In recent years, the low interest rates that have undermined apartment fundamentals have given rise to the phenomenon of condo conversions, a phrase which refers to a changeover in multifamily-property use from individual rental units to resident ownership. Though the units are privately owned with common areas open to all, the condo exteriors are typically maintained by a professional management company.

At the market's peak, condo conversions also extended apartment owners the opportunity to cash out during an economic boom. However, with interest rates rising and housing demand on the decline, will condo conversions remain a favored industry strategy, or will they dwindle with time and changing conditions?

Analyst Rod Petrik of Stifel, Nicolaus & Co. says that AvalonBay took wise advantage of the condo-conversion boom. "They build a quality product, and over the last few years when fundamentals were very soft in the apartment markets, they would capitalize on their very high-quality portfolio and were able to sell a number of them off to condo converters, who converted them to individual condos," he says. "It allowed them to take advantage of the downturn in the cycle."

However, AvalonBay's West Coast senior vice president of development Steve Wilson does not envision selling property to condo converters as an ongoing tactic. "Converting directly or selling to converters is opportunistic for AvalonBay, but it is not a great driver of our long-term strategy," Wilson says. "I suspect conversions will continue in the industry, but at a substantially lower level than in the past couple of years.

The margins between acquisition costs and net sales proceeds are being compressed on both ends."

Gary London, president of consulting firm The London Group, says the recent flood of condo conversions has resulted in an oversupply on the market. "Too many converters have come late to the party," London says. "Many have overpaid, and there is a danger of them getting repossessed. The current inventory has to be burned off, and depending on the market, this could take several years."

However, London considers condo-converted apartments one of the few viable options for entry-level buyers in what remains a heated, yet slightly cooling, market. "Therefore, their long-term niche is secure," he says, "particularly for new apartment buildings built to condo specifications, and those in better locations."

The relatively low price of condo-converted apartments is what London considers one of the ultimate amenities to attract entry-level buyers into the market. He notes, however, the necessity for converters to add value to the properties before attempting to put them on the market: "The challenge is to upgrade the apartments so that there is no deferred maintenance for entry buyers who can least affords financial surprises."

London is still keeping a wary eye on the condo-conversion trend, though, pointing out his home market as an example of oversupply. "In San Diego, there are almost 7,000 units of conversion inventory," he says. "That's way too much in a housing market that's in a cyclical decline."