Indulging in Luxury Investments
Multifamily developers treat themselves to this upscale market.
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 isfinding 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 tothese residents, builders have to provide exceptional floor-plan designs, distinctive architecture, lifestyle conveniences, and five-star luxuries. (See sidebar.)
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.
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 theluxury 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.