Glen Creno
The Arizona Republic
Jun. 16, 2006 12:00 AM

Developers are delaying or dumping plans to convert some Phoenix-area apartment complexes into condominiums.

A year after they pulled more than 7,000 apartments off the market, condo converters are finding that buyers in many areas are not interested in paying top dollar for a refurbished rental unit, particularly now that the Valley’s housing market is slowing and prices for single-family homes are beginning to drop.

“The condo-conversion market is not the frenzy it was a year ago,” said Pete TeKampe, an apartment specialist at Marcus & Millichap, a commercial real estate brokerage. “It is rapidly decelerating.”

Apartment experts say some developers got carried away in conversion mania, overpaid for buildings and now must run them as rentals rather than selling fast and getting out.

Some of the projects were hits, particularly those in pricier areas of the Valley, where affordable housing is at a premium. But, in other cases, developers are having problems persuading anyone to buy. Some market professionals say vulnerable complexes include those in central Phoenix, where buyers can pay just a little more for a new unit that was built as a condominium.

“The viable deals in great locations like Scottsdale still have good sales velocity,” said Tyler Anderson, an apartment broker at CB Richard Ellis, a commercial real estate firm. “The deals that will be challenged are those buildings that didn’t look like a condo to start. You just had people trying to cash in.”

Condo converters descended on the Valley in the wake of the wave of investor speculation that pushed up prices for single-family homes. They saw a chance to market for-sale housing to first-time buyers who couldn’t afford a house or to people who wanted the no-yardwork lifestyle.

The condo-reversion trend has hit in other areas where too many condos were built too quickly. Southern Florida is one example. The turn in the Phoenix market demonstrates how quickly trends come and go in the area’s volatile housing business and the inherent hazards for investors.

Developers count on selling some of the conversions to people who already lease the apartments. Yet some of these residents find the prices too high and look for other places to live.

A woman moving out of the Hawthorne Condominiums, on Third Avenue near Indian School Road in Phoenix, said Thursday that she had been leasing a two-bedroom, 1,040-square-foot apartment. When the complex went condo, she rejected the proposed sales price of $230,000.

She said she was a former real estate agent in California and was leery of condo conversions. “I’ve been on the downside of a market before,” she said.

Consumers were caught in the condo-conversion craze and often forced out of their apartments. Now, they may be caught in a situation where their condo complex is being turned back into for-rent housing. But they have protections.

“To turn a condo conversion back into an apartment complex, you need the approval of every buyer,” real estate attorney Christopher Combs said.

He said some condo-conversion developers may be giving cash incentives to buyers to get them to turn back the units.

The Valley’s apartment market has been squeezed as condo conversions remove inventory. Grubb & Ellis-BRE Commercial estimates that more than 7,000 apartments were taken off the rental market by converters last year. The combination of fewer apartments and higher prices for single-family homes pushed apartment rents higher. Marcus & Millichap said asking rents would rise 3.2 percent to $735 per month in the Valley this year while vacancies declined. Vacancy was projected to decline fractionally to 7.4 percent in 2006.

But there is a twist to how conversions are affecting the rental market. Experts say a lot of the buyers were investors who now have dumped them back on the market as rentals. TeKampe said that 27,000 apartments have been announced as conversions since 2004 and estimated that half went to investors, with 70 percent in some projects.

“The condo-conversion market has not been driven by the end user, Joe and Betty Home Buyer,” he said.

Reid Butler, a Valley apartment and condo developer, said a lot of the investor units aren’t reselling.

“Many investors bought five to 10 units in a condo-conversion project and need to hold them for a year so they don’t have to pay capital gains,” he said. “So now, they are hiring management firms and renting them.”

Terry Feinberg, president of the Arizona Multihousing Association, said his trade group is trying to assess the impact of the flood of investor rentals hitting the market. He said some couldn’t rent them for as much as they need to cover the monthly mortgage payments. He wonders if those condos are headed for foreclosure.

Feinberg believes there were too many unsophisticated investors snapping up condos. He compared their behavior to tech investors in the 2000 stock market.

“Why did so many people lose money in 2000 when the dot-coms crashed?” he asked. “The investor behavior is the same. Some people get in at the end of a trend. They have bad timing.”

By June Fletcher

Question: I am looking to buy a couple of condominiums — having them as rental units and then selling them. I am interested in areas that are up-and-coming and have good growth potential but where property prices are still reasonably inexpensive. From the little research I have done, Phoenix seems like a good place. What are your thoughts?

– Shivanee Nadarajah, Oakland, Calif.

Shivanee: I certainly can see why you’d be interested in Phoenix. At a time when media chatter is all about how much housing is cooling, Phoenix has been as hot as a mid-summer day in the desert. According to the National Association of Realtors, in the first quarter of 2006, the largest single-family home price increase in the country was in Phoenix, where the median price rose to $268,300, up 38.4% from the same period a year ago. Phoenix topped the list in the condo sector, too — the median price hit $179,600, up 38% from a year ago. Multi-Housing News says it expects Phoenix to be “one of the better performing markets in the nation,” over the next year, with 8,000 new residents expected to come to the metro area each month in 2006, as employers add 71,000 new jobs, an increase over last year of 4%. The trade publication expects that over the rest of the year, vacancy rates will decline 70 basis points, to 7.4%.

But the city’s housing heat wave may not last much longer. Arizona State University’s Arizona Real Estate Center noted that the housing market in Phoenix and its suburbs slowed in April, with sales of existing homes falling to 5,980, a 32% drop from the year before — the weakest April since 2000. Price growth is slowing, too, the center notes, since the rapid gains of the past year have made homes less affordable. The financial Web site Bankrate.com recently put Phoenix on its “bubble buster” list, partly because lot prices are rising rapidly and the area is being flooded with new homes.

So I’d suggest that you exercise some caution. While an influx of job-seekers and rising home prices will strengthen Phoenix’s rental market in the short run, in the long term, supply may well outpace demand. If that happens, today’s hot housing buys will be tomorrow’s hot potatoes.

To hedge against that risk — in Phoenix or any other potentially bubblicious city — you may want to buy a property and then offer your tenants a lease with an option to buy. A lease option will attract renters who are serious about buying but are put off temporarily because of high prices, rising mortgage interest rates or other factors. No matter what happens to home prices in the area, your tenants will still have an incentive to buy from you, since you won’t have to pay a real-estate commission and will be able to offer buyers a lower price — and the place will already be their “home.”

– June Fletcher is a staff reporter at The Wall Street Journal and the author of “House Poor” (Harper Collins, 2005). Her “House Talk” column appears most Fridays on RealEstateJournal.com. Email your questions about the residential real-estate market. Please include your name, city and state. If you don’t want your name used in our column, please indicate that. Due to volume of mail received, we regret that we cannot answer every question.