B product, but we couldn't
make it work financially."
While developers can pass some rising costs on to the more affluent
buyers and renters who occupy luxury multifamily units, financing
often requires substantial capital outlays, Burns says. "The return
on capital doesn't occur for several years. There is little ability
to phase construction, so pro forma profit margins should be much
higher than traditional home builder profit margins."
With rising steel and concrete prices making it more difficult
to control construction costs, lenders are skittish about financing
projects, often requiring a developer to put up 20 percent to 30
percent equity, Martin says. "If the developer has $20 million to
$30 million of his own money in a $100 million project, the lenders
are more comfortable and it increases their expectation that the
project will be completed."
While financing is a major obstacle, finding the right site is
nearly as difficult. "One of the biggest challenges for our company
is finding viable sites to build our high-rise communities," says
Nat Bosa, founder and president of Bosa Development. "Urban sites
in the geographic markets where we build are getting more difficult
to find and acquire. Our site requirements are very specific, such
as nearby community amenities including retail, entertainment, and
recreation facilities that our residents want to live close to.
Finding these sites is a real challenge."
Capitalizing on Changing Demographics While the climate
varies from market to market, developers around the country concur
that a new breed of sophisticated urban residents is spurring luxury
multifamily growth. While most of these residents can afford to
own a single-family home, they prefer the flexibility of apartment
or condominium living.
Emerging luxury product types target couples with no children,
singles, and empty nesters. These occupants want unique communities
to fit their lifestyles and life stages. To appeal to these residents,
builders have to provide exceptional floor-plan designs, distinctive
architecture, lifestyle conveniences, and five-star luxuries.
A cultural trend of trading up to luxury items, documented by the
Boston Consulting Group, also is fueling the growth of luxury multifamily
housing. Housing tops the list of items that consumers are willing
to spend "as much as they can or more for," according to Trading
Up: The New American Luxury, published by BCG.
"Luxury is all we're doing now," says Greg Currens, a principal
of Style Interior Design in Irvine, Calif. "The specifications and
quality are going up multiple levels. Luxury property developers
are upgrading everything and not just the unit specs. We're also
seeing more attention being paid to the corridors, garages, and
elevators. It's not just about materials, it's about design. It
has to be unique, something different than the other properties
in the market."
Growing interest in high-rise living also is driving luxury multifamily
development. For instance, Bosa currently has four projects in downtown
San Diego with more on the drawing board and recently sold out Marquee
Park Place, a two-tower, 18-story, 232-unit luxury condominium complex
in Orange County. The project's units ranged from $600,000 to $1.8
million. Based on the overwhelming response, the company now is
planning additional high-rise developments in the area.
Downtown redevelopment movements nationwide also are fueling the
luxury multifamily niche. "When the urban trend started a few years
ago, most renters and home buyers were young singles or childless
couples," says Cox. "Now we are seeing empty nesters who want a
simpler lifestyle, as well as the children of empty nesters who
don't want to live in the suburban environment their parents lived
in."
Demand for shorter commutes and less traffic congestion also play
into this trend, Burns adds. "As urban and suburban areas grow together,
more pressure is being placed on housing developers to figure out
ways to get housing closer to jobs."
The Conversion Craze As in the traditional multifamily market,
developers are converting luxury rental properties to condominium
projects at a feverish pace. Many units already are equipped with
the features and options typically found in luxury condominiums,
making conversion an easy transformation. This tactic has been popular
in the last few years as home prices have increased and rents have
fallen in most markets.
"Since rental revenues are low and condo revenues are high, it
makes a lot of sense to convert," Burns says. "I expect the condo
conversion boom to last several more years because the for-sale
housing market will remain strong. Conversions are not that risky
and the units can always be rented if mortgage rates rise."
Upscale condominiums already line the streets of affluent neighborhoods
in Miami, Chicago, New York, and other major cities. Now they're
starting to pop up in other areas such as Las Vegas and Orange County
. "We have about 900 A+ rental units in the Las Vegas area and we're
going to convert all of them because the margins are so much higher,"
Cassidy says.
Converting also makes sense from an investment angle. "For investors
discouraged by weak apartment fundamentals, converting to condos
provides an opportunity to cash out near the top of a housing boom,"
says William Ktsanes, director of research and analysis with RealFacts
in Novato, Calif. "For many, it is a profitable exit strategy from
a weak apartment market."
For other investors, the cost of acquiring, upgrading, and converting
multifamily properties is far less expensive and time-consuming
than new development. And an existing building in relatively good
shape substantially reduces construction risk. "Frankly, we can
bring [condominiums] into the marketplace at much more reasonable
prices than we could from the ground up," says Geoffrey Stack, managing
director of Sares Regis Group. Many developers are converting rental
products that are still in relatively good shape, although "we still
have to invest a substantial amount of capital for major rehab,"
he notes.
Continued Success? As demand increases for luxury product,
the field is expanding. "Growing consumer interest in this product
type is attracting developers from other sectors of the real estate
industry, including commercial, retail, and single-family developers,"
Cox says. The competition already is fierce in certain markets:
"As land becomes more scarce in areas like Southern California,
luxury high-rise housing is luring more companies."
Although the luxury multifamily market is gaining new entrants,
experts predict that the rising cost of building new, high-density
for-sale and rental housing - especially in urban areas where land
costs are high - will thin the competition. Larger developers, such
as real estate investment trusts and national companies, may push
small local developer/owners out of business. Smaller builders must
innovate to stay in the game.
"Development companies . will have to utilize newer, better construction
methods such as modular construction, off-site manufacturing, and
pre-fabrication," Cox says. He adds that many of these techniques
can help save time and money, improve and control quality, eliminate
waste, and bolster the projects' return on investment.
It's a "balancing act requiring excellent design, efficient construction,
strategic marketing and sales, and tight budget management," Bosa
adds.
Copyright © 2005 CCIM Institute. All rights reserved. For more
information call 312.321.4460 or e-mail
us.
Original source: http://www.ciremagazine.com/20050407.htm
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