Downtown Los Angeles 2010: Banks, Mezzanine Lenders and Developers Tussle at the Negotiating Table

Since the Great Depression, bankruptcy -- both personal and corporate -- has cast a long shadow over the American psyche. Whether it was the titans of 20th century commerce canonized in Monopoly -- or the wizards of Wall Street canonized in the last decade -- the greatest financial parties of all time terminate in one brief acronym - BK, or its adoring sibling, foreclosure.

Now, as some mega-projects go under, foreclosure of real estate projects is reaching a new apotheosis. This week, the owners of Stuyvesant Town and Peter Cooper Village -- a haven for the middle class on the East Side of Manhattan -- handed back the keys to its creditors. Four years ago, Tishman Speyer Properties purchased the 11,227 apartment complex for $5.4 billion dollars -- the largest real estate deal in US history. Their projections of a 13.5% return on capital never came to pass.

Because real estate relies on a large measure debt for its financing, when values drop the equity portion of a deal can very quickly evaporate. CALPERS (California Public Employees' Retirement System) wrote off its entire $500 million investment in the project (a 26.5% stake). Even the Church of England got punished, losing its $64 million investment in the project. Gross miscalculations based on bubble-era projections turned good money into naught.

The Flat, Downtown Los Angeles

Downtown Los Angeles has its fair share of projects in bankruptcy, and they are shaping the city. The dual-headed Hydra of BK and foreclosure is impacting at least five projects Downtown, according to reports from the Los Angeles Downtown News.

1. LA Central (South Park, 11th and Figueroa) Wells Fargo is in the process of foreclosing on NY developer the Moinian Group for failure to make payment on its $45.6 million note. The developer is in negotiations with the lender and hopes to keep the land, set to become a $1 billion mega-project near Staples Center.
   
2. The Flat (Downtown West, 750 Garland Avenue) China Trust Bank foreclosed on owner 750 Garland LLC after they defaulted on a $23 million construction loan, and later sold the project to private equity fund SA Properties for $20 million. The rental building's cash flows were likely attracted the new investors.
3. EVO South (South Park, 11th and Grand) The mezzanine lender, Westport Capital Partners, took over the project after Portland-based South Group stepped away from its loan on this 311-unit condo project. The building continues to sell units, uninterrupted by this transfer in ownership.
4. Santee Village (Fashion District, 716 S Los Angeles Street) Bank of America now owns the four condominium building project after investor Patriot Group and developer MJW investments defaulted on its $47 million loan. One of the buildings never opened and probably will not any time soon.
5. Brockman Building (Jewelry District, 7th and Grand) Developer West Millenium Group defaulted on its $35 million loan for this 12-story condominium projects, but has not yet been foreclosed upon by lender Bank of America.

In the best of times, developers and investors project mighty cash flows and dramatic increases in the value of their assets. When times don't prove so flush, they run for cover -- and in the process may lose a building or two.

Who will benefit from this financial churn? Buyers and renters. There is a lot of discounting going on, and others' losses will prove to be their gains.

Southern California Office Market on the Brink: Vacancies Edging Up, Rents Edging Down, Landlords on Edge; Recovery May Be Far in the Horizon

Don't look for over-crowding in the adjacent cubicle, according to a report by the Los Angeles Times.

The office fundamentals in SoCal region can be pegged somewhere between pathetic and downright awful:

Perhaps the best news coming out of the fourth quarter was that the ongoing rise in commercial vacancies slowed noticeably, and many expect the rental market to finally bottom out by the middle of this year. Unfortunately for landlords, though, it may take a long time for their buildings to fill up again. That means more bargains ahead for tenants.

Overall office vacancy in the fourth quarter in Los Angeles, Orange, San Bernardino and Riverside counties was 18.5%, a substantial jump from 14.4% a year earlier, according to commercial real estate brokerage Cushman & Wakefield.

What will be the panacea to the beleaguered office market? In three words: jobs, jobs and jobs. Although economists declare we are in a recovery, an increase in hiring -- and the willingness for firms to increase their space requirements -- may be a year or more away.

Furthermore, firms have down some internal "downsizing" in terms of space requirements for their employees. The report cites how law firms, a mainstay for the Los Angeles office market, are now alotting 500 sq ft per attorney vs. 700 sq ft during flusher times.

The office market is expected to stabilize in 2010 and may not recover in earnest for some time after that.

On a positive note, Downtown Los Angeles has proven to be a somewhat stable market, experiencing a 16.7% vacancy rate vs. about 14% a year earlier.

