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The Apartment Report | Condo Development Hits Peak

Expect condo development starts to remain strong in 2019 but slow down overall. There are many developers still bullish on condos and trying to get new projects off the ground. However, lenders will be a little more hesitant. Banks will shy away from condos almost completely, leaving private money lenders and debt funds to pick up the slack. Watch for an uptick in condos delivered compared to last year but expect a slowdown in starts. Condos will be high-risk, high-reward ventures with sought after returns around 2x or 25% IRR.

Projects being delivered in the next 12 to 18 months should perform strongly. After that point, the cyclical nature of condos may go downhill. Marginal areas, high-priced units and resales will collapse first when a correction hits, so first-tier markets will be the safest bet for condo deals just getting started. Los Angeles, San Diego, Denver, Portland, Ore., New York, Washington, D.C., Florida and Northern California will be ripe for condos. Look for developers to push for condos in second-tier suburbs of primary markets in addition to townhouses.

Some multifamily projects may transition into condos during this period, which will impact supply. The Fed easing up on interest rates has also been a boon for the condo industry, as rising interest rates affect condo exit strategies. When interest rates were running up, it was a breaking point for many buyers.

Condos are a spot market, which means a viable exit-strategy will be critical going forward in case the market starts to slide. Condo developments will be underwritten for units to be converted into rental apartments more often. Luxury units with large layouts will face major hurdles going forward as they have a challenging time transitioning into rental apartments when a condo project fails or the market turns. Agencies require a 50% presale before funding a unit, so smaller projects with 100 to 150 units will be easier to pull off. Markets that are under $750 per s.f. should remain robust.

Leverage will go up to 75% of costs. If a loan amount is at 65% LTC, that will give lenders a little bit of comfort for the project and may even loosen to partial recourse. With that said, most projects will be in the 65% to 70% range. Private equity groups will be active. Institutional money or pension funds won’t be nearly as comfortable with the risk involved at this late stage of the game. Lenders feel confident in condos because they can typically be converted to rental units, and multifamily holds strong during corrections.

Most developers won’t focus solely on condo development and aim to strike a balance with traditional rental multifamily. There was a supply shortage on condos over the last three years, which explains the recent boom in oncoming supply. Smaller developers having difficulty getting multifamily deals to pencil have found solace in condo development. The affordability crisis of single family will continue to benefit condos. Millennials who want to transition to ownership but want to stay in urban areas will aim to buy condo units.

Parkview Financial will be one of the lenders comfortable that the condo market will be strong. The firm looks to close about $550M in loans, and of that total, it projects about $200M will be condo construction. It will offer up to 75% LTC and doesn’t require a DSC if leverage is below that point. The company will underwrite some deals as apartment conversions, but deals will typically work as condos. One of the reasons Parkview Financial is so comfortable with condos is because its CEO, Paul Rahimian, used to be a developer and has a good understanding of how they work and how to exit the deal. The firm also targets multifamily for lease, industrial, office, retail and some single family, but about 75% to 80% of its portfolio consists of multifamily for lease or sale. It will be active in the West.

Banks such as Wells Fargo, Bank OZK, HSBC, JP Morgan Chase and CapitalSource will selectively fund condo deals. Private lenders and debt funds such as Canyon Partners Real Estate, Madison Realty Capital, Apollo, ACORE Capital, Starwood, Fortress, KKR, Blackstone, iStar, Square Mile Capital, UC Funds, Ready Capital Corp., BridgeInvest, Grosvenor and INCA Capital will also be active.

NOVO Properties started out as value-add buyers but is focusing more on development. It has condo projects in Bethesda, Md., and Washington, D.C., totaling 165 condo units. The firm’s typical portfolio consists of 25% condo and 75% apartments. NOVO Properties has another apartment development under contract and remains bullish on value-add deals in the D.C. MSA.

Companies such as Related, Wangard Partners, Real Capital Solutions, Avery Hall Investments, Aria Development Group, Mega Home LLC, Urban Investment Partners, United NYA, Extell Development, Oakwood Investment Group, Buckhead, Megaworld and Urban Sky Developments will also look at condo developments going forward.

via Crittenden Research


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