San Diego Business Journal

The once red-hot condo conversion market in San Diego is now heating up in court, while builders report a definite cooling trend as investors become increasingly skittish about jumping into the fray.

Based on recent events, the future of condo conversions is an open question.

Last month, San Diego City Attorney Michael Aguirre advised the city to start complying with the California Environmental Quality Act to ensure that the conversions were not adversely affecting the city's affordable rental housing stock. This was followed Dec. 1 with a public hearing on the issue, presided over by Aguirre and 76th District Assemblywoman Lori Salda & #324;a.

Most recently, a San Diego attorney, representing two consumer groups, filed a lawsuit against the city, with another one in the pipeline, challenging the city's refusal to do comprehensive environmental impact reviews of all conversions. A court hearing is scheduled for Dec. 13 to consider imposing an injunction on future condo conversions until the issue is resolved.

Anxious Times

Why all the turmoil? One camp believes that condo conversions are eating into rental property and leaving lower income people out in the cold. But another camp counters that most of the converted apartments are being bought by former renters , their one shot at homeownership in San Diego's pricey market.

Paul Tryon, the chief executive officer of the Building Industry Association of San Diego, considers condo conversions to be "one of the few opportunities many San Diegans have for homeownership."

"It's been a very important part of San Diego's housing stock. If they require all of these projects to go through CEQA, there will be a moratorium, adding a year and a half to two years to bringing these to market," he added.

While Tryon said he can appreciate the social issues involved in the debate, "CEQA is not the tool to address this. If we're going to be thoughtful and address those kinds of concerns, it should be in the proper context, and not bastardizing the law to meet those needs."

All this uncertainty about the market has made some developers nervous. Among them is Patricia Haulley, vice president of GVA IPC Commercial Real Estate in San Diego, and a partner in a condo conversion project called Axos, a four-building complex in Golden Hill offering one-, two- and three-bedroom units.

"Axos is docketed for Planning Commission approval December 15, and we have had every reason to believe that it will be approved," she said. "We've met all of the conditions. But this situation is ominous, given the political climate in the city of San Diego. Everyone is concerned they will make a wrong move, hence the tendency to do nothing.

"It's not just our project, but a number are in the pipeline," she said. "To stop the process could ultimately result in harm and will have a direct impact on housing costs. It is virtually the only source of affordable housing in the county. The average new condo is about $500,000, but the average price of a condo conversion is just over $300,000 countywide."

Mike Mahoney, project manager for American Property Enterprises in Sorrento Mesa, agreed.

"I think condo conversions are a good thing," he said. "It's a zero-sum game. Yes, you're displacing tenants, but many of those tenants are moving up to homeownership."

But San Diego attorney Cory Briggs said that homeownership is not the point of the suit he filed Dec. 2 in San Diego Superior Court on behalf of the Affordable Housing Coalition of San Diego and Citizens for Responsible Equitable Environmental Development.

"Ownership is great, but it's important that people have a place they can call home," he said. "Whether their name is on the deed, we are less concerned about. We want roofs over their heads."

Assemblywoman Saldana agreed.

"Seniors on a fixed income are not in a position to buy, they want to rent," she said. "Maybe they've been in a place for decades. Some have disabilities."

But, Saldana added, she is not against all condo conversions.

"I am committed to increasing the number of homeowners in my district," she said. "This isn't about opposing conversions per se, but making sure there is a thorough vetting of the process."

The city's Development Services Department said that all condo conversions do go through an initial CEQA review. According to the most recent figures supplied by the department, since February 2004, the city has approved 282 condo projects, representing 7,266 units, and 56 of those appealed by Briggs are under consideration.

"The city has been successful in either having challenges to its CEQA documents set aside by the court, or in reaching settlements with the plaintiffs in all but one CEQA challenge in the last seven years," said Eileen Lower, senior planner for the department.

Most of the proposed projects do get greenlighted without further scrutiny, because they don't involve changing the physical environment, such as converting a historic site, or interfering with parking, said Gary Halbert, development services director.

His department is proposing stronger regulations governing conversions, which will be considered next year, but they are short of a thorough CEQA review , not good enough for Briggs.

