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Condominium conversion and its impact on the rental market
Published July 21, 2007
July 20, 2007 - Chris Cordes, the Assistant Director of the Office of Program Research for the Washington House of Representatives asked us to provide some data about condominium conversion trends in preparation for a Housing Committee meeting on August 3rd in Seattle to discuss the effect of condominium conversion on affordable housing.
 This information is for 5-unit and larger properties. The total amount of development was 28,374 units. Our April 2007 edition of The Apartment Development Report shows 26,955 market rate apartment units opened in the 2000-2007 time period in 20-unit and larger properties. We do not publish a report for 5-19 unit properties, or survey developers, architects, etc. for information on these developments. However, we do maintain a database of 5-19 unit properties for our rental and investment market research. Based on the relationship between the inventory of 5-19 unit properties compared to 20-unit and larger properties built since 1990, we estimate 1,419 market rate apartment units were added in 5-19 unit properties between 2000 and 2007. This represents 5% of the total market rate apartment units added in this period.
 This information is for 5-unit and larger properties. The total number of units converted in this time period is 17,717. This information is from our June 2007 publication, the Condominium Conversion List. The list reports properties that either have converted to condominiums or plan to convert to condominiums. Although the June report covers only a partial year, the total reported here is a reasonable total for the entire 2000-2007 time period because most future buyers of apartment properties intending to convert those units to condominiums will most likely not have time to complete or even begin the conversion process until next year. In addition, we have begun to see instances of a shift in the market, where condominiums are converting to apartments.
 The total number of units converted in this time period is 17,717. Between 10 and 20% of all condominium units are rented rather than occupied by the homeowners. This figure is based on sample research we have conducted and interviews with condominium converters, condominium marketing firms, developers, and lenders. There are exceptions on both the low and high side, include one large property where we were informed more than 40% of the condominiums were occupied by renters rather than homeowners. Based on an average of 15% rentals, we estimate that 15,059 units in condominium conversions are occupied by homeowners.
 Based on 17,717 condominium conversion units between 2000 and 2007 and 15% of those units occupied by renters rather than homeowners. The result is 2,658 rental units.
 Conway Pedersen Economics reports multifamily permits between 2000 and 2007 in King, Pierce, Snohomish, Kitsap, and Island counties totaled 73,000 units. Deducting the 28,374 market rate apartment units opened in that period leaves 44,626 permitted units that were not market rate apartments. We estimated 30% of those units were either outside King, Pierce, and Snohomish counties, or were non-profit or subsidized rental housing, or were not built. That leaves 31,238 units as estimated condominium construction between 2000 and 2007. If 15% of those units are rented rather than occupied by homeowners, condominium development between 2000 and 2007 added 4,686 additional rental units.
 This is from the combination of 10,657 additional units in traditional market rate apartments after deducting the impact of conversions, 2,658 units in apartments that converted to condominiums between 2000 and 2007, and 4,700 units in new condominium development between 2000 and 2007.
 The net change in demand totaled 14,121 units. This is based on 5,708 units in 20-unit and larger apartments between March 2000 and March 2007, based on our April 2007 edition of The Apartment Vacancy Report. We estimated the net increase in rental demand between 2000 and 2007 was 1,362 units in 5-19 unit properties, 2,658 units in condominium conversions, and 4,686 units in new condominium construction between 2000 and 2007.
 Our Fall 2006 edition of The Apartment Vacancy Report shows that the average annual turnover in apartments was 49.8% in the five years ending September 2006. That equates to an average tenure of two years.
 Conversions reduce the number of rental units resulting in lower vacancies and higher rents which lead to improved financial feasibility for new apartment development, as demonstrated by our 2009 forecast.
 Our weekly update of The Apartment Investment Report shows that apartment properties sold so far in 2007, scheduled to convert to condominiums, had anticipated gross income 4% above the gross income at the time of purchase. The rent forecast is from our April 2007 issue of The Apartment Advisor.
 This is based on our forecast of 12,643 new units in 20-unit and larger developments, published in the April edition of our Apartment Development Report, plus an estimate of 665 units in 5-19 unit market rate rental developments (based on the traditional relationship between smaller and larger property activity discussed elsewhere in the memorandum). Our forecast for the next 12 months has typically been close to actual development. Our forecast for the period 13-24 months out has overstated actual development in recent years. However, we have not changed our forecast methodology because we believe the overstatement until now was the result of a deteriorating rental market making projects less feasible each month. Now, however, we anticipate an improving rental market should correct that error.
 Our development forecast (discussed above) expects 13,000 new apartment units between 2008 and 2009. In addition, new condominium construction estimated at 13,000 units will generate 2,000 rental units. We estimated 7,000 units of condominium conversions, with 85% of those units occupied by homeowners, for a net loss of 5,950 rental units.
 The net annual average increase in rental stock is based on the net change in the rental stock published in the online edition of our Apartment Development Report updated in April 2007 and also adjusts for additions from 5-19 unit apartment developments, and rental units in new condominium construction during that period (estimated as 50% of total 20-unit and larger apartment development).
We received a lot of positive comments about this article. we felt the following comments were worth shating with you. If you would like to comment on this or other articles, either fill in the comments form at the bottom of this article, or email us. If you would like to comment, but prefer to remain anonymous, just check "no" on the "May we quote you" line in the comments form at the end of this article.
Legal and regulatory bias towards conversions
August 2, 2007 - The current legal and regulatory environment biases developers towards condominium conversions and away from new apartment construction. On the cost side, an identical conversion unit will cost approximately $7,000 less to produce due to a much lower cost for builder's liability insurance.
On the timing side, conversions are faster to complete and do not require the long permitting time of new construction. Faster turnaround means less risk that the market will change, demand will disappear, interest rates will move higher, loan underwriting will change, or construction costs rise.
On the risk side, new condominium construction faces a significantly increased potential for construction defect litigation. Some of that is changing with more experienced builders doing a better job of exterior envelope construction on new construction and having staff or consultants establish repair, maintenance, and service relationships with individual unit owners following the sale.
Recently, the weak market for builder’s insurance in the rest of the country means that premiums have declined significantly, but that is cyclical and may not last.
Most of the proposed "reform" of the condominium act has been too biased and thankfully never passed. But there is a role for strong industry, legislative, and consumer action to help reduce the defects and litigation associated with new condominium development.
It is not necessarily a good thing that the current Washington Condominium Act is biased toward homeowner associations. On the flip side, producing poorly built housing is not socially helpful and ends up increasing housing costs for all.
Editor's note: This is the complete article.
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