Condos Trail Apartments in L.A. Multifamily Market
California Real Estate Journal -- February 19, 2008
By KEELEY WEBSTER
CREJ Staff Writer
In a year that looks dim for Los Angeles home builders and condominium developers, apartment owners are likely to profit.
Apartment owners tend to prosper when the single-family market bottoms out because they can push rents and retain credit-worthy tenants likely to be wooed away by the for-sale market during boom times.
Those looking to sell might not get the price they want, but the ones looking to hold are likely to prosper as long as renters don't have the option of moving up into a single-family home or condominium.
"I don't think we are seeing a shadow market in Los Angeles much," said Laurie Lustig-Bower, executive vice president and managing director in the Beverly Hills office of CB Richard Ellis. "I do think that, overall, we are going to have rent appreciation in Los Angeles, but it will not be as robust as the 4 percent projections that were projected in 2007 for this year."
Marcus & Millichap Real Estate Investment Services projected in its 2008 National Apartment Report that asking rents would increase by 5 percent to $1,504 per month by year end, while effective rents will pick up 4.8 percent to reach $1,452 per month. In 2007, asking and effective rents climbed 5.7 percent and 5.5 percent, respectively, according to the report.
Lustig-Bower described Los Angeles as a very complicated market, particularly hard to pinpoint in the current economic environment. The overall apartment investment market is very strong, particularly since it is buffered by the fact that if people lose their condominiums they are going to become renters, she said. But high gas prices and other economic factors make it tough for middle-class Angelenos to afford existing rents, which creates a ceiling on how much rents can be pushed, she said.
"Keep in mind that the Los Angeles rental market is such that people are already spending 25 to 35 percent of their income for housing now," said Steve Fifield, chairman and chief executive officer of Chicago-based Fifield Cos. "So their ability to absorb a 20 percent rent increase in a year or two is not there. If that happened, they would move to the Inland Empire or leave the state." What that means is that it will probably stay at a healthy 5 percent or 6 percent increase, but there won't be huge spikes in rent, Fifield said.
Cautious Environment
Apartment investors enticed by Los Angeles' super-low vacancy rate of 3 percent, as reported in the NAI Global Market Report 2008, will likely grow more wary. The Los Angeles-Long Beach-Santa Ana metropolitan statistical area had the second-highest average rents at $1,647 in fourth-quarter 2007, according to a RealFacts Inc. report. The San Jose-Sunnyvale-Santa Clara area ranked No. 1, even though it too had average rents of $1,647, according to the report.
The continued slippage of the national economy has created an environment where even credit-worthy homebuyers are having a hard time getting a loan. Meanwhile, no one wants to buy a home or condominium that could drop in value over the next six months. Lustig-Bower doesn't think condominium developers trying to sell units currently on the market will resort to discounts, however.
"I think they will hold," Lustig-Bower said. "With interest rates coming down that ought to help keep the prices buoyant. Mortgage payments went down twice, between the 75 basis point and 50 basis point cut [created by the Federal Reserve over the past several months]."
The prime Westside multifamily markets that Lustig-Bower operates in might not see much of a shadow effect from single-family homes on the rental market, but outlying areas are likely to be impacted. "In multifamily, there is a whole shadow rental effect occurring as a result of the illiquidity in the buying side of single family residential," said Lewis Feldman, chairman of the Los Angeles office of the firm Goodwin Procter LLP.
Units are coming on line as rentals through foreclosures in both the single-family detached and condominium markets, Feldman said. The numbers are hard to track because the only numbers available are those provided anecdotally through auctions, and so far those events haven't attracted a lot of buyers, he said. "As people buy more than one home in a foreclosure situation, they have to rent it if they can't find buyers and the banks will also go after rental income on the houses they foreclosed on if they can't sell the homes that came back to them," Feldman said.
The issue is one of economic diversity for Los Angeles. Feldman said homes in Pomona, Palmdale and Corona, where developers built large single-family home developments, will likely end up on the rental market. "I think a lot of those units are going to be rental units for quite some time," Feldman said. "The National Association of Home Builders said it wouldn't turn around until 2010. First, they said 2008, then 2009, and now they are saying 2010." The NAI report predicts a similar timeframe for the return of investor interest in for-sale product. It expects that investors will shift back from rental back to for-sale product in 2010 or 2011 as confidence returns to the for-sale market.
In the meantime, the rental market should remain exceptionally tight because prices for apartments have climbed to record highs and capitalization rates have dropped to record lows, the report states. Buyers can find higher yields in areas such as South Bay/Long Beach, where capitalization rates often exceed 6 percent, according to the Marcus & Millichap report. In locations poised for more rapid rent growth, such as the Westside areas, properties often trade with initial yields below 5 percent, according to the report.
