Equity Residential made quite a splash in 2004 when the behemoth apartment REIT chaired by billionaire investor Sam Zell made its first foray into Manhattan's rental market. The Chicago-based company spent $93.1 million to buy Hudson Crossing, a 259-unit apartment complex on the western edge of Midtown.

The price wasn't steep enough to raise eyebrows. But the deal was exceptional for another reason. Unlike most investors that had recently bought New York City apartment buildings, Equity Residential chose not to convert Hudson Crossing into high-priced condos.

Alan George, chief acquisitions officer at Equity Residential (NYSE: EQR), says it wasn't an easy decision. “Condo conversion is like a drug. It's very hard to resist doing this in a market like Manhattan,” says George. Equity Residential has spent more than $1.07 billion on Manhattan apartment properties over the past four years, including shelling out $816 million to buy Trump Place, a three-building apartment complex.

Signs of the late-stage condo boom are hard to ignore. Some corridors of the city are so crowded with shiny glass condo towers that entire block-long stretches of sidewalk are hidden beneath protective sheds.

Supply concerns

These new units, many of which aren't flying off the shelves, are fueling speculation that New York City is facing a condo glut. Miller Samuel, a local appraisal firm, reports that 3,535 new condo units hit the Manhattan market in the second quarter compared with 1,827 units for the same period a year ago, a 93.5% increase.

One hotspot is West 18th Street, which cuts across the eclectic Chelsea district. No less than three condo towers, all conversions or new construction located within as many blocks of one another, have risen along this street within the past two years. Developers aren't being too picky about sites, either. One 15-story project rising on Seventh Avenue and 19th Street is being developed adjacent to one of the city's busier fire stations.

There's just one problem. Many of these new condo units are colliding with slackening demand. Miller Samuel reports that only 1,934 Manhattan condo units were sold during the second quarter this year, a 14.8% decline from the same period in 2005. That drop is significant because the second quarter typically generates the highest sales volume of the year.

Ripple effects from this overabundant condo market are changing the way some investors view the market. Specifically, the flood of condo units is steering some investors toward the rental market, which in New York boasts incredibly low vacancy rates and rising rents. As George of Equity Residential puts it, New York City's tight rental vacancy and huge barriers to entry are extremely attractive features for any investor.

Rental calculus

There's no question that New York City's strong real estate fundamentals, propelled by a growing economy and a scarcity of land, are enticing for investors. Real estate research firm Reis Inc. reports a 2.9% apartment vacancy rate in New York City at mid-year, the lowest of any major U.S. market. Manhattan, the epicenter of New York City condo development, registered a paltry 0.5% apartment vacancy rate at mid-year.

“[Apartment] vacancy is extremely low in the New York City market, especially in Manhattan,” confirms Dr. Sam Chandan, chief economist at Reis. His firm tracks 143,221 investment-grade rental units throughout all five boroughs. Most of those units are located in Manhattan.

“You also have so much demand in this market because it's so expensive to buy condos or co-ops in the entire city,” he says. Chandan adds that two-thirds of all residents living in the New York City metro area rent apartments. For the nation as a whole, however, the reverse is true: roughly two-thirds of all Americans own their homes.

The New York City market certainly is not cheap. Based on data from the National Association of Realtors, the median sales price of a single-family home in the New York metro area registered $458,500 at the end of March compared with a national average of $217,900. The flip side, however, is that New Yorkers take home fatter salaries than most Americans. According to the Bureau of Labor Statistics, per capita income in the New York metro area averaged $43,277 in 2005. That registered 31% higher than the national average of $33,050.

This buying power, propelled by lofty bonuses paid out to Wall Street executives, is what condo converters have bet on in recent years. Plus, as residential values have soared since 2001, condo conversion activity has followed suit. Nearly all new housing units added to Manhattan's inventory in the past three years have been delivered as condos, be it new construction or conversion from rental buildings, reports Miller Samuel.

Chandan, the Reis economist, notes that many older apartment buildings, not to mention office buildings, have been converted into condos. He credits this conversion trend for thinning the rental inventory by 7,345 units over the past three years.

