By: Daniel McGinn
For the condo developers Jeff Blum and David Franco, the evening of Sept. 14, 2006, couldn’t have been more perfect. For two years the partners had worked on plans to construct a nine-story condo building called View 14 at the intersection of 14th Street and Florida Avenue in northwest Washington. On this night, they welcomed nearly 1,000 potential buyers into a nearby furniture store that they’d transformed into a nightclub. A D.J. spun music while bartenders poured an orange concoction called the View-tini. And as the party hit its peak, the partners unveiled a giant Lucite model, complete with dry-ice fog and glowing lights, of their building, which would cost $55 million to build. ‘‘It was like the Detroit debut of a new car,’’ Blum says. ‘‘We had everything except the turntable.’’
The morning after the party, the View 14 sales center opened. Over the next few weeks, a crowd of potential buyers came through, ogling floor plans and artists’ renderings of the units, which had an average price tag of $500,000. The sales team signed contracts for the penthouses, with one fetching $1.2 million. But sales of run-of-the-mill units were agonizingly slow. ‘‘People loved the building, loved the finishes, but they weren’t writing contracts,’’ Blum says. According to the partners’ business plan, 50 of the building’s 180 units should have sold in the weeks following the launch party. But by early December, during a meeting with a key financial adviser, the partners closed the door to talk candidly. ‘‘We haven’t sold 40 or 50 units,’’ Franco said. They’d sold only 18. The adviser’s jaw dropped. A minute later, they gave him another shock: instead of selling View 14 as condos, Blum and Franco were thinking of converting the building — on which construction hadn’t yet begun — into rental apartments.
It’s an act of real estate hocus-pocus that’s starting to become common. ‘‘It’s happening all over,’’ says Greg Willett, the vice president for research at M/PF YieldStar, an apartment-market consulting firm. Willett saw the first signs of the shift in early 2007 in places like Washington, Boston and Miami, where the condo boom had been particularly frenzied. Buyers were realizing that condo prices had reached a plateau. The speculators who once loved to flip new-construction condos had disappeared. Instead of rushing in with deposits, buyers began taking a wait-and-see approach, hesitant to risk watching their investment lose value during the course of construction. The credit crunch that began in mid-2007 made things only worse. As condo demand has fallen, some developers have tried to adapt by turning their projects — some of them still in the planning phase, some partway through construction, some completely finished — into rentals. ‘‘We’ve been tracking this market for 35 years, and we haven’t seen anything like this,’’ says Gregory Leisch, the chief executive of Delta Associates in Alexandria, Va., which recently counted 15,000 capital-area condo units under development that would eventually hit the market as rentals.
For developers, switching a project from condos to apartments can be difficult. In general, condo buyers are looking for larger units, with more square footage and bedrooms. They want better cabinetry, flooring, lighting and appliances. The ceilings in condos are often 6 or 12 inches higher than in rentals. Meanwhile, in a rental building, developers tend to invest more in shared amenities like lobbies, gyms, pools and roof decks. That’s because condo owners spend more time inside their units, so amenities within the apartment are more important, whereas shared amenities like gyms and pools drive condos’ common charges higher. In rental buildings, however, better common areas make it easier for landlords to re-lease apartments, which turn over more frequently than condos.
Aside from design changes, the economics of making this switch can be daunting. Projects financed on an assumption that condos will sell for $550 per square foot look much different when the spreadsheets are tweaked to show monthly revenue of $3 per square foot stretching out for years. ‘‘The lender has to be sold on it as well — it’s not necessarily you flip the switch, and all of a sudden you’re a rental,’’ says Jonathan Miller, a veteran Manhattan property appraiser.
For Blum, 46, and Franco, 43, the shift was an emotional decision as well as a financial one. They’d spent a couple of years negotiating to buy the land, which is located a little more than a mile north of the White House. (They say the site contained a dilapidated garage that the seller told them appeared in the 1983 Mr. T movie ‘‘D.C. Cab.’’) By late 2006, the partners had already spent $13.5 million on the land and another $5 million or so on ‘‘soft costs’’ (including architects’ fees, permits and the launch party). But before breaking ground, they would have to line up financing for the tens of millions in construction costs.
