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Cashing in onthe condo boom

Home prices are soaring and making apartments look like much more affordable alternatives. To some, that makes apartment REITs — securities that sell like a stock and invest in real estate — especially enticing. CNBC’s Jane Wells reports.
/ Source: CNBC

If you haven’t scanned the real estate section of your local newspaper recently, brace yourself for some sticker shock.

Home prices continue to climb, and they are making apartments look like much more affordable alternatives. And that makes apartment real estate investments, or REITs — essentially, securities that sell like a stock and invest in real estate directly, either through properties or mortgages — especially enticing investments to some.

REITs are seen as a hedge against rising interest rates. The thinking is that as interest rates rise, fewer people will buy homes and they will rent instead, driving up rental costs.

The head of one such REIT, Bryce Blair, who is chairman and CEO of apartment development and construction company AvalonBay Communities, says there are three stages of recovery in the apartment business.

“Typically, in the apartment sector what happens first is occupancies improve, and we’ve seen that, and then runaway concessions abate, or slow down, and we’re starting to see that,” Blair said. “Finally, rental rates grown and we are seeing that in many of our markets, but not all.”

Blair projects AvalonBay will see 3 percent rental growth this year after a flat 2004. But a lot of companies, including his, are selling some apartment buildings in this red hot market. And many of the buyers are condo converters trying to cash in on the home ownership boom.

Even the Plaza Hotel in Midtown Manhattan is feeling the heat.

The hotel’s new owners have sought to turn much of the landmark building into condos, although a deal was recently struck with its union to limit the number of residences to be created.

The condo craze is both a good thing and a bad thing for apartment companies says Constance Moore, president and CEO of BRE Properties, a REIT for multi-family apartment properties in the western United States.

“It certainly cuts the supply of renters, or rental units, but it also makes it very difficult for us to buy well-located apartments because the prices are being bid up by these condo converters,” Moore said.

BRE Properties has been selling properties in Salt Lake City and Phoenix and pouring that money into Southern California. It’s focusing on building complexes in so-called “urban infields” that are near transportation hubs.

BRE Properties and Palo Alto, Calif.-based Essex Property Trust are the top ranked REITS in a new index developed by Merrill Lynch. “The housing affordability index” tracks companies with a lot of rental units in markets where buying a house is least affordable and where there are supply constraints, so you can’t build new ones.

Good markets in which to own an apartment buildings include Southern California, Washington, D.C., New York City and Southern Florida.

Apartment REIT stocks, on the other hand, had a great 2004, but have struggled so far in 2005, although they have started to regain some strength over the last few weeks.

However, Steve Sakwa, who runs REIT research at Merrill Lynch, points out that with mortgage interest rates dipping back below 6 percent last week, he’d rather wait until rates rise again, which would likely weaken these stocks’ prices again, before he invests in them again. But near in mind that Sakwa downgraded a lot of stocks in the sector last June — just before it enjoyed a great second half.