Back in business: the for-sale market's downturn gives apartment developers and investors a new venue for expanding their operations: would-be condominiums.

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Although many have winced sympathetically at the devastation being experienced in the for-sale market, apartment industry professionals also should consider opportunities rising from the rubble of would-be condominiums. Just as many opportunities were created by the acceleration of the condo boom, there, too, will be just as many opportunities created by its demise. And those opportunities should present themselves to almost every type of player in the industry, from developers to opportunity funds to core investors.

These opportunities first became apparent in 2007, and more are forecast in 2008. But just as the condo boom ran its course more quickly than most would have liked, opportunities on the backside of the condo market won't be around for long, either. Acting with speed and intelligence is essential when attempting to profit off the potentially lucrative market in 2008.

CAPITALIZING ON CONDOS

Real Capital Analytics reports that nearly 13,500 condominiums nationwide reverted to rentals in 2007--almost 25 percent of which were on the West Coast. Following are some notable examples:

* Allure (Orange, Calif.). This 278-residence apartment community (formerly known as Alexan Pacific Grove), located just blocks from the developing Platinum Triangle in Anaheim, Calif., was built as condominiums by Trammell Crow Residential and presold to K. Hovnanian during construction. By the time the community was completed, the condo market had stalled and K. Hovnanian declined to close. Instead, UBS bought the community as apartments.

* Regents at La Jolla (La Jolla, Calif.). LaSalle Investment Management purchased the "fractured," non-condo portion of the Regents at La Jolla community in La Jolla from Montecito Property. The 332-residence deal did not include 242 residences at the community that previously were sold as condos. Montecito originally had planned to sell all of the residences as condos, but the changing market conditions spurred the decision to sell the remaining residences as apartments to LaSalle.

* Il Palazzo (San Diego, Calif.). This 108-residence community, formerly known as Porta d'Italia, was built by Intracorp in 2002 and sold to a joint venture of Lennar and Centex Homes as apartments in 2005. The partnership was able to convert and sell 76 residences in the first building but was unable to sell the 108 residences in the second building. The Picerne Group purchased the community and reverted it to apartments.

* Mozaic Apartments (Los Angeles, Calif.). This 278-residence apartment community, formerly known as Axis, is located at Union Station in Downtown Los Angeles. The property was conceived as apartments by Lincoln Property Co. and was presold during construction to Standard Pacific as a condo conversion opportunity. After being unable to secure enough deposits, Standard Pacific dropped out of the development and Lincoln Property Co. reverted it to an apartment community.

Because buyers of these condo reversions were willing to move quickly and to buy projects with few, if any, leases in place, they were able to buy communities at higher cap rates and lower prices than comparable fully stabilized offerings.

MARKET OPPORTUNITIES

The Core Opportunity. Perhaps the best investment opportunity of all in 2008 for apartment investors with confidence in their abilities to underwrite rents will be found in recently completed condo projects with no recent closings. Many of these projects, which often can be purchased and easily repositioned, are extremely attractive to core apartment buyers because they usually offer:

* The best locations. These condos often are built in urban locations close to jobs and entertainment.

* Superior product. Condo finishes are often higher quality than apartment finishes in any submarket.

* More parking. Condo developments are required to have higher parking ratios than apartment developments. This is an added marketing tool when leasing.

* Condo Maps. The recent condo boom showed the value of a condo map. Although investors usually don't pay extra in the short term for a condo map, all would prefer to allocate their investment dollars to projects with this upside opportunity. This attribute puts these condo opportunities at the top of most core buyers' shopping lists.

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The Opportunistic Opportunity. Some investors might find investment opportunities in fractured or broken condo deals, where some closings already have occurred. Because a smaller market exists for these deals, cap rates generally are higher (in the 6 percent to 7 percent range, depending on the location and likelihood of accessing the for-sale market in an intermediate time frame). Projects in which fewer than 49 percent of residences have been sold and closed--and in which the buyer can maintain control of the condo association--have more appeal.

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The Construction Opportunity. As homebuilders seek to reduce their inventories and strengthen their balance sheets, many are looking for builders who will take over construction of a condo property midstream.

The Development Opportunity. In recent years, apartment developers were at a disadvantage when it came to buying land. Most of what was for sale was snatched up by condo developers who could pay a much higher price based on the returns expected in the skyrocketing for-sale market. Apartment developers just couldn't compete.

With the current state of the for-sale market, it is likely that much of the land purchased for condo development by homebuilders will be sold off for apartment development.

Some sites will need to be re-entitled. But in a market where finding buildable land is like finding a needle in a haystack, these opportunities should be extremely attractive to apartment developers. Pension fund advisors are forming funds to purchase and hold various types of land. Expect to see developers buy sites directly from homebuilders and partner with pension funds to form longer-term development platforms.

