Single-Family Home Builders Join the Condo Party

PHOENIX — There’s a new twist to the condominium development and investment boom: single-family home builders are entering the condo arena in response to changing demographics, increasing difficulty in finding available lots on which to build new homes, and pressure to grow revenues.

Bruce Karatz, CEO of KB Home Inc. (NYSE: KBH), which delivered more than 37,000 homes in 2005, says this convergence of factors offers a new avenue for single-family home builders, but poses potential pitfalls as well. “While there are huge opportunities for us and others like us in the multifamily for-sale arena, there are lots of risks. The risk profile is very different from what we’re normally used to,” remarked Karatz during a panel discussion on the state of the multifamily industry held Tuesday morning at the Hyatt Gainey Ranch in Scottsdale, Ariz.

The 75-minute session was part of the National Association of Home Builders’ three-day “Pillars of the Industry Conference and Awards Gala,” which attracted several hundred developers, owners and property managers from across the country.

KB Home, which does business in 16 states, is no stranger to the for-sale multifamily market abroad. The company has been building condos in France for 25 years. “I do not think that condo developers [in the U.S. market] price enough risk into their pro formas,” remarked Karatz. “In France, we will not start construction until we’ve sold over 40% of the units.”

KB Home plans to build 8,000 multifamily units in France this year, two-thirds of which will be condos. In the U.S., condos represent 10% of Los Angeles-based KB Home’s overall business activity, but Karatz expects that percentage to inch up over time.

In January, KB Urban, a division of KB Home, announced that it was partnering with AEG to finance and build a 50-story, 1,100-room convention center hotel in Los Angeles budgeted at more than $600 million and offering more than 70,000 sq. ft. of banquet/ballroom space. At least 250 luxury residential condominiums will also be part of the development.

Home builders, much like their brethren in the commercial/multifamily sector, recognize demographic shifts taking place. One-quarter of American households today are classified as traditional – households with a husband, wife, and children, according to Karatz, who views that figure as a wake-up call.

“The vast majority, and a growing percentage, of American households are something other than traditional, and most of those folks are interested in lifestyles very different from what traditionally home builders built,” he told the audience. In pursuit of that demographic trend, home builders such as KB Home have opted to enter the condominium sector.

There is another reason single-family homebuilders are entering the condo market, explains Karatz. “As builders have gotten bigger, appetites have gotten bigger, and so this is one avenue that presents itself as a growth opportunity.”

Condominium starts approached 150,000 units in 2005, according to a newly released research report by Trammell Crow Residential, up from nearly 110,000 units in 2004 and the highest level since 1985. To put those figures into context, consider that in the late 1970s and early 1980s as many as 200,000 for-sale multifamily units were being produced annually.

Demand for condos has remained robust. Through 2004, roughly 75% of newly built condo units were occupied within 90 days after the construction was completed, according to Trammell Crow. The median price of existing condos sold in the third quarter of 2004 was $197,000, 20% above the median price a year earlier (that is the most recent data available on median sale prices provided by Trammell Crow).

Still, there is growing concern that some select condo markets have become highly speculative in nature. In the Miami Beach area, 70% to 80% of the purchases are by investors who plan to flip the properties, estimates Ron Terwilliger, CEO of Atlanta-based Trammell Crow Residential. Other overheated markets of concern include Las Vegas, San Diego, and to a lesser degree Washington, D.C.

But Terwilliger, whose company plans 6,000 rental starts and 3,000 condo starts this year, insists that the demand for condos is not a passing fad. Furthermore, he argues that the industry is much better positioned now than it was in the early 1990s when condo prices fell rather precipitously during a recession.

“The condo units in the early 1990s were not as well built — or in as good of a location — as they are today. I think people had more single-family home choices than they do today,” says Terwillger.

“What’s different today is that we have tremendous traffic congestion in this country,” Terwilliger adds. “We have a lot more people who want to live in locations close to urban centers and to amenities, so they’re not willing to be satisfied with the suburban location that they might be able to afford.”

In short, Terwilliger believes that condo ownership is gaining acceptance nationally, a trend he characterizes as a secular shift. It certainly helps that there has been more price appreciation in condos than single-family homes over the last three or four years. “Now that you can brag about price appreciation,” says Terwilliger, “you can feel better about the investment aspect of it.”

But Karatz remains somewhat wary of all the exuberance among condo investors and developers these days. It’s as if the industry is in the midst of a gold rush. “The tendency to move as a herd into markets and products that seem to be going well is something that, when you have a lot of money in your pocket, is exactly the wrong way to move.”

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