Chandan declines to estimate how many additional units will be thinned out of the rental inventory over the next few years. Like other New York real estate experts, Chandan believes that a certain number of condo conversion projects will switch gears to rental use in the coming months.

Conversion-led sales momentum

Apartment investors looking for deals may actually benefit from a slowdown in conversion-led apartment sales. The reason? Condo-mania, which has pitted aggressive buyers against each other for deals, has chiseled away at apartment yields. The average capitalization rate — the initial return based on the purchase price — on Manhattan apartment buildings fell by 100 basis points to hit 4% between mid-year 2005 and 2006, reports Real Capital Analytics, which tracks sales $5 million and higher.

No other market in the U.S. posted such a sharp decline in apartment cap rates during the period. According to Dan Fasulo, Real Capital Analytics' national director of market research, Manhattan's $2.5 billion deal volume during the first half of 2006 represented almost 40% of all mid- and high-rise sales volume in the nation.

It's easy to see why. Converters have spent more than $12 billion buying up older apartment and office buildings in New York City over the past two years, reports Real Capital Analytics. During the preceding two-year period, converters spent less than one-quarter of that total on apartment buildings. It also appears that 2005, which broke the record for the single-most expensive apartment sale to a condo converter, was a peak year for conversion-led apartment sales (see sidebar, p. 46).

Paring down the number of rental units proved healthy for the apartment market, but the trend won't likely last. At least one local sales broker says that conversion deals are becoming increasingly rare in the New York City market (see sidebar, p. 48).

“The capital markets have really shut down on these conversion projects,” says Jeffrey Appel, managing director of Manhattan-based residential brokerage Pari Passu, who hasn't come across any new conversion loans of $100 million or more over the last eight months.

According to Appel, the average price of a new condo unit in Manhattan has fallen by as much as 10% over the past six months. It's a different story on the rental side of the aisle. Appel says that some Manhattan apartment rents have risen by as much as 10% during that period.

Meanwhile, the average rent for a New York City apartment unit rose by 6.7% between the end of 2005 and mid-year 2006. The average rent in New York City registered $2,469 per month at mid-year, up 1.6% from the end of March.

The trend of falling condo prices and rising apartment rents has not gone unnoticed by investors, either. Local sources believe that an increasing amount of capital will flow into new rental development in the next few years. There is already a fair amount waiting in the wings.

According to the New York City Rent Guidelines Board, which tracks new apartment growth in the city, 20,382 new rental units were completed in 2005, the largest number in any year since the mid-1970s when federal housing construction brought 21,000 units to the market. Permits for roughly 31,559 new rental units were issued in 2005, up by more than 6,000 units in 2004.

Sources credit two trends for this jump in new rental supply. Years of rezoning campaigns have left many areas of the city, particularly large swaths of lower Manhattan and the Brooklyn waterfront, ripe for residential development.

Couple that with New York City's ability to boost apartment rents every year for the past 15 years and it's easy to understand why developers have raced to get building permits in recent years.

Trusts remain active

One thing that's fairly certain is that New York City's apartment market will continue to lure hordes of capital. REITs such as Equity Residential, Archstone-Smith and AIMCO are leading the charge. Up until two years ago, the REITs largely avoided this market.

But the seeds of that change were planted in 2002. That year, Archstone-Smith spent $209 million to buy 101 West End Avenue, a high-rise apartment complex on Manhattan's upper West Side.

Archstone-Smith also plunked down another $125 million in 2004 to buy a rental tower on East 39th street. Both apartment buildings, which Archstone continues to own and operate, remain rental properties.

Only two years after its Hudson Crossing deal, too, Equity Residential continues to whet its appetite for Manhattan apartments. Last summer, for example, the REIT spent $803 million to buy Trump Place, a 1,325-unit high-rise located on Manhattan's far west side. That deal now stands as the second most expensive apartment acquisition in Manhattan history.