REAL DEAL ANALYSIS

Moran & Company represented the seller in the sale of The Montecito, a recently completed, 85-residence luxury condominium project in the Warner Center area of Woodland Hills, Calif. The community was developed as condos by an affiliate of Chandler Partners. The Montecito sold as apartments for $44 million ($517,647/residence) to Cupertino, Calif.-based Sobrato Development Dec. 20, 2007. The community received its temporary certificate of occupancy in mid-December. At the time it closed, roughly 10 days after delivery of the temporary certificate, no apartments were leased.

REVERSION OPPORTUNITY PROFILE

* Residences ranged from 1,562 to 2,273 square feet, averaging 1,772 square feet.

* Condo prices ranged from $580,000 to $890,000, averaging $735,000 per residence, or $415 per square foot. Reservations were taken on approximately 20 percent of the residences by late summer 2007.

* Finishes were far superior to typical luxury apartment finishes. These condo-quality finishes included Viking appliances; travertine tile flooring in kitchens, entryways and bathrooms; separate tubs and showers with marble surrounds; tile backsplashes; and gas fireplaces with precast concrete surrounds.

* The community featured a full complement of common area amenities, including a pool, fire pit, fitness center, private screening room, Internet cafe, conference room and sky deck with barbeque grills.

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Although there were no apartment comps in the Warner Center area for an apartment property with an average residence size of 1,772 square feet and the high-quality finishes found at The Montecito, Moran & Company didn't believe that constructing an apartment pro forma for such a community was rocket science.

Moran & Company felt that there were three important rental comps in the market to consider when bracketing rents. These included the three newest rental projects in the market, all located within a mile of The Montecito. Because The Montecito's residences are so much larger than any of the comps, Moran & Company looked at the rents of the largest floor plans at these comps to determine The Montecito's base rents. Additionally, it looked at single-family rentals to determine the ceiling for multifamily rental product. Attractive single-family rentals started at approximately $3,600 per month, thus capping multifamily condo rentals at that price point.

Although the average residence size at The Montecito was 29 percent to 57 percent greater than the largest residences in the most comparable projects, the gross rent per square foot was projected to be 16 percent to 22 percent lower.

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Because the nearby Archstone Warner Center is still in lease-up, and there are several other rental properties in the pipeline projecting deliveries over the next couple of years, Moran & Company felt the need to run a worst-case scenario where the company dropped The Montecito's average rent projection from $3,177/residence ($1.79 per sq. ft.) to $2,900/residence ($1.64 per sq. ft.).

This worst-case projection dropped the average rents at The Montecito to less than the average gross rent on the largest residence at Archstone Warner Center, and to just 2 percent to 10 percent over the average gross rents at the largest residences in Bella Vista and Pointe at Warner Center.

Thus, The Montecito traded at a cap rate somewhere between 4.27 percent and 4.86 percent (depending on the rent pro forma) with a $1 million allowance for the cost of leasing up this empty project. Sobrato got the best apartment property (with Viking appliances, travertine floors, separate tub and shower units, fireplaces, etc.) in one of the best submarkets in Southern California (Warner Center) at a better-than-market return. The company seized one of the best opportunities in the market today.

May Ann King is President of Moran & Company, a brokerage firm that specializes in the sale of institutional quality apartment communities, based in Costa Mesa, Calif. She can be reached at 714/444-3533.

Property                   Unit Type    unit size   Rental Range

Pointe at Warner Center      2Bd/2Ba      1,129     $2,540-$2,755
Archstone Warner Center      3Bd/2Ba      1,375     $2,893-$2,953
Bella Vista                  2Bd/2Ba      1,245     $2,840-$2,840
Montecito (Smallest Unit)  2Bd/2.5Ba      1,562     $3,000-$3,000
Montecito (Largest Unit)   2Bd/2.5Ba      2,273     $3,600-$3,600
Montecito (Average Unit)                  1,722

Property                    gross Avg. Rent   Concessions

Pointe at Warner Center         $2,648          ($221)
Archstone Warner Center         $2,923          ($365)
Bella Vista                     $2,840          ($355)
Montecito (Smallest Unit)       $3,000             $0
Montecito (Largest Unit)        $3,600             $0
Montecito (Average Unit)        $3,177

Property                    Net Avg. Rent   Net Avg. Rent/Sq. Ft.

Pointe at Warner Center        $2,427               $2.15
Archstone Warner Center        $2,558               $1.86
Bella Vista                    $2,485               $2.00
Montecito (Smallest Unit)      $3,000               $1.92
Montecito (Largest Unit)       $3,600               $1.58
Montecito (Average Unit)       $3,177               $1.79