According to a panel of commercial real estate experts who convened on Friday, in spite of the area's woes, California may be down, but is not out. They cite the following reasons:

• California is prone to booms and busts, but since 1994, the state has exceeded national norms in terms of income, employment and population growth
• California, by virtue of its proximity, should benefit from the global recovery which is led by Asia
• The predicted flood of distressed assets has yet to materialize

It may be hard to swallow, but pundits predict that office valuations may end up being 30 - 40% off market highs achieved just 2 - 3 years ago. But, as punishing as these numbers are, they are remarkably consistent with the declines in the stock market and other artifacts of the bubble era.

Los Angeles Housing Department Landlord & Tenant Guidelines for 2010

It's a new year, and we thought it a good time to review recent Los Angeles Housing Department (LAHD) ordinances that concern Landlords and Tenants.

(1) The annual allowable rent adjustment for units subject to the Rent Stabilization Ordinance (RSO) is:

• 3% for 7/1/10 - 6/30/11 (updated 5/10/10)
  
• 4% for 7/1/09 - 6/30/10.
  

Because of the decline in rental rates during the past year, few landlords will be able to pass this increase on to tenants. Landlords with units well below-market will be the exception, and this period of "soft" rents will allow them to "catch up" to market value.

(2) The City has adjusted the required amounts for Tenant Relocation in the case of no-fault evictions. The RSO includes two tenant categories, 'Eligible' and 'Qualified'. "Households which include a senior citizen, disabled person, or minor dependent child are qualified tenant households. All other households are eligible."

Relocation amounts due from Landlord:

Eligible -- $7,300 (less than 3 year tenancy) or $9,650 (more than 3 year tenancy or less than 80% of Area Median Income Limit)
Qualified -- $15,500 (less than 3 year tenancy) or $18,300 (more than 3 year tenancy or less than 80% of Area Median Income Limit)

(3) The LAHD has changed the requirements for evictions for owner-occupancy. New provisions allow for grandchildren and grandparents to get relocation assistance. Additional requirements have also been imposed on landlords who evict tenants to owner-occupy. They must move in within 3 months of vacancy and occupy the rental unit for at least 2 years and if they fail to do so must offer to rerent the unit to the previous tenant.

[LAHD]

FHA Changes Loan Guidelines: 5% Downpayment Requirement for Low FICO; Mortgage Insurance Bumped from 1.75% to 2.25% of Loan Balance

FHA Loans, with low downpayment and credit score requirements, have tightened their underwriting guidelines:

• Mortgage insurance will be raised from the current 1.75% of loan balance to 2.25% of loan balance
• Downpayment requirements for those with FICO below 580 will be increased from 3.5% of purchase price to 5% of purchase price [note that FICO below 620 is considered 'subprime']
• Allowable seller credit will be reduced from 6% of purchase price to 3% of purchase price

FHA loans, which totaled less than $100 billion in 2007, increased to over $360 billion in 2009. HUD has initiated these guidelines, in part, because 1 in 6 FHA loans is now delinquent.

In other FHA news, the agency has now waived a requirement that 90 days pass before "flipped" REO properties are eligible for FHA loans. This will help move the inventory in areas dominated by distressed properties.

In 2010, SoCal Housing On the Mend: Los Angeles County Median Home Price Up 5.9% Year-Over-Year, Sales Up 31%

The Los Angeles Times reported that the median home price in the five-county Southern California region rose 4% to $289,000 -- the first year-over-year gain since prices started collapsing 2-1/2 year ago.

Certainly, the median home price is 43% below the peak price of $505,000 attained in 2007. But the simultaneous trends of rising prices and increasing sales indicate a recovering market.

In terms of a percentage of the overall market, sales of $500,000 or more rose from 16.5% a year ago to 20.2% in December 2009, showing that this higher-end segment is also experiencing more activity.

Many argue that the higher prices and increased sales are spurred by two, government-backed programs: an $8,000 Buyer Credit and interest rates that have been artificially lowered through stepped-up purchases of mortgage-backed securities. The market could sputter once these two measures are terminated mid-year.

Others contend that low prices and diminished threat of economic meltdown are driving buyers to "get into the market".

Whichever view you hold, it's clear -- at least for now -- that the market is in an upswing.

Westside Los Angeles Multifamily 4th Quarter 2009: Investors Pay Premium to own in Santa Monica; West LA Offers Highest GRMs

Analysis of Westside apartment building sales in the the 4th Quarter 2009 show that investors are willing to accept a wide variety of returns in such neighborhoods as Santa Monica, Venice, West LA and Palms-Mar Vista. The dominant themes:

• Santa Monica - Close to the beach, Gross Rent Multipliers (GRMs) are in the range of 14.0 - 14.5. Close to the freeways, or areas further north, east or south in Santa Monica, GRMs are in the 10 - 12 range. Some of the largest sales were the best-located buildings that offered the lowest GRMs.
• Venice - The biggest sale of the quarter (15 Horizon Avenue) was for a vacation-rental by the beach offering a straight 10.0 GRM (with presumably a lot more management than a traditional rental building). Most other Venice sales are duplexes and other owner-occupied properties.
• West LA / Palms-Mar Vista - West LA offered investors the highest GRM -- 8.7 (1973 S Bedford Street). Palms-Mar Vista was light in multifamily sales -- only one sale topped $1 million.
  