But a record breaker may be in the offing. In July, insurer MetLife announced plans to sell its sprawling rental apartment campus, known as Peter Cooper Village and Peter Stuyvesant Town, for an undisclosed price. The 11,200-unit complex, which straddles seven acres of land below East 23rd street, contains the most units of any single apartment complex in New York City.

For the past four years, MetLife has been selling off its real estate holdings. MetLife stated publicly that it will only entertain “acceptable” offers on the Peter Cooper Village and Peter Stuyvesant Town complex. In early August, the insurer hired CB Richard Ellis to market the complex. Neither CB Richard Ellis nor MetLife were willing to discuss the sale as of late August.

Analysts and local brokers believe that the campus could fetch as much as $4 billion. A sale of that magnitude, of course, would enable bidders to place a record-breaking bet on the future of Manhattan's residential market. And the possibility of 11,200 condo units hitting the market at some future point could be huge.

“This could be such a large deal that it might attract a group of private equity firms or some combination of private equity and REITs,” according to Fasulo of Real Capital Analytics. “Nobody really has any sense of what the pricing could be on this deal though.”

One REIT that Fasulo expects will eye this deal is Equity Residential. The REIT has a solid track record of buying large rental complexes in Manhattan in recent years. George, the chief acquisitions officer with Equity Residential, declined to comment on whether or not the REIT is seriously considering a bid on the complex, but his remarks certainly left the door wide open for such a bid.

“I think it's a fascinating deal, but it would be quite a challenge,” says George. “It's something we would look at, though.”

Parke Chapman is the senior editor of NREI

REITS TAKE MANHATTAN BY STORM

Private investors have sold into a wave of institutional apartment demand over the past four years. REITs have driven much of that demand, too.

Year Buyer Property Price (Millions) Seller
2002 Archstone-Smith 101 West End $209 Tishman Speyer
2003 AIMCO 311-313 E. 73rd $37.5 Primrose Corp.
2004 Archstone-Smith 300 E. 39th $125.5 Related Cos.
2005 Equity Residential 180 Riverside Dr. $339.3 Extell Development
2006 Archstone-Smith 235-245 E. 40th $165 Glenwood Management
Source: Real Capital Analytics

NEW YORK - BY THE NUMBERS

METRO POPULATION: 9 million

Source: U.S. Census Bureau

UNEMPLOYMENT RATE: 4.6%

Source: New York State Department of Labor

LARGEST EMPLOYERS:

  1. Columbia University
    15,000 employees
  2. Merrill Lynch
    13,000 employees
  3. Mount Sinai Medical Center
    13,000 employees

Source: New York City Chamber of Commerce

METRO AREA VITAL SIGNS

Office:

7.8% vacancy, 2Q 2006

9.8% vacancy, 2Q 2005

$43.46 rent per sq. ft., 2Q 2006

$40.80 rent per sq. ft., 2Q 2005

Source: Cushman & Wakefield

Multifamily:

2.9% vacancy, 2Q 2006

3.2% vacancy, 2Q 2005

$2,432 avg. effective rent, 2Q 2006

$2,105 avg. effective rent, 2Q 2005

Source: Reis Inc.

Retail:

5.7% vacancy, 2Q 2006

6.0% vacancy, 2Q 2005

$113 rent per sq. ft., 2Q 2006

$100 rent per sq. ft., 2Q 2005

Source: Marcus & Millichap

Industrial:

4.0% vacancy, 2Q 2006

5.6% vacancy, 2Q 2005

$25.11 rent per sq. ft., 2Q 2006

$22.30 rent per sq. ft., 2Q 2005

Source: Grubb & Ellis

Hotel:

87.4% occupancy, 2Q 2006

87.5% occupancy, 2Q 2005

$241.06 average daily rate, 2Q 2006

$211.55 average daily rate, 2Q 2005

Source: Smith Travel Research

MAJOR PROJECTS:

Atlantic Yards, the largest mixed-use project ever proposed for Brooklyn, will create 6,800 new rental units and roughly 600,000 sq. ft. of office space. The controversial 22-acre project will also feature a 58-story tower that's slated to become the tallest building in Brooklyn.

