Rogue wave

Silverstone Communities has grown from a single-division start up three years ago to five divisions. The most amazing this is their product: for-sale condos. Wait a minute. Didn't that industry tank?


In today’s soft housing environment, a company that focuses entirely on development of infill for-sale housing with a strong emphasis on condos may appear contrarian. But take a closer look at Silverstone’s strategy and you’ll see a savvy and opportunistic course that has as much to do with relationships as it does location and price point.

Bruin guides the company’s overall strategy, identifies expansion markets and handpicks each division president. He also holds the position of president and COO at Hearthstone, a leading provider of institutional investment capital to residential developers in the U.S., where he oversees a national portfolio of real estate investments producing more than $1 billion in revenue.

Silverstone was launched in San Diego in 2003 with capital from Hearthstone, which has no ownership stake in the Silverstone companies. “They really are owned by the individual principals,” said Bruin. Most of those principals — Bill Fanning in San Diego, John McMorrow in the San Francisco Bay Area, Michael Ging in Florida, Steve Anrod in the Midwest and Jeff Wikstrom in Denver — had prior experience with Hearthstone when they were executives with other builders.

“The only difference between Silverstone and any other developer Hearthstone would finance is that we agreed to loan Silverstone the capital to help them launch their business, cover the initial overhead expense of renting office space and pay salary to get them up and running. In return, we get to look at every single deal they do,” Bruin said.

But, is it a good time to up the ante on the for-sale sector? The single-family housing market hit a wall this year. Last month, with inventory at record highs, home prices declined nationally for the first time in 11 years. On the condo side alone, sales were down 14.5 percent year-over-year in August and inventory was up 75.5 percent to an 8.6-month supply. Some condo players like Crescent Heights are renting out unsold units or flipping yet-to-be-built phases to apartments.

Developers like Trammell Crow Resi-dential and apartment REITs like Post Properties, United Dominion and Equity Residential, which cashed in when the conversion wave began to build, are cutting back their for-sale business to capitalize on strong rent and occupancy growth in the apartment sector through this current cycle. Forecasts for the housing sector today are divided between a hard and a soft landing.

Bruin sees the slowdown as the beginning of price stabilization. “First of all, our crystal ball doesn’t say we have a five- to seven- year down cycle,” he said. “I think it’s an 18-month cycle, driven by excess supply. The impact of the speculative buyer was totally underestimated and under-reported. No one realized the impact they would have.”

Bruin understands the homebuilding industry. He began his real estate career 26 years ago working for his family’s homebuilding business in Colorado. Prior to joining Hearthstone in 1995, he held executive and senior management positions with Richmond American Homes and Chicago- based Town & Country Homes.

“There isn’t a good just-in-time mechanism for a house,” said Bruin. “Builders get an order and spend six months processing that order and building. So if the speculators decide they’re out of the market — and that’s what happened — we still have houses being built for the next six months because builders have ramped up production to supply the demand they saw. What I’m seeing is excess inventory that got built up quickly in markets that had the highest number of speculators looking to make the quick flip. Once that inventory is burned off, I think we get back to normal.”

Bruin lays some of the blame for the slowdown on negative press and a herd mentality among buyers. “My theory is that if Katie Couric’s lead story had been ‘Now’s the time to buy a house, things are going to get better,’ builders would have seen a big spike in home orders the rest of the week,” said Bruin.

Silverstone targets markets that will attract employers and residents who want to relocate there and focuses on developments in those markets that are affordable and attainable for the first-time home buyer, a strategy that will hold even more weight as interest rates rise. “There’s no question interest rates become an important factor to consider, because we found with the product and strategy we’re pursuing, its not at all about total cost,” explained Bruin. “We’re talking about buyers who predominantly are coming from the rental market and are equating everything in the housing market to how much they pay each month for rent.”

