Condo Sector Vulnerable in Slowing Housing Market
The boom in condo production and conversions during the last three years seems to have been perceived by developers and apartment owners as an invitation to jump on the bandwagon, rather than a warning that the market could become oversaturated. Although many of the condos under development have been pre-sold, concerns are growing that the for-sale multifamily sector may be vulnerable to a cooling housing market.

A large share of sales contracts could be cancelled and condo units purchased by speculators may quickly be put back on the market in the face of oversupply and sinking sale prices. It will be hard to absorb all of the supply that will become available for occupancy in 2006 and 2007, especially in hot markets such as Florida and the Southwest where the condo craze has been most pronounced.
  
A slowdown may be coming, however, even before the impending supply glut actually arrives. Condo development and conversion deals are highly leveraged, unlike rental investments, which have increasingly relied on equity capital. Lenders are starting to cut back on their support of condo production and conversions, a fact that could be the controlling factor leading to a slowdown. Well-established builders are not having as much difficulty getting financing as opportunistic new entrants, but those well-established firms will begin to share the reservations of lenders about the ability of the market to absorb the supply in the pipeline. As a result, the 43% share of the multifamily starts that condos captured in 2005 will probably be the high-water mark.

The qualitative differences between condo and rental apartments generally have meant that only the most upscale of rental properties were considered suitable for condo conversions. In the recent conversion frenzy, however, conversions have been reported among properties that are much more modest.
 
Newly-built and converted condo apartments often end up being offered for rent, either as an investment strategy by individual owners, as a result of owner-occupants moving elsewhere and choosing to rent rather than sell their former homes, or because the developer had difficulty selling units and chose to temporarily rent them out.

The 2003 American Housing Survey (conducted by HUD and the U.S. Census Bureau) found that a third of occupied multifamily condos were rented. Among occupied single-family condos, only about 18% were occupied by renters.

While rentals represent a large share of multifamily condos, rented condos are not a large share of all multifamily rentals. The 2003 AHS found that 5.4% of renter-occupied multifamily units were condos or co-ops. Among luxury rentals, however, the condo share is greater.

With the explosion of condo construction and conversions since 2003, it can be expected that the renter-occupied share of condos will increase, and at the upper end of the rental market, investor-owned condos will be a significant presence.

More detailed data showing the financing and use of investor-owned condos are available from the 2001 Residential Finance Survey, a supplement to the 2000 Census. Unfortunately, the report doesn’t distinguish between single-family condo units and multifamily condos, but with about 78% of rented condos in multifamily buildings, the data for rented condos largely represent multifamily condo rentals. The median monthly rent for condos was reported as $729, compared to about $475 for non-condo multifamily rentals and $564 for rented non-condo single-family homes. The average monthly rent for condos was reported as $2,523, compared to $712 for non-condo multifamily rentals and $1,361 for rented single-family non-condos. Among condo rentals, 28% had monthly rents of more than $1,000, compared to 10% of other multifamily rentals and 21% of single-family rentals. Although condos represented only 4.7% of all rental units, they accounted for 9.2% of those renting for $1,000 or more per month, with single-family non-condos accounting for 41.4%.

Condo Units Bigger, More Buildings Go Vertical

The increase in the condo share of multifamily construction was largely responsible for the increased size of new multifamily units. Multifamily units intended for condo ownership tend to be significantly larger and better equipped than those built for rent. The median floor area of multifamily condo (and other for-sale) units completed in 2004 (the latest year for which separate for-sale and for-rent characteristics are available) stood at 1,359 sq.ft., compared to 1,049 for rental units. Moreover, a substantial number of condo units are much bigger and fancier than the median, making the difference in average size even greater—1,504 versus 1,080 sq.ft. This trend is not, however, seen within the rental segment. Among condo units completed in 2004, 81% had two or more bathrooms, compared to 49% of rental completions, while 21% of new condos but only 4% of rentals came equipped with fireplaces.

Since the mid-1990s, multifamily buildings have been getting been getting bigger. In 2005, 55% of the new multifamily units completed were in structures of 20 units or more (Figure 1).

Although that was slightly lower than the 56% share that such structures represented in 2004, it is a big increase from the 39% share in 1995. Moreover, of the multifamily units started in 2005, 59% were in structures of 20 or more units, indicating a renewed uptrend in average size in the supply that will be completed in 2006 and 2007. More detailed data on the characteristics of multifamily structures built in 2005 are not yet available, but the data for 2004 and earlier years show that among those units in structures with 20 or more units, a growing share were in structures of 50 or more units. In 1995, only 8% of all units were in structures of 50 or more units. By 2004, 24% of all units were in structures of 50 or more units, while another 32% were in structures of 20 to 49 units.

Increases in the number of units per building were generally achieved by building up rather than sideways. From 1995 to 2004, the percentage of new multifamily units completed in structures of four floors or more increased from 8% to 22%. The mid- to high-rise share increased among both for-sale and for-rent multifamily projects. There were increases in all regions, except perhaps the Northeast, where high-rise structures have been common for some time, but where the total number of multifamily projects is smaller and the high-rise share fluctuates from year to year.

Multifamily Driving Urban Areas

The shift to larger, high-rise structures reflects a shift in the location of multifamily construction. Although there has been no major shift of population back to cities, there has been a shift of multifamily development to densely populated cores of major metropolitan areas.