Cost: $3.5 billion

Developer: Forest City Ratner Corporation Property Co.

Completion: 2010

The Goldman Sachs Tower, rising at West and Vesey St. across from the original World Trade Center site, is a 43-story office tower with 1.5 million sq. ft. of office space. The LEED-certified, 740-ft. tall building will become one of the largest sustainable buildings in the nation. The Manhattan-based bank plans to relocate more than 75% of its 12,000 New York City personnel to the tower.

Cost: $2 billion

Developer: Bovis Lend Lease

Completion: 2009

Blockbuster sale highlights condo frenzy

To understand the lengths that condo converters will go to acquire prime New York City apartment buildings, consider a former rental apartment property on the Upper East Side of Manhattan. The mega-deal occurred last November when the 583-unit, white-brick apartment tower known as Manhattan House sold for a record $625 million.

At roughly $1.07 million per unit, the Manhattan House sale now stands as the highest amount ever paid by condo converters to buy an existing apartment building in the U.S. The joint venture entity of Manchester Real Estate and O'Connor Capital Partners bought Manhattan House from insurer New York Life.

Manhattan isn't the only market to go condo crazy in recent years. In fact, data from Manhattan-based real estate research firm Real Capital Analytics shows that roughly 180,000 rental units nationwide were lost to condo conversion projects in 2005 compared with less than half that amount in 2004.

“The condo converters are very aggressive buyers who aren't interested in long-term holds,” says Dan Fasulo, director of national research at Real Capital Analytics. “That makes them [essentially] flippers, so they are willing to pay a lot to secure properties, and then sell them out.”

The Manhattan House deal mirrors a national trend that appears to have run its course. Condo converters bought 203,000 rental units in 2005, a sharp increase above the 80,000 units that this investor group acquired in 2004. But 2005, as it turns out, was a peak year. The number of units acquired by converters has fallen consistently over the past four quarters. The second quarter of 2006 saw just 12,000 units sold to conversion interests — and that was the lowest quarterly acquisition volume since the beginning of 2004.

Another shift in the market involves pricing. Real Capital data shows that 20 mid- and high-rise apartment properties sold for $100 million or more during the first half of this year. While that was the same volume as the first half of 2005, condo converters were behind only 30% of these $100 million-plus deals this year. The first half of last year was a different story: Condo converters represented 70% of those nine-digit acquisitions.

On a market basis, New York City led the nation with $3.8 billion in apartment sales through the first half of 2006. That volume only takes into account sales of mid- and high-rise apartment buildings, which have arguably lured the most investor capital in recent years. The second most active market for mid- and high-rise apartment sales during that period was the Washington, D.C./Northern Virginia region that saw $1 billion in sales.

“Conversion buyers are definitely slowing down because some of these markets are really oversupplied with new units,” explains Fasulo of Real Capital Analytics. “And they have pretty much pulled back from buying in New York City, too.”
— Parke M. Chapman

Condo converters face new lending hurdles

Lenders have inundated the New York City condo market with capital, much of it earmarked for condo conversions. But the subsequent deluge of units that have hit the market over the past three years has soured some lenders on the market. As a result, many are closely scrutinizing potential deals or choosing to finance rental conversions.

“There are definitely fewer new condo projects being financed now than there were 12 months ago, but we're seeing plenty of capital flow into the [rental conversion] market,” says Andrew Singer, principal at Manhattan-based real estate finance firm Singer & Bassuk. His firm has arranged more than $4 billion in construction loans for New York City rental projects and conversions over the past three years.

“Lenders realize that the New York City market needs more rental units. Plus, with such great demand to rent these units, landlords can boost rents,” adds Singer.

In June, Singer arranged a $100 million construction loan on 67 Wall Street. The 25-story, 325,000 sq. ft. Lower Manhattan office building will be converted into 211 rental units with ground-floor retail space. The owners of 67 Wall Street, private investors Nathan Berman and Ronny Bruckner, expect this apartment conversion to be completed early next year.

