Thursday, March 11, 2010

Los Angeles Apartment Investor: "This Is the Best Market Since 1994"; Falling Values Galvanize Buyer Interest, Despite Declining Rents

Los Angeles apartment buildingBuy low, sell high, is a principle of such simplicity that even a novice investor can use it as a guiding mantra.

A couple of years into the worst real estate market in decades, prices have come down and the Los Angeles Times scribed an article, "Braving a dismal apartment market," highlighting how apartment investors are seeking to get into the market while prices are low.

In our opinion, this is indeed an excellent time to be looking for investment opportunities. The financial shakedown of late has had several dramatic effects on the local multifamily market:

  1. Rents have declined;
  2. Vacancies have risen;
  3. Prices have declined -- but a lot less than many had hoped, and few "firesale" opportunities have been created;
  4. The majority of owners remain well-capitalized and well-equipped to ride out the current economic turbulence;
  5. The allure of real estate as an asset class -- and its traditional role as a hedge against inflation -- is rising;
  6. Investors are many and good deals are few, and buyers are still finding that the Los Angeles apartment market has high barriers to entry.
We see the greatest opportunity in the 2 - 15 unit market. Owners of buildings with 16 or more units (which require an on-site manager) tend to be wealthy individuals with no intention to sell in a downmarket, fiscally-stable syndicates, or, for the larger properties, deep-pocketed institutional investors (insurance companies, pension funds, and the like).

In the 2 - 15 unit category, there are some over-leveraged buyers who purchased their properties at the peak of the market and are forced to sell because of declining fundamentals. Others are family-type investors who are selling because of death, divorce, relocation, etc.

The Los Angeles Times provides investors with some tips, which include:
  1. Familiarize yourself with a particular area;
  2. Do not overpay for a property;
  3. Keep cash reserves;
  4. Make sure the building is up to code and check public records for any citations;
  5. Don't wait for ideal market conditions;
And we'd like to add a few of our own:
  1. Don't fall in love with a building - if you can't make a deal that is justified by current (not projected) cash flows, walk away;
  2. Cap rates may be 8% or more in other areas of the country, but it may be a long, long time (never?!?) before Los Angeles sees cap rates in that range. A cap rate of 6% in central Los Angeles is probably a very good deal.
  3. Ignore published cap rates for properties. They are based on the owner's profile -- and the owner's property tax may be a fraction of what a new buyer will pay. A buyer needs to calculate what the cap rate is for their income and operating expenses.
  4. Plan on owning the building for the "long haul" (5 years or more) unless the building is a value-added opportunity (e.g., distressed, vacant property).
  5. Use your local knowledge to buy in an area with solid, future rental potential (is the area becoming a population center? subject to overbuilding? near future transit hubs? near the urban core?);
  6. Get to know local rent regulation ordinances. The cities of Los Angeles, West Hollywood, Beverly Hills, and Santa Monica (among others) all have differing (and sometimes stringent) rent regulations;
  7. Brush up on your accounting, or even better, learn to create your own investment pro-formas. Become an expert on the tax benefits of owning income property. Become proficient in analyzing and managing operating expenses -- these will be your key to earning profits.
  8. Anticipate how you will manage the building. Will you hand over ownership to a management company? If you are going to self-manage, how will you lease the units? Manage tenants? Handle emergencies?
  9. Find a broker, lender and insurance company that you can trust. These parties will become your partners in your financial success.
With low interest rates and investor sentiment still tempered by the recent bruising financial climate, buyers now have an excellent opportunity to research and plot their investment strategy. We are brokers specializing in the Los Angeles apartment market, so please feel free to contact us with any questions or queries you might have.