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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.

Condominium conversions by year

  • Developers opened 28,400 new market rate apartment units between 2000 and 2007.[1]
  • 17,700 apartment units either converted or are planned to convert to condominiums since 2000.[2]
  • Conversions reduced the rental stock by 15,059 units.[3]
  • Conversions retained 2,700 rental units.[4]
  • Almost 4,700 rental units were created between 2000 and 2007 through the rental of new condominiums.[5]
  • Rental supply grew by 18,000 units between 2000 and 2007, after deducting units lost to conversions.[6]
  • The net increase in rental demand totaled 14,100 units between 2000 and 2007.[7]

Net apartment rental supply

  • Regional economic growth and net in-migration suggest rental demand would have been significantly greater than our region actually experienced between 2000 and 2007. Low interest rates, the emergence of the subprime mortgage market, the emergence of teaser-rate financing programs, along with government goals for increased homeownership, created demand substitution from rental to ownership housing. Condominium conversion is a natural market response to these events.
  • Renters move every two years on average.[8] This mobility makes it easy for renters to switch from apartments to condominiums or other types of for-sale housing when financial and other considerations favor such substitution. Condominium conversions expand the stock of for-sale housing beyond what would have otherwise existed. In addition, conversions also stimulate new apartment development sooner than it would other wise occur.[9]
  • Although apartment supply increased faster than new renter demand between 2000 and 2007, condominium conversions in the past two years took more units out of the rental market than developers added in the same period. That has not been the long-term trend and we do not expect it to continue beyond 2008.
  • Conversion activity will slow down due to a number of factors, including: higher interest rates for home buyers as well as investors in conversion projects, tougher loan qualification guidelines for both prospective home buyers as well as investors in conversions, higher apartment prices reducing margins for converters, and higher apartment rents reducing the incentive for investors to sell to converters.
  • Investors buying properties for ultimate condominium conversion continue to rent units for some period of time, usually raising rents before finally converting. However, rent increases in conversions average 4% compared to the 7% market-wide increase we currently forecast.[10]
  • Apartment construction activity is increasing. We forecast developers will open 13,300 new apartment units in 20-unit and larger properties in the next two years (2008-2009).[11]
  • After deducting estimated condominium conversions in 2008 and 2009, the rental stock is forecast to increase by 9,000 units in this two year period, an average of 4,500 units a year.[12] By comparison, excluding recent higher condominium conversion years, the rental stock grew an average 3,700 units a year between 1996 and 2003.[13]


[1] 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.

[2] 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.

[3] 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.

[4] 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.

[5] 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.

[6] 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.

[7] 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.

[8] 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.

[9] 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.

[10] 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.

[11] 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.

[12] 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.

[13] 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).

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Legal and regulatory bias towards conversions

By Steve Price
Terra Property Analytics LLC
ph (206) 213-0810

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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