Of the more than 3,000 counties or county equivalents in the nation, there were 18 with more than 5,000 people per square mile of land area in 2000. This highly-urbanized group included each of New York City’s five boroughs, together with three nearby New Jersey counties. San Francisco County, Philadelphia County, Cook County (Chicago) Illinois, the independent cities of Baltimore and St. Louis, the District of Columbia, and Suffolk County (Boston) Massachusetts also had very high population densities. In addition, the high density group includes some independent cities in Virginia with relatively-small populations but even smaller land area, such as Falls Church, which had 10,139 people living in its two square miles.

These 18 most densely populated counties had combined population of 20.2 million, representing 7.2% of the nation, in 2000. With net out-migration and stagnant populations, their share of U.S. population declined to 6.8% in 2005, but they have seen substantial increases in multifamily construction over recent years. Their share of national multifamily permits rose from 3.1% in 1995 to 7.4% in 2000 to 10.6% in 2004 and 13.2% in 2005. Construction in and around New York City accounted for much of the increase, but other very-densely-populated counties also saw unusually large gains (Figure 2).

The 40 counties with population densities of 2,000 to 5,000 people per square mile, with a total population in 2000 of 34.6 million, represented 9.4% of multifamily permits in 2005, down from 11.1% in 2004.

The increases in New York City, Philadelphia, Chicago, Baltimore, the District of Columbia, and so forth were not simply a reflection of increased multifamily production in their metropolitan areas. In each of those markets, the high-density counties’ share of metropolitan area multifamily permits grew. In the cases of San Francisco and St. Louis, the core county’s share of the metropolitan total has fluctuated, but their shares in 2005 were higher than the average for the preceding five years. Of all eight metropolitan areas containing one or more of the18 high-density counties, the only area where the high-density counties did not increase their share of the metropolitan multifamily total was in the Boston-Cambridge-Quincy MSA. Suffolk County (Boston) had a lower share of total metro multifamily permits in 2005 than in the preceding five years. That was due largely to increases in highly urbanized sections of adjoining Middlesex County, such as Cambridge.

In the West, counties generally cover more territory than in the East, so county-wide population densities are typically lower. Los Angeles County, for example, extends over more than 4,000 square miles. So, despite a population of nearly 10 million, its density was only 47th highest among counties in 2000. Even where overall population density in large counties may not be particularly high, places within counties may be highly urbanized and many of those places have seen increased multifamily construction. The incorporated city of Los Angeles, with a population of 3.7 million in 2000, covers a mere 469 square miles, for a population density of 7,878 per square mile. The number of multifamily units authorized in the city increased from 1,119 in 1996 to 10,620 in 2004 before slipping to 8,513 in 2005. The city’s share of Los Angeles County multifamily permits went from 37% in 1996 to 67% in 2005, and its share of national multifamily permits went from 0.3% to 1.8%.

Counties with moderately high population densities of 2,000 to 5,000 per square mile generally showed no clear trend in multifamily permits over the past five years, and most reported a reduction in multifamily permits from 2004 to 2005. Central cities with moderately high population densities, such as Phoenix, Houston, Dallas, and Atlanta, saw an increase in the single-family share of permits, with the number of multifamily permits declining or growing slightly.
 
The increased share of multifamily construction occurring in the most densely populated areas thus helps to explain the increase in the share of new multifamily construction that consists of structures with more than three stories, or more than 50 units per building.
 
A Sustainable Trend?

With population stagnant or falling in most of the counties with high population densities, there might not seem to be a basis for accelerating multifamily construction. There are several reasons why new housing is built even where population is falling. First, in most of the high-density places where population declined, the number of households has continued to increase. The number of households with only one or two people has grown, even as the number of larger households declined. Second, with few greenfield building sites available in high-density areas, building a new multifamily structure often involves demolishing older structures, reducing the net increase in the number of housing units. The majority of existing apartments in these areas are more than 50 years old, and demolitions occur for a variety of reasons, so demolitions to accommodate new multifamily buildings are only one of the factors creating replacement demand.

These factors explain why there is some construction in high-density locales, but not why it increased so much during the past decade. Residential construction in counties and cities with the highest population density still is not large, relative to population, but nearly all of the new housing built in these locations is multifamily.

Over the next couple of years, multifamily construction is unlikely to be so heavily concentrated in high-density areas, unless there is a movement of population into those areas. Population data for 2005 indicate, on the contrary, that net outmigration from high-density counties actually accelerated. The share of multifamily construction in suburbs and moderate-density cities should increase, as vacancy rates fall and higher prices and mortgage rates dampen competition from single-family houses. The entry of the echo baby boom into the housing market should help to sustain some demand and production in big cities, however, since twenty-somethings are typically more attracted to big cities than to suburbs.

The Source for the Data

The material in this article has been excerpted from NAHB’s executive level forecast, courtesy of HousingEconomics.com. In addition to occasional articles featuring multifamily housing, the executive level forecast includes estimates and forecasts of multifamily starts by state and metro area (starts per se do not exist at the state or metro level and have to be estimated from permit and other data). For subscription information and product samples see http://www.nahb.org/product_group.aspx?groupID=2&sectionID=401. Subscribing on line provides immediate access to the state and metro forecasts of single family and multifamily housing starts. [ return to top ]