15 Horizon Avenue in Venice sold for $3,600,000. Gross operating income is $359,628 -- or a 10.0 GRM. The building's twenty units have been operated as a vacation rentals.
1518 9th Street in Santa Monica sold for $2,775,000, for a GRM of 13.9. The building has fifteen units, eight of which have below market rents, and is located a short distance to the beach and freeways.

1001 12th Street in Santa Monica has nine units and sold for $2,495,000, or 12.6 times gross rents.
1334 16th Street in Santa Monica has ten units and sold for $2,375,000 or 15.1 gross rents.

2584 S Centinela Avenue in West LA has eight units and sold for $1,995,000 or 11.5 gross rents. This 1988 building is not subject to Los Angeles Rent Control.

The highest GRM in the quarter was recorded for 1973 S Bedford Street. This 16 unit building, by Los Angeles standards, is a "cash cow", generating $217,320 for its $1,900,000 purchase price of $1,900,000.

Where's The Los Angeles Home Market Heading? Prices Coming Off Bottom - Tightening Market over $1 million - Under $1 million Market in Full Swing

To get an impression of where the Los Angeles home market is heading, we took a look at the combined statistics of seven Los Angeles neighborhoods: Beverly Center - Miracle Mile, Hancock Park - Wilshire, Hollywood Hills East, Los Feliz, Silver Lake / Echo Park, Sunset Strip - Hollywood Hills West, and West Hollywood.

Our assessment? The worst is behind us. In terms of pricing, the bottom may have been reached somewhere in the 1st half of 2009.

This is a broad market, covering everything from bank-owned shacks to gilded mansions. To further break it down, we separated the market into the under $1 million and over $1 million segments.

Over $1 million market. For much of 2009, job and portfolio loses, coupled with jumbo loan underwriting hurdles, created a challenging environment for residential real estate. Data show that the percentage of homes under contract has been trending up since December 2008. As bad as the news has been, it hasn't arrested the sale of houses priced over $1 million.

Under $1 million market. The under $1 million market has been tightening up since it reached its most flaccid state in the 1st half of 2008. Now, nearly one in five homes under $1 million is under contract, compared to one in ten homes for much of 2008.

Conclusions: This central area of Los Angeles, which has always had high barriers to entry because of price, will still continue to have high barriers to entry because of price. The median sales prices is trending up. The market, in all ranges of the price spectrum, is experiencing increased sales activity.

Some unknowns remain in terms of how many owners in distress will get foreclosed upon, elect to do short sales, or negotiate loan modifications. But in terms of current dynamics, the market is in an upswing and the bottom is behind us.

The New Gold Rush? Schwareznegger Proposes $10,000 Tax Credit for California Buyers - No Income Limits

Those contemplating purchasing a home or condo in California in 2010 may be entitled to a big windfall.

The Governor has proposed allocating $200 million towards providing 20,000+ California homebuyers with a $10,000 tax credit.

There are few strings attached to this proposed legislation. The credit would be payable to the buyer as a $3,333 discount to state taxes over three years. It would apply to primary residences only -- but is not limited to new construction like the 2009 tax credit.

Buyers, tee up your purchases. The 2009 tax credit allocation of $100 million was exhausted in a little over three months. The credit is applied on a "first come, first served" basis.

Updated 3/23/10: The bill looks like it's become reality. $200 million will be allocated as a $10,000 tax credit for first-time buyers and those purchasing newly-constructed homes, effective May 1, 2010. That means, there are only 20,000 beneficiaries. Don't miss out on this big handout, it may be the last incentive. (5% interest rates aren't bad, either.)

Updated 3/24/10: The bill should be signed later this week. More detail was provided by the California Association of Realtors:

• "The California legislature on Monday passed AB 183, providing $200 million for home buyer tax credits. The Governor is expected to sign the bill into law this week. C.A.R. supported this important legislation since its inception. Part of a package of four bills passed at the request of the Governor, AB 183 is designed to help stimulate the economy and create jobs. It allocates $100 million for qualified first-time home buyers who purchase existing homes and $100 million for purchasers of new, or previously unoccupied, homes.
• The eligible taxpayer who closes escrow on a qualified principal residence between May 1, 2010 and December, 31, 2010, or who closes escrow on a qualified principal residence on and after December 31, 2010 and before August 1, 2011, pursuant to an enforceable contract executed on or before December 31, 2010, will be able to take the allowed tax credit.
• This credit is equal to the lesser of 5 percent of the purchase price or $10,000, taken in equal installments over three consecutive years. Under AB 183 purchasers will be required to live in the home as their principal residence for at least two years or forfeit the credit (i.e. repay it to the state)."