“Condo lenders are really scrutinizing these deals before they commit any capital,” says Steve Kohn, president of Manhattan-based Sonnenblick-Goldman. But there is still money for experienced and well-capitalized players. “They want to see a condo converter with a solid track record, and they also want the borrower to have liquidity in case something goes wrong.”

Mezzanine debt, which enables borrowers to finance nearly the entire deal through high interest-rate loans, is still readily available. Singer of Singer & Bassuk says that the super-competitive market to place mezzanine debt is masking larger changes in condo underwriting, too. But he believes that lenders have noticed and begun to worry about what he calls an “endless supply” of new condo units that have been developed in the city.

Supply isn't the only problem. Rising mortgage rates, which make it harder for condo buyers to afford units, may also be souring demand. According to Freddie Mac, the interest rate on a 30-year mortgage was 6.78% at mid-year, up from 6.35% at the end of 2005. It's the same story for the one-year adjustable rate mortgage (ARM), which increased 60 basis points to hit 6.35% at mid-year.

“The next few years will continue to see modest growth in New York City apartment rents,” says Sam Chandan, chief economist at research firm Reis Inc. “But if lenders believe that condos will appreciate by 20% every quarter, you can bet they'll keep financing them.”
— Parke M. Chapman

Rental calculus

There's no question that New York City's strong real estate fundamentals, propelled by a growing economy and a scarcity of land, are enticing for investors. Real estate research firm Reis Inc. reports a 2.9% apartment vacancy rate in New York City at mid-year, the lowest of any major U.S. market. Manhattan, the epicenter of New York City condo development, registered a paltry 0.5% apartment vacancy rate at mid-year.

“[Apartment] vacancy is extremely low in the New York City market, especially in Manhattan,” confirms Dr. Sam Chandan, chief economist at Reis. His firm tracks 143,221 investment-grade rental units throughout all five boroughs. Most of those units are located in Manhattan.

“You also have so much demand in this market because it's so expensive to buy condos or co-ops in the entire city,” he says. Chandan adds that two-thirds of all residents living in the New York City metro area rent apartments. For the nation as a whole, however, the reverse is true: roughly two-thirds of all Americans own their homes.

The New York City market certainly is not cheap. Based on data from the National Association of Realtors, the median sales price of a single-family home in the New York metro area registered $458,500 at the end of March compared with a national average of $217,900. The flip side, however, is that New Yorkers take home fatter salaries than most Americans. According to the Bureau of Labor Statistics, per capita income in the New York metro area averaged $43,277 in 2005. That registered 31% higher than the national average of $33,050.

This buying power, propelled by lofty bonuses paid out to Wall Street executives, is what condo converters have bet on in recent years. Plus, as residential values have soared since 2001, condo conversion activity has followed suit. Nearly all new housing units added to Manhattan's inventory in the past three years have been delivered as condos, be it new construction or conversion from rental buildings, reports Miller Samuel.

Chandan, the Reis economist, notes that many older apartment buildings, not to mention office buildings, have been converted into condos. He credits this conversion trend for thinning the rental inventory by 7,345 units over the past three years.

Chandan declines to estimate how many additional units will be thinned out of the rental inventory over the next few years. Like other New York real estate experts, Chandan believes that a certain number of condo conversion projects will switch gears to rental use in the coming months.

Conversion-led sales momentum

Apartment investors looking for deals may actually benefit from a slowdown in conversion-led apartment sales. The reason? Condo-mania, which has pitted aggressive buyers against each other for deals, has chiseled away at apartment yields. The average capitalization rate — the initial return based on the purchase price — on Manhattan apartment buildings fell by 100 basis points to hit 4% between mid-year 2005 and 2006, reports Real Capital Analytics, which tracks sales $5 million and higher.

No other market in the U.S. posted such a sharp decline in apartment cap rates during the period. According to Dan Fasulo, Real Capital Analytics' national director of market research, Manhattan's $2.5 billion deal volume during the first half of 2006 represented almost 40% of all mid- and high-rise sales volume in the nation.

