Revamping stalled condos

Condo deals are making a comeback on the West Coast. No, the for-sale market hasn't recovered. But a number of moth-balled condo projects are being revived as rentals by new owners with financing from a few lenders who have opened their wallets to a select group of strong borrowers.


The trend began in 2009, when a few distressed condo assets were snapped up by REITs and well-capitalized privates with balance sheets and/or equity partners that allowed them to close all-cash deals quickly.

Essex Property Trust, the West Coast-focused apartment REIT that owns 28,689 units in San Diego, Los Angeles and Orange Counties, Ventura, the San Francisco Bay area and Seattle, has been active on the acquisitions front, even as cap rates for Class A properties have compressed to the mid-four to 5.5 percent range in the best coastal markets.

The Palo Alto-based REIT acquired six existing assets, the note on a 165-unit apartment community in downtown Los Angeles and 3.6 acres of land in the Bay area that is entitled for up to 309 apartments in a shopping spree that began late last year and gained velocity in the second quarter of 2010.

Those buys include a couple of stalled condo developments in Orange County foreclosed on by banks after the original developers defaulted on their construction loans. Essex is seeing leasing success at both properties, despite asking rents at the top of the market.

Craig Zimmerman, Essex Executive VP of acquisitions, points out that neither of those transactions were classic “busted condo” deals, which he says are condo projects wherein a number of units have sold, creating headaches for new owners of the asset. “Not that we would never buy them, but with those deals you usually have some very unhappy homeowners. They’ve started the homeowners association, which also means you have to make payments for every unit you own into the HOA and it’s an expensive proposition,” he said in September.

The REIT’s first stalled condo buy closed last December, when the company purchased the 85-percent-complete, 115-unit DuPont Lofts in Irvine for $27 million in cash, well below the estimated replacement cost of $60 million, from Cathay Bank, which had taken back the property from Millenium Homes, a Los Angeles based home builder that filed Chapter 7 bankruptcy in mid-2009.

Essex changed the name of the property to Axis 2300 and spent another $7 million to complete it, anticipating delivery in June, but was forced to push back the completion date two months because of unforeseen issues with the renewal of building permits and city approvals.

The property was 30 percent pre-leased with occupancy expected in August, Mike Schall, Essex COO, told analysts during Essex’s Q2 earnings call, and said that 35 units had been leased, including 18 below-market-rate (BMR) units. Excluding those BMR units, rents averaged $2,600 for a 1,500 sq. ft. condo unit, he said. Today, the community is approximately 65 percent leased.

The upscale podium-style apartment property, located a block from John Wayne Airport, close to major freeways and shopping venues and 10 minutes from the beach, offers studios and one-bedroom, two-bedroom and three-bedroom units ranging from 943 sq. ft. to 2,300 sq ft. with fireplaces, hardwood flooring, granite counter tops, stainless steel appliances and a resort-style amenities package.

High-rise jewel
In March, the REIT inked another deal in an approximately 50/50 joint venture with an institutional financial partner for the 349-unit Skyline at MacArthur Place, a stalled 25-story twin tower condo high-rise on the border of Santa Ana and Irvine that company execs are calling the crown jewel in the REIT’s portfolio.

The partners paid seller iStar Financial, a New York-based mortgage REIT, $128 million, or $365,000 per unit, for the asset in what could be the highest-dollar transaction for a single apartment asset in Orange County in ten years. That steep sale price still was 55 percent less than the $322 million cost to build the stunning two towers that original owner/developer Nexus Cos. valued at $350 million when it secured a couple of loans totaling $230 million and broke ground on the project at the height of the market in mid-2006, with completion planned for March 2008.

Nexus’ plans were put on hold, as were a number of other high-rise for-sale projects across the nation, when the bottom fell out of the market. Although Nexus claimed to have sold a number of units in the building, those contracts were voided when iStar took over the property.

Essex had its eye on the trophy asset for about a year before finally pulling the trigger when its financial partner was brought into the deal, mitigating the impact such a purchase would have on the firm’s funds from operations (FFO).

“Because Skyline was 100 percent completed, but unoccupied, it had no income going forward, which is difficult on FFO. So, by bringing in a partner we could cut that in half and, as well as our promote, we get certain fees which are balanced against that loss in the first year, so it has less impact on our FFO,” Zimmerman said.

Essex and its partner took out an $80 million loan, secured by the property, in July for a four-year term plus a one-year extension at an interest rate of LIBOR plus 285 basis points.

As of August, Skyline’s north tower was 75 percent occupied. With move-ins to the South Tower expected by the end of the third quarter, the project was 36 percent leased overall and 30 percent occupied in August.

“We leased 100 units in the first 100 days of commencing leasing in late March, which is ahead of plan, and have 127 leases as of the August 1, averaging 32 leases per month, with rents of approximately $3,000 per unit, consistent with the company’s initial expectations, and concessions that range from one to two months, also less than anticipated, depending on unit type and location,” said Schall.

By mid-September, the number of leased units inched closer to 160 and more than 140 units were occupied. The project’s five penthouse units are expected to command rents in the $11,000 to $12,000 range.