"We believe the city should analyze all the impacts," he said. "It's not our job to hire consultants to analyze impacts. That is up to the city and the developers to do. I need to show them the smoke, and they need to send the fire department to see if there is a fire. There is plenty of smoke there, and enough evidence already on the table that it triggers an obligation to do a complete study."

But, Halbert countered, "We don't see any smoke. We don't chase fires when we have no evidence that they exist. We need evidence that there is a physical environmental effect on converting apartments into condos."

In the meantime, the city's real estate community is waiting for the smoke to clear and pondering the state of the condo conversion market these days.

"The frenzy has gone," said Mahoney. "There aren't as many investors out there. We're in a more reasonable sales pace. Rather than 20 a month, maybe seven to 10 a month."

And that's not necessarily bad, he said.

"In general, the buyers we're seeing are the owner/occupants, which would signal a more healthy and stabilized market," said Mahoney. "You strip out the investors, who were competing against other investors, who were driving up the prices."

Brian Yui, real estate author and chief executive officer of House-Rebate.com in San Diego, said the problem has been too many condo conversions coming on-line at the same time.

"They're having to offer incentives, like a car, or HOA (homeowner association fees) payments," said Yui. "It's a good opportunity for buyers to get a good deal. Investors are now staying on the sidelines, thinking that prices have peaked. They are not going to be jumping in and buying as they were in the past. It's a good time for investors to cash in their chips as far as condo speculation. Carrying costs will outweigh any benefit they would get from an increase in price for next year."

Some have already flown the condo coop, heading to Los Angeles, looking for the next venue, said Bob Pinnegar, the executive director of the San Diego County Apartment Association.

But for those aspiring condo converters who still want to take the plunge, he cautioned, "Converting is a specialty. You have to know what you're doing, or you can lose it all. If you are acting as your own general contractor, you can get into a bad situation with liability issues, from a construction defect standpoint."

Cosmetic Surgery

Mahoney's company is selling units in a condo conversion called Alder Woods, 148 one- and two-bedroom apartments, located on 10 acres in El Cajon, selling from the low $200,000s to the low $300,000s.

"If it wasn't for condo conversions, you wouldn't have housing being offered in the $200,000 and $300,000 range," he said. "Builders have to upgrade everything to get a higher price point to cover costs. Construction increases have really hurt. With condo conversions, there is less construction that has to go into it, just a little bit of rehab. It doesn't require the same amount of concrete and framing."

But how much rehabbing is necessary? Mahoney said his company wouldn't have considered doing another "McConversion," but instead opted to do something "out of the box," tapping into the area's lush green belt.

But Saldana questions those builders who are performing only "cosmetic surgery, taking a 30-year-old building, giving it a face-lift, with granite countertops."

"That doesn't mean you will have a good product that will last during a 30-year mortgage," she said.

Russ Valone, the president of Market Pointe Realty Advisors, a San Diego-based market analyst, has heard similar complaints. But, he added, "I would say that most of the projects I have looked at are not just new countertops, but new windows, insulation, new roofs. Some of the buildings are 20 to 25 years old that are being converted, and a lot of these, without rehabilitation, would be approaching their useful life span. If you are an apartment owner, you either pour a lot of money in, upgrade it and up the rent, or convert it and sell. The impact is pretty much the same either way."

Ground Zero

Saldana's 76th Assembly District covers the central and north portions of San Diego, including Pacific Beach, Ocean Beach, Point Loma, Hillcrest, North Park and Downtown San Diego.

"My district is ground zero, with 80 percent of permit requests, because it is the older part of San Diego," she said. "Instead of sprawling outward, they want to put density in the central city area, which may make sense. But it impacts my constituents disproportionately.

"I saw this happen in Pacific Beach in the late '70s and early '80s," she said. "Developers put in apartments, some condos, but didn't take into account the traffic, the parking and public safety issues. By the time the zoning changed back, the long-term impact was in place. Without that long-term view of how it impacts neighborhoods, they wound up with unintended consequences."

But, Saldana said she would prefer that local jurisdictions work out their differences, rather than state lawmakers coming in with new laws. She said she intends to sit down with Mayor Jerry Sanders early next year to discuss the issue.

Kevin Mulhern, of CB Richard Ellis in San Diego, is content to let the market work it all out.

"The market has an awfully good way of correcting itself, and already is correcting itself," he said. "It's best to let market forces take control, rather than imposing artificial controls when they may not be necessary."