It's easy to see why. Converters have spent more than $12 billion buying up older apartment and office buildings in New York City over the past two years, reports Real Capital Analytics. During the preceding two-year period, converters spent less than one-quarter of that total on apartment buildings. It also appears that 2005, which broke the record for the single-most expensive apartment sale to a condo converter, was a peak year for conversion-led apartment sales.

Paring down the number of rental units proved healthy for the apartment market, but the trend won't likely last. At least one local sales broker says that conversion deals are becoming increasingly rare in the New York City market.

“The capital markets have really shut down on these conversion projects,” says Jeffrey Appel, managing director of Manhattan-based residential brokerage Pari Passu, who hasn't come across any new conversion loans of $100 million or more over the last eight months.

According to Appel, the average price of a new condo unit in Manhattan has fallen by as much as 10% over the past six months. It's a different story on the rental side of the aisle. Appel says that some Manhattan apartment rents have risen by as much as 10% during that period.

Meanwhile, the average rent for a New York City apartment unit rose by 6.7% between the end of 2005 and mid-year 2006. The average rent in New York City registered $2,469 per month at mid-year, up 1.6% from the end of March.

The trend of falling condo prices and rising apartment rents has not gone unnoticed by investors, either. Local sources believe that an increasing amount of capital will flow into new rental development in the next few years. There is already a fair amount waiting in the wings.

According to the New York City Rent Guidelines Board, which tracks new apartment growth in the city, 20,382 new rental units were completed in 2005, the largest number in any year since the mid-1970s when federal housing construction brought 21,000 units to the market. Permits for roughly 31,559 new rental units were issued in 2005, up by more than 6,000 units in 2004.

Sources credit two trends for this jump in new rental supply. Years of rezoning campaigns have left many areas of the city, particularly large swaths of lower Manhattan and the Brooklyn waterfront, ripe for residential development.

Couple that with New York City's ability to boost apartment rents every year for the past 15 years and it's easy to understand why developers have raced to get building permits in recent years.

Trusts remain active

One thing that's fairly certain is that New York City's apartment market will continue to lure hordes of capital. REITs such as Equity Residential, Archstone-Smith and AIMCO are leading the charge. Up until two years ago, the REITs largely avoided this market.

But the seeds of that change were planted in 2002. That year, Archstone-Smith spent $209 million to buy 101 West End Avenue, a high-rise apartment complex on Manhattan's upper West Side.

Archstone-Smith also plunked down another $125 million in 2004 to buy a rental tower on East 39th street. Both apartment buildings, which Archstone continues to own and operate, remain rental properties.

Only two years after its Hudson Crossing deal, too, Equity Residential continues to whet its appetite for Manhattan apartments. Last summer, for example, the REIT spent $803 million to buy Trump Place, a 1,325-unit high-rise located on Manhattan's far west side. That deal now stands as the second most expensive apartment acquisition in Manhattan history.

But a record breaker may be in the offing. In July, insurer MetLife announced plans to sell its sprawling rental apartment campus, known as Peter Cooper Village and Peter Stuyvesant Town, for an undisclosed price. The 11,200-unit complex, which straddles seven acres of land below East 23rd street, contains the most units of any single apartment complex in New York City.

For the past four years, MetLife has been selling off its real estate holdings. MetLife stated publicly that it will only entertain “acceptable” offers on the Peter Cooper Village and Peter Stuyvesant Town complex. In early August, the insurer hired CB Richard Ellis to market the complex. Neither CB Richard Ellis nor MetLife were willing to discuss the sale as of late August.

Analysts and local brokers believe that the campus could fetch as much as $4 billion. A sale of that magnitude, of course, would enable bidders to place a record-breaking bet on the future of Manhattan's residential market. And the possibility of 11,200 condo units hitting the market at some future point could be huge.

“This could be such a large deal that it might attract a group of private equity firms or some combination of private equity and REITs,” according to Fasulo of Real Capital Analytics. “Nobody really has any sense of what the pricing could be on this deal though.”