Zimmerman would jump on other deals like Skyline if they became available, but there are few out there that pencil out, he said. “There weren’t a lot of high-rise high-end condominiums that failed or didn’t sell some of the units. So those opportunities aren’t limitless and I think only a few remain,” he said.

Hunting for dollars
Resmark Equity Partners and Wood Partners LLC both acquired partially completed and entirely unoccupied condo developments early last year, but it was months before either company secured the construction financing needed to complete the projects.

Resmark, a Los Angeles-based full-service residential investment advisor that manages, finances and oversees the acquisition and development of residential for-sale real estate in the Western U.S. and select markets nationwide, bought the remaining interest in the 180-unit Madrone in Hollywood, in a trustee sale in August 2009. Resmark was an original investor in the condo development John Laing Homes subsequently was building. John Laing Homes was purchased for $1.05 billion in 2006 at the peak of the housing boom by Dubai-based real estate giant Emaar, but filed for bankruptcy protection under Chapter 11 in February 2009. The five-to-seven-story condo development with 14,000 sq. ft of ground-floor retail over three levels of subterranean parking was 70 percent complete when John Laing halted construction on the project..

Resmark’s ORO discretionary multihousing investment fund that targets Class A and B multifamily, value-added properties for renovation and repositioning and development opportunities for ground-up multifamily projects, paid $20 million for the remaining interest in the asset with plans to complete it and rent the units.

But it took a year for Resmark to lock in the financing needed to get construction underway again and cover the lease-up period. George Smith Partners, a leading national real estate investment banking firm that specializes in arranging financing for commercial and residential properties, helped Resmark obtain a $32 million three-year construction loan with U.S. Bank at LIBOR plus 325 basis points and a 1.25 debt service coverage ratio.

Resmark has renamed the property The Avenue and is under construction with a new general contractor, having retained the Cunningham Group, the original project architect, and construction company Arbor Building Group, with a completion date of summer 2011.

“This is the first large construction loan we have completed since the financial turmoil began,” Steve Bram, principal and managing director of George Smith Partners, said. “As a result, it was challenging to find a lender to do a large construction loan, particularly given the new supply of multifamily product that has recently come online,” he said.

Not only is finding a construction lender difficult today, but their requirements are exceedingly stringent. Loan-to-value ratios are around 65 percent and lenders typically require a borrower’s net worth to be at least 100 percent of the loan amount with liquidity of at least 25 percent of the company’s net worth, and some lenders want a net worth of up to two times the loan amount, said Bram. “That’s why it’s important to use an investment banking firm that knows which lenders are lending, who they are lending to and what they require,” he said.

Wood prevails
Wood Partners, one of the nation’s largest multifamily developers, with a successful track record of financing, entitling and building everything from luxury high-rises to work-force housing, went through a number of financial sources before securing the financing needed to restart the 264-unit City Walk from Berkshire Property Advisors L.L.C., which became the developer’s joint venture equity partner.

Wood Partners bought the high-profile, half-finished mix of retail and for-sale housing in downtown Oakland for $5 million in September 2009 from Seal Beach-based condo builder The Olson Cos., which purchased the site for $8.7 million in 2004 from the city’s redevelopment agency, but went into default with construction lender Wells Fargo after the project’s general contractor, UPA, declared bankruptcy in 2007.

But Wood Partners, the third firm to go under contract for the City Walk site, would need an additional $55 million to finish the project. According to the multifamily developer, the city of Oakland was pivotal in bringing the necessary financing package together, agreeing in April to the company’s request for a $5 million loan. At that point, Wood Partners had approximately 85 percent of the necessary construction debt in place. The city’s loan improved the project’s debt-to-equity ratio, which in turn allowed Wood Partners to secure the balance of funding from a life insurance company.

“In this economic climate, assembling the right financial package can be difficult,” said Wood Partners’ Brian Pianca, who is overseeing the project. “The city of Oakland understands what City Walk means to downtown and they stepped in at a critical juncture to help us get it across the finish line,” he said.

Located just two blocks from Oakland’s city hall, the site is one of the most visible in downtown. Local officials have long had high hopes that the urban-infill project would be a key part of the city’s ongoing revitalization.

The project is expected to generate the equivalent of more than 170 full-time onsite jobs, with another 75 to 100 office workers to support construction. Because it is partially complete with most of the material already purchased and onsite, the majority of the $39 million construction budget will go towards wages.

“It’s been a long road, with a number of complex issues to resolve, so it’s very gratifying to reach this point,” said Frank Middleton, regional director of Wood Partners’ West Coast division, in June. “Now we’ll be able to fulfill the potential of this project and deliver a true asset to downtown Oakland.”

The property has been renamed to reflect Wood Partners’ signature Alta brand. Now called Domain at Alta, it is scheduled for completion in mid-2011.

When finished, it will offer area residents the first new apartment homes in the city center in approximately two years, putting residents within blocks of thousands of jobs, mass transit and a range of shopping and dining options.

Meanwhile, Marietta, Ga.-based Wood Partners is gearing up to be active on all multifamily fronts around the country, having closed on land for development in Atlanta, a suburb south of Boston, Littleton, Colo., and San Diego’s Spectrum Center Business Park, and expanded both its acquisition team and its specialty housing group that oversees development, financing and construction of workforce, student and age-restricted housing.