To make View 14 work as a rental, they needed to lower their original $55 million budget. They also had to plug in new assumptions about how much they could earn in rental fees for the 180 apartments (current estimates range from $1,450 a month for a 500-square-foot studio to $4,500 for a 1,700-square-foot two-bedroom with a den), how much that rental revenue would grow each year (3.5 percent), how long it would take to fully lease the building (nine months) and what percentage of the apartments would be vacant, on average (in their estimation, 5 percent). They needed to think about their exit strategy: whether to try to sell the building as soon as the apartments were rented or hold on to it, acting as long-term landlords and hoping the building grew in value over time. Blum says they haven’t decided yet, but ‘‘we’d been condominium developers. Our mind-set has been: build a project, sell a project.’’
For Franco, the switch came at a personal cost. He had set aside one of the nicest units — a triplex with 3,200 square feet of living space and a 2,300-square-foot terrace — for himself; now that penthouse would be chopped into apartments. ‘‘I’m not the only developer that had great visions of living in their building and had to see those visions disappear,’’ he says. Eliminating the penthouses boosted the number of units to 185 from 180.
Inside the apartments, the developers changed the designs in the hope of cutting costs and appealing to a broad pool of renters. They increased the sizes of bedrooms and closets — they worried that the spaces would look skimpier in an actual walk-through than to someone buying from a floor plan, as many predevelopment condo buyers do. At the same time, they slightly reduced the overall size of each one — by about 31 square feet apiece — leaving them with an average size of 835 square feet. They switched from Italian cabinets to domestic ones; they swapped out KitchenAid appliances for Whirlpool and chose Moen plumbing fixtures instead of Grohe.
The more visible changes came in the common area, which originally was just 1,800 square feet. To make the building more appealing to prospective renters, the partners expanded the lobby, added a game room, a business center and a fitness center and increased their spending on the roof deck. They also added a ‘‘party room’’: a loungelike space large enough to hold dozens of people, with nice furniture and an attached kitchen, that residents can rent out for events. ‘‘You’re selling a lifestyle, a community, in a rental project — unlike a condo project, where you’re selling somebody their own unique home,’’ Franco says. These changes came at yet another cost: that extra 2,200 square feet was originally devoted to the restaurants and shops that would lease the first floor, so larger common areas would mean about $7,000 less per month in retail rent, which the partners hope to make up by charging residents a $500 annual ‘‘amenities fee.’’
There were some things about the building they couldn’t change. They wish they could have replaced the building’s central heating/air-conditioning unit with cheaper in-unit models, at a savings of about $1 million. They might have changed the building’s exterior, to cut down on its use of expensive glass. But by that point the permits and plans were too far along. Still, they’d cut enough corners to reduce the overall budget by around $5 million, though neither partner particularly enjoyed the exercise. ‘‘Every time you go back, you strip out a layer of luxury, a layer of sexiness,’’ Franco says.
The partners were lucky that they decided to make the shift from condo to rental before they broke ground, which gave them leeway to make changes. Less than a mile north on 14th Street from View 14 lies Highland Park, a seven-floor building that at midsummer stood nearly complete. The developer, Chris Donatelli, began construction on two large condo buildings across the street from each other in 2005. The plan called for Highland Park to include 229 condos costing $300,000 to $600,000 each, with the building across the street containing 153 units at similar prices.
By early 2007, however, Donatelli’s sales force was experiencing the same slowdown as Blum and Franco’s — and the situation was made worse by having two condo projects so close to each other. ‘‘We were competing against ourselves,’’ Donatelli says. So he decided to switch Highland Park to rentals. By then it was too late to make structural changes to the building. But inside the units, his team made cosmetic adjustments, choosing 229 identical kitchens and shifting from hardwood floors to stained concrete, which would be easier to maintain in a rental. But Donatelli says the building, which was nearly half-rented during the summer while workers completed the upper floors, should work well as a rental because the original design and prices were in keeping with this up-and-coming neighborhood. ‘‘It wasn’t like we were trying to sell million-dollar condos and then tried to rent them — that doesn’t work well,’’ says Donatelli, whose apartments will rent for $1,600 to $3,400 a month.
Among developers, it’s widely understood that constructing a rental building requires more patience than building condos. In a perfect world, when an apartment building is fully leased, the rental revenue will cover the building’s carrying costs, giving the owner some profit — but the developer never knows exactly how well he’s done until he sells it down the line. Blum and Franco express confidence. They have a great location and unbeatable views of the city, they say, and despite the cost-cutting, the units still feel luxurious. ‘‘We have absolutely no uncertainty that it’s going to lease up,’’ Franco says.
Up the street at Highland Park, Donatelli points out that if the market for condos heats up again in a few years, developers who have shifted from condos to rentals could always go full circle by converting their rental buildings back to condos. But for now, even developers whose projects once seemed like can’t-miss propositions are learning to think long term, just like the rest of us.