One REIT that Fasulo expects will eye this deal is Equity Residential. The REIT has a solid track record of buying large rental complexes in Manhattan in recent years. George, the chief acquisitions officer with Equity Residential, declined to comment on whether or not the REIT is seriously considering a bid on the complex, but his remarks certainly left the door wide open for such a bid.

“I think it's a fascinating deal, but it would be quite a challenge,” says George. “It's something we would look at, though.
REITS TAKE MANHATTAN BY STORM

Private investors have sold into a wave of institutional apartment demand over the past four years. REITs have driven much of that demand, too.

Year Buyer Property Price (Millions) Seller
2002 Archstone-Smith 101 West End $209 Tishman Speyer
2003 AIMCO 311-313 E. 73rd $37.5 Primrose Corp.
2004 Archstone-Smith 300 E. 39th $125.5 Related Cos.
2005 Equity Residential 180 Riverside Dr. $339.3 Extell Development
2006 Archstone-Smith 235-245 E. 40th $165 Glenwood Management
Source: Real Capital Analytics
NEW YORK - BY THE NUMBERS

METRO POPULATION: 9 million

Source: U.S. Census Bureau

UNEMPLOYMENT RATE: 4.6%

Source: New York State Department of Labor

LARGEST EMPLOYERS:

  1. Columbia University
    15,000 employees
  2. Merrill Lynch
    13,000 employees
  3. Mount Sinai Medical Center
    13,000 employees

Source: New York City Chamber of Commerce

METRO AREA VITAL SIGNS

Office:

7.8% vacancy, 2Q 2006

9.8% vacancy, 2Q 2005

$43.46 rent per sq. ft., 2Q 2006

$40.80 rent per sq. ft., 2Q 2005

Source: Cushman & Wakefield

Multifamily:

2.9% vacancy, 2Q 2006

3.2% vacancy, 2Q 2005

$2,432 avg. effective rent, 2Q 2006

$2,105 avg. effective rent, 2Q 2005

Source: Reis Inc.

Retail:

5.7% vacancy, 2Q 2006

6.0% vacancy, 2Q 2005

$113 rent per sq. ft., 2Q 2006

$100 rent per sq. ft., 2Q 2005

Source: Marcus & Millichap

Industrial:

4.0% vacancy, 2Q 2006

5.6% vacancy, 2Q 2005

$25.11 rent per sq. ft., 2Q 2006

$22.30 rent per sq. ft., 2Q 2005

Source: Grubb & Ellis

Hotel:

87.4% occupancy, 2Q 2006

87.5% occupancy, 2Q 2005

$241.06 average daily rate, 2Q 2006

$211.55 average daily rate, 2Q 2005

Source: Smith Travel Research

MAJOR PROJECTS:

Atlantic Yards, the largest mixed-use project ever proposed for Brooklyn, will create 6,800 new rental units and roughly 600,000 sq. ft. of office space. The controversial 22-acre project will also feature a 58-story tower that's slated to become the tallest building in Brooklyn.

Cost: $3.5 billion

Developer: Forest City Ratner Corporation Property Co.

Completion: 2010

The Goldman Sachs Tower, rising at West and Vesey St. across from the original World Trade Center site, is a 43-story office tower with 1.5 million sq. ft. of office space. The LEED-certified, 740-ft. tall building will become one of the largest sustainable buildings in the nation. The Manhattan-based bank plans to relocate more than 75% of its 12,000 New York City personnel to the tower.

Cost: $2 billion

Developer: Bovis Lend Lease

Completion: 2009

Blockbuster sale highlights condo frenzy

To understand the lengths that condo converters will go to acquire prime New York City apartment buildings, consider a former rental apartment property on the Upper East Side of Manhattan. The mega-deal occurred last November when the 583-unit, white-brick apartment tower known as Manhattan House sold for a record $625 million.

At roughly $1.07 million per unit, the Manhattan House sale now stands as the highest amount ever paid by condo converters to buy an existing apartment building in the U.S. The joint venture entity of Manchester Real Estate and O'Connor Capital Partners bought Manhattan House from insurer New York Life.