"Schwarzenegger Proposes Tax Credit to Spark New Home Building", Sacramento Bee

Homes Prices in Hollywood Hills at 2004 Levels - But Market Bottom Behind Us - Still Some $10 Million Sales Above Sunset Strip

High above the city, from the Bird Streets to the Hollywood Knoll, lie the fabled Hollywood Hills West. Since the days when Sunset Boulevard was a dirt road heading from the Beach to Hollywood, the Hills have never gone out of style. The Hills proved its eternal draw even in dire times -- in 2009 there were three sales of over $10,000,000.

But like other neighborhoods, the Sunset Strip - Hollywood Hills West has gone through some seismically shifting times during the recent real estate heyday.

From 2004 to the peak of the market in 2007, the median sale price in this area rose 36%, from $1,125,000 to $1,525,000. From 2007 to 2009, the median sale price fell back to earth, dropping 25%, back to 2004 levels.

Sales volume dropped an amazing 60% from 2004 to its low point in 2008. In 2009, there was a 16% increase in sales off the 2008 bottom.

The market bottom in sales activity was in approximately October - December 2008, during the prime of the financial crisis. The percentage of properties under contract lagged at around 3% for months. Sales activity picked up in 2009, and current sales activity is at a level seen in the early days of 2008.

Conclusions:

• Easy, available money, contributed to the huge run-up in prices from 2004 - 2007
• The sales activity "bump" in 2009 was due to the large number of well-priced bank-owned properties (REOs) that hit the market
• An increase in sales activity in 2009 is a sign of a stable market
  
• Many buyers who purchased homes from 2003 - 2008 have "negative equity" -- or are "upside down" -- whereby they owe more on the mortgage than the the value of the house
  
• Homeowners with negative equity who fail to get loan modifications will "walk away" from their houses, even if they can afford their monthly payment
  
• Look for short sales and foreclosures to "make the market" in 2010
  

West Hollywood Market: 2009 $835,000 Median Price off 22% from 2007 Peak, Sales Decline 62% from 2004

It's a new year and a new decade and a great time to take stock of what has happened over the past few dizzying, topsy-turvy years in real estate. We're first going to look at what has unfolded in our home turf of West Hollywood.

Single Family Market. The charts above and below provide a snapshot of how the wave of liberal lending led to a boom in prices that peaked in 2007 -- and then a subsequent crash when lending was tightened.

From 2004 - 2007, the median home sale in West Hollywood rose 34% from $795,000 to $1,065,000. This was the time of "stated income", "no documentation" loans, and "100% financing."

That era ended in August 2007, when the banks started to turn off the lending spigot (since some of their "liar loans" started to turn sour.) From 2007 - 2009, the median home sale declined 22% to $835,000.

We can see the same trend in the number of sales $1 million and higher. There were 65 of these in 2007, 39 in 2008, and 17 in 2009.

Sales show a different trajectory. The number of home sales in West Hollywood declined 38% from 2004 - 2007 and then declined 39% from 2007 - 2009. In fact, the number of home sales in West Hollywood in 2009 is down an incredible 62% from the number of sales in 2004.

Condo Market. The trends for the condo market in West Hollywood mirror the single family market.

From 2004 - 2007, the median condo sale in West Hollywood rose 35% from $450,000 to $609,000. From 2007 - 2009, the median condo sale in West Hollywood declined 20% to $485,000.

Sales have also been battered during this time. The number of condo sales in 2009 was down 55% from peak sales in 2004.

Conclusions. The single family and condo markets in West Hollywood have a similar profile, and we can draw similar conclusions from the data:

• Current prices are at 2004 levels
• The West Hollywood market peaked in 2007
  
• The 2009 median home sale price of $835,000 is just above the $729,750 "jumbo" conforming loan limit for Los Angeles County. Financing dictates pricing.
• The 2009 median condo price of $485,000 is just above the $417,000 conforming loan limit for Los Angeles County. Financing dictates pricing.
• The greatest number of sales took place in 2004 with a rising market and liberal lending.
• The fewest number of sales took place in 2009 with a declining market and tight lending.

The boom and subsequent bust in the real estate market over the past six years was largely structural in origin, caused not by an increase of salaries or population, but by the availability of cheap money. As we analyze the data of other neighborhoods, we will likely draw similar conclusions.

And what can we extrapolate for 2010 and beyond? If the economy doesn't "lose the other shoe", we are expecting a stabilizing market. Big price declines -- and job losses, and stock portfolio losses -- have already taken place. The economic outlook is dour, but West Hollywood still remains a central, highly-sought after neighborhood in the US's second largest city. We expect 2010 to look and feel a lot like 2009.