Rents have been trending up, thanks to fewer apartment starts and the huge number of apartments that have been taken out of the supply to feed condo converters. That trend factors favorably into Silverstone’s underwriting. “Every time we look at a project we look at today’s interest rates and add maybe 50 bps, because we don’t know what rates will be six months from now. We’ll say, “OK, a buyer is going to borrow 90 percent, this is the interest rate and what it’s likely to cost adding taxes, homeowners insurance and everything.’ Generally speaking, we’re purchasing properties that, on a pro-forma basis, we price for sale at within $150 of what it would cost to rent something very comparable in terms of amenities and size in the market.” That formula has been a reliable indicator to Silverstone that the company still will be able to entice buyers to buy rather than rent.

“I’m not saying we’re insulated from a downturn, because we’re not. But even in a housing downturn, there’s a need for people to buy that first home,” continued Bruin. “Our guys are very careful to find properties that can be easily converted, rehabbed and upgraded to condo spec in desirable areas with close car commutes to big job centers.”

Bruin sees close-in locations becoming more important with rising energy prices that add to the cost of owning a home. “So many buyers, especially in California, went 50 miles away from their jobs because they could buy a house $200,000 cheaper then what was close in. Now, they’re faced with long commutes and their gas bills have probably gone up $200/month if both the husband and wife are commuting to work,” said Bruin. “Now people are saying, ‘I’d rather live closer. I’ll trade off having a single family home with a back yard for something much closer to my job and I can use those two hours I would commute to do something I like to do.'”

But even as people look to live closer to where they work, cities are spreading outward. Bruin believes a kind of Europeanization is gradually taking hold in America, where land in the outer ring suburbs is being consumed at an unbelievable rate. “By the year 2050, at the current rate of land consumption, 110 million acres — as much land as exists in the states of New York, Pennsylvania, New Jersey, Connecticut, Rhode Island, Delaware and Virginia — will be taken out of rural uses and put into development uses.”

Agricultural land will continue to be devoured as developers answer demand from the echo boomers, who just now are entering the workforce, and the growing immigrant population, which Bruin believes has been strongly underestimated and will continue to be a big part of the demand for housing.

Challenges ahead
Bruin sees finding talent as one of the biggest hurdles for any building organization today. “The ability to go from executing three projects to six or seven projects is dependent on the ability to find good people who know what they’re doing. That puts pressure on being competitive with compensation and all the other things that are important when people choose where they want to work,” said Bruin.

“The second challenge, because we’re focused on attached product, which by definition, comes with homeowners associations, is construction litigation risk — an HOA deciding to do class action and sue a developer. This has been particularly visible in California and some of the Western states, but is making headway in other jurisdictions.”

That’s putting pressure on Silverstone to create operating systems, policies and procedures as best practices. “We’re doing that,” said Bruin, “but it does cause insurance costs to go up. Currently, there’s only one company that will insure for construction defect in condo conversions and that company is Glencoe. We’ve been able to keep our overall rates in check, but we’ve increased our deductible and doubled the amount of our self-insured retention, which is the same as deductible. So, we’re taking more risk on the front end to keep the overall rates the same.”

Is Silverstone looking at new regions? Washington, D.C., is on Bruin’s radar as the next market the company will enter and, based on Silverstone’s research, Seattle and Portland look interesting. “We’ve done a deal in Phoenix with Bill Fanning,” said Bruin, who thinks Silverstone will get back into that market when things get a little better there. The mix will vary by market, but over the next couple of years, Bruin expects Silverstone’s projects will be 20 percent conversion, 80 percent ground-up. “When this cycle shakes out, we’ll stabilize at around 50/50,” said Bruin.

Southern California
Since opening its doors in 2003, the Southern California division of Silverstone Communities LLC has converted three apartment properties to condos in San Diego, one of the markets hit hardest by the condo cool-down. Sullivan Group Real Estate Advisors reports that 6,922 converted units in 111 projects were unsold in San Diego as of June. But most pundits believe the Southern California city already had passed its condo sweet spot by the year Silverstone was launched.