Manhattan isn't the only market to go condo crazy in recent years. In fact, data from Manhattan-based real estate research firm Real Capital Analytics shows that roughly 180,000 rental units nationwide were lost to condo conversion projects in 2005 compared with less than half that amount in 2004.

“The condo converters are very aggressive buyers who aren't interested in long-term holds,” says Dan Fasulo, director of national research at Real Capital Analytics. “That makes them [essentially] flippers, so they are willing to pay a lot to secure properties, and then sell them out.”

The Manhattan House deal mirrors a national trend that appears to have run its course. Condo converters bought 203,000 rental units in 2005, a sharp increase above the 80,000 units that this investor group acquired in 2004. But 2005, as it turns out, was a peak year. The number of units acquired by converters has fallen consistently over the past four quarters. The second quarter of 2006 saw just 12,000 units sold to conversion interests — and that was the lowest quarterly acquisition volume since the beginning of 2004.

Another shift in the market involves pricing. Real Capital data shows that 20 mid- and high-rise apartment properties sold for $100 million or more during the first half of this year. While that was the same volume as the first half of 2005, condo converters were behind only 30% of these $100 million-plus deals this year. The first half of last year was a different story: Condo converters represented 70% of those nine-digit acquisitions.

On a market basis, New York City led the nation with $3.8 billion in apartment sales through the first half of 2006. That volume only takes into account sales of mid- and high-rise apartment buildings, which have arguably lured the most investor capital in recent years. The second most active market for mid- and high-rise apartment sales during that period was the Washington, D.C./Northern Virginia region that saw $1 billion in sales.

“Conversion buyers are definitely slowing down because some of these markets are really oversupplied with new units,” explains Fasulo of Real Capital Analytics. “And they have pretty much pulled back from buying in New York City, too.”
Condo converters face new lending hurdles

Lenders have inundated the New York City condo market with capital, much of it earmarked for condo conversions. But the subsequent deluge of units that have hit the market over the past three years has soured some lenders on the market. As a result, many are closely scrutinizing potential deals or choosing to finance rental conversions.

“There are definitely fewer new condo projects being financed now than there were 12 months ago, but we're seeing plenty of capital flow into the [rental conversion] market,” says Andrew Singer, principal at Manhattan-based real estate finance firm Singer & Bassuk. His firm has arranged more than $4 billion in construction loans for New York City rental projects and conversions over the past three years.

“Lenders realize that the New York City market needs more rental units. Plus, with such great demand to rent these units, landlords can boost rents,” adds Singer.

In June, Singer arranged a $100 million construction loan on 67 Wall Street. The 25-story, 325,000 sq. ft. Lower Manhattan office building will be converted into 211 rental units with ground-floor retail space. The owners of 67 Wall Street, private investors Nathan Berman and Ronny Bruckner, expect this apartment conversion to be completed early next year.

“Condo lenders are really scrutinizing these deals before they commit any capital,” says Steve Kohn, president of Manhattan-based Sonnenblick-Goldman. But there is still money for experienced and well-capitalized players. “They want to see a condo converter with a solid track record, and they also want the borrower to have liquidity in case something goes wrong.”

Mezzanine debt, which enables borrowers to finance nearly the entire deal through high interest-rate loans, is still readily available. Singer of Singer & Bassuk says that the super-competitive market to place mezzanine debt is masking larger changes in condo underwriting, too. But he believes that lenders have noticed and begun to worry about what he calls an “endless supply” of new condo units that have been developed in the city.

Supply isn't the only problem. Rising mortgage rates, which make it harder for condo buyers to afford units, may also be souring demand. According to Freddie Mac, the interest rate on a 30-year mortgage was 6.78% at mid-year, up from 6.35% at the end of 2005. It's the same story for the one-year adjustable rate mortgage (ARM), which increased 60 basis points to hit 6.35% at mid-year.

“The next few years will continue to see modest growth in New York City apartment rents,” says Sam Chandan, chief economist at research firm Reis Inc. “But if lenders believe that condos will appreciate by 20% every quarter, you can bet they'll keep financing them.”
— Parke M. Chapman