“We’ve been ragged on for that,” said Bruin. “It’s easy, with the benefit of hindsight, to say it was late in the game, but at the time, no one knew it. There certainly was no indication in our mind for a couple of reasons: One, we had a high comfort level with Bill Fanning’s knowledge and expertise and Hearthstone had been investing in housing deals in San Diego since its formation back in the early 1990s. Secondly, we avoided, on purpose, going into the downtown area where everyone else piled in. We focused on Class A and Class B apartments in the suburban area of San Diego proper. But I’ve heard statistics, one last week, that at the time we started in San Diego there were about a dozen condo conversions — not ground-up construction, just conversions — and today there’s 65 in San Diego County. At the time, we had almost a monopoly in our submarkets.”

Today, Bill Fanning is working on condo conversion deals in Los Angeles, where he’s opened a new office and brought aboard Bill Derrick as VP and manager. Fanning will do ground-up construction in San Diego if he can find land at the right price, but probably not any conversions there for a while. He’s underway on the conversion of the 20-year-old, 82-unit Entourage (previously called Park Place) in Burbank that Silverstone purchased for $22 million from R.W. Selby last summer.

Northern California
Bay Area Division President John McMorrow has five ground-up projects under development, from the heart of the Silicon Valley to Los Altos, and expects the bulk of his work in the region will be new construction. “Most apartments built here in the 1980s to answer the huge demand for housing are just boxes with roofs on them and aren’t built that well. We went into escrow on several, but found the properties were in such disrepair that it would cost too much to do a rehab,” said McMorrow, who would like to start three to five projects per year out of the Bay Area office.

Current projects include the almost completed $44 million Villagio in Cupertino and the $65 million, 109-unit Park Broadway in Millbrae, which broke ground in September. Villagio, which consists of 80 condos and 19,300 s.f. of retail on a 1.9-acre site that Silverstone bought for $8.3 million, is more than half sold at prices from $465,000 to around $800,000. Park Broadway includes 13 live/work lofts that front El Camino Real, the corridor running up and down the peninsula, and is one mile from a brand new Bart terminal. Sales will start next spring at price points from the mid-$400,000s to a little north of $800,000. Some 1,600-s.f. units will sell for close to $900,000.

McMorrow’s division is breaking ground in Santa Clara on 35 single- family detached four-bedroom, three-bath homes with about six feet between them. They are located in a private enclave with one gated entrance in the blue ribbon Cupertino school district that people pay an extra $100,000 for, said McMorrow. The residences, which will range from 2,100 s.f. to 2,400 s.f., will sell for $1.1 million to $1.2 million. Last month, Silverstone closed on the site for the $24 million, 45-unit Birch Terrace in Pleasanton, paying $3.2 million for the land. The one-, two- and three-bedroom townhouses that will back to an open-space arroyo will be the only new for-sale construction in the quaint bedroom community. Price points will start at $625,000 and probably top out at $775,000 when sales begin next spring.

“Probably our best location is in Los Altos, where we plan to start next April on 78 condos. The area is like Beverly Hills for us,” said McMorrow. The $49 million yet-unnamed project will consist of stand- alone townhouses, three stories of six-flats and a bevy of site amenities.

Michael Ging opened Silverstone’s Florida division in February. He admits the timing might not be the greatest, but he still sees opportunity in the soft market, where population over the next 25 years is expected to double. “It could be a good time to get into the business,” said Ging. “There are a lot of deals that are in trouble and we have the capital and the ability to step in on both ground-up and conversion projects when the timing is right,” he said.

“The last three years in Florida, the average home price went up more than 30 percent each year. Looking back over the past 12 months, appreciation has been flat but holding steady. It’s becoming more of a buyer’s market every day.” He thinks anyone buying residential in Florida today is in a good position, although many buyers are staying on the sidelines waiting for prices to go down. While not yet in serious negotiations, Ging is looking at a mixed-use deal in Broward County and would like to have a couple of projects under contract in the next 12 months.

Ging currently is converting the 273-unit Citrus Falls in the Citrus Park area of Tampa and is pursuing land for ground-up construction in Orlando and Palm Beach County. Silverstone paid $37.5 million to JP Morgan Investments for the three-year-old community that was built on 45 acres by Crescent Resources, a division of Duke Energy Corp. The property is in close proximity to Tampa International Airport, offices and shopping. Presales began in September at starting price points ranging from $125,000 to $260,000, targeting first-time home buyers, buyers of second homes and national and international income investors. First move-ins will be in December.

Jeff Wikstrom heads up Silverstone’s Colorado division, which was launched around the same time as the company’s Florida division. Denver, which has been a lagging market, has had positive job growth for the past few months. “The Denver market varies by submarket. Downtown is strong for attached product. The burbs are slower, but there’s good job growth in the areas we want to be in. The biggest job growth pockets are the Northwest Corridor (Highway 36 between Boulder and Denver), the CBD and the Tech Center,” said Wikstrom.

Since the Mile High City didn’t experience the big condo boom that other parts of the country did, the market hasn’t been overheated. But the Uptown submarket of Downtown Denver, where Wikstrom is selling units at the recently converted 21-story, 159-unit Park One Hundred, has seen a bit of condo growth over the past couple of years. Silverstone paid Waterton Associates $147,000/unit for the 21- year-old high-rise in March and is spending $2 million to renovate the building.

“We’re coming in at entry-level prices between the high $100,000s and the high $200,000s, targeting first-time home buyers between the ages of 25 and 35. Most other condos in the area have sold out and there is very little high-rise product with unobstructed views available Downtown for less than $300,000,” said Wikstrom. Park One Hundred offers ones averaging 750 square feet and a few unique penthouse units. The condos opened for sale in July.

Wikstrom is under contract on a site in Westminster in the Northwest Corridor for a 150-unit ground-up project, called Highland Village. He expects to close on the land and break ground in summer of next year, and deliver first units in 2008. The all stick-built development will offer a mix of product types, including four-story, tuck-under podium and two-stories of flats. “If our timing is right and we deliver 18 months after start,” said Wikstrom, “I’m hoping to hit the market on the upswing.” Highland Village, designed by local architect JG Johnson, will be a mix of 20 percent ones and 80 percent twos priced in the mid-$200,000s.

Wikstrom is chasing another ground-up project in Southeast Denver. If he prevails, the deal will put Silverstone’s Colorado division in all three of Denver’s three hot job growth pockets. He expects the bulk of his deals over the next several years will be weighted on the ground-up side.

The Midwest
As a city-dweller who lives in the Lincoln Park sub-market of Chicago, Silverstone Midwest President Steven Anrod appreciates pedestrian- friendly neighborhoods that have something to offer besides national restaurant chains. Today he’s working on projects in St. Louis and has Chicago and possibly outlying areas like the Waukegan lakefront, which is early in its rejuvenation, on his radar screen. Anrod also will consider Madison, Wis., and Indianapolis.

Silverstone’s Midwest division in July acquired the 45-year-old, 60 Plaza Square in Downtown St. Louis from a private investor and is spending $4 million to $5 million to bring the 160-unit, 13-story building that previously housed independent seniors rentals up to condo spec. Prices will start at $80,000 for studios and range from $120,000 to $170,000 for ones, offering an affordable alternative to the for-sale product in the nearby Loft District, where units are priced between $170,000 to $220,000.

“Where loft spaces are a raw space, sometimes deep and dark, we offer a finished unit with a full kitchen and a full bath,” Anrod said. “Our interior upgrades include all new finishes, flooring, maple wood cabinets, granite counters and stainless steel appliances. There will be either office or retail space on the ground floor with the potential for a restaurant on lower/basement level, which previously served as a dining hall for the senior residents and has a sunken terrace,” he explained. Sales will get underway this fall.

Anrod is under contract on a new construction project in the South Grande neighborhood next to Tower Grove Park, a Victorian-style park near the Missouri Botanical Gardens. Planned for the 2.2-acre site is a series of six-flat buildings with a total of around 60 units targeting move-up buyers. He hopes to close on the land for the South Grande Condominiums in Q1 2007 and expects a close-out value of around $18 million, with unit sale prices averaging $300,000.