Capitalization rates edged up 30 basis points into the low- to mid-5 percent range in 2007, causing prices to stabilize, according to the report. Going forward, the report recommends that investors seeking upside potential monitor the impact of downtown redevelopment and gentrification efforts, including L.A. Live and the Park Fifth Towers.
Halt on New Construction
Construction of new for-sale multifamily in Los Angeles is expected to be anemic in 2008. Los Angeles had the largest number of housing starts in the state at 20,228, but experienced a 23 percent decline in housing starts in 2007 as compared with 2006, according to the California Building Industry Association.
California single-family home construction in 2007 fell to the lowest level in 25 years as builders around the state dramatically ratcheted back production in response to a softer sales environment, the building association reported. Permits for new homes, condominiums, town homes and apartments in 2007 were down nearly 32 percent statewide to 112,300 from figures recorded for 2006, which is 100,000 units less than recorded in the most recent peak year of 2004, according to the Construction Industry Research Board. The number of building permits issued for new housing units in Los Angeles County dropped by 26.6 percent on a yearover-year basis in December 2007, according to the CIRB. The Oxnard-Thousand Oaks-Ventura County market experienced a 55.6 percent decline in building permits issued for new housing units in December 2007 from the previous year, the CIRB reported.
"I don't think anything for sale is going to get built in Los Angeles this year that wasn't already under construction," Fifield said. Even condominium developments that have good underwriting standards based on solid fundamentals are having a difficult time securing financing.
"What I am seeing in the market right now is that it has gotten more challenging for developers to do condo developments than it was during the fall of last year," Lustig-Bower said. "The subprime problems have made it difficult for anyone seeking financing. Some lenders have shut down and are not making loans until they work out the problems they have with other loans they have made."
Condominium Conditions
Some developers are saying that lenders won't lend on anything for sale, so even if the project was entitled as a condominium development, banks are insisting the project be underwritten as an apartment.
"Lenders are now worried that condominium developments won't make their performance goals," Lustig-Bower said of the restrictive underwriting condition. "In a significant amount of cases, we are seeing properties that were going to be built for condos repositioned as apartments."
Even well-established developers are faced with much more onerous lending terms, such as having to put 30 percent to 35 percent equity into a project, when they only required 20 percent to 25 percent before, Lustig-Bower said. "In some cases, their partners are having financial troubles and need liquidity," she said. "Lenders are also very concerned about assumptions made last year that the market would be healthier than it is this year."
There are probably five companies well-capitalized enough to contribute the amount of equity that the banks are requiring of developers doing for-sale residential construction, Fifield said. One of those is AEG, which is under construction with the third and final phase of its 4 million-square-foot L.A. Live project. Included in this phase is the exclusive condo hotel tower, which will house a JW Marriott and Ritz-Carlton Hotel, as well as serviced Ritz-Carlton Residences.
Another company Fifield has faith in is The Related Cos., the New York-based company that is building the multibillion dollar, mixed-use The Grand project across from Disney Hall in downtown Los Angeles. Related recently received a $1.2 billion infusion from its financial partners, including Goldman Sachs.
"Los Angeles is still a very strong market, even though we are in a huge credit crunch and only the largest, well capitalized, institutionalized developers will be active," Fifield said. "Developers like ourselves, who joint venture with pension funds, are selectively going to get deals done this year. Some of us might do six deals in Las Vegas, Phoenix, Northern California and Southern California this year."
The housing shortage in California is going to get worse now that condominium developers and home builders are abandoning condominium projects because there is no debt or equity for those projects, he said. The big public real estate investment trusts, such as Essex Property Trust and Archstone-Smith, are re-pricing their land, he said.
"Archstone is liquidating right and left, because of the leveraged buy-out that Tishman Speyer did with them," Fifield said. "We are seeing for the first time in the last three years, land that makes sense for apartment development." In inland areas where KB Home was building condominiums for $500 per square foot, they have dropped their options and left money on the table. Land speculators can now go back to $150 per square foot and still make a profit. Even so, Fifield is looking for opportunities to build high-end, high-rise rentals in coastal markets.
"It won't create a windfall for us," Fifield said. "We build low-yield on deals backed by institutional capital. There won't be a lot of fat; it will just be doable where it wasn't a year ago." It won't mean a lot of rental housing will be built in Southern California, either, because the institutional partners and banks are being extremely selective about what they will finance and what they won't, Fifield said. "If you have a marginal site in the Inland Empire or Riverside, that deal won't get financed," he said. "If you have a deal in Marina del Rey or Oxnard, where the rents stayed up and you don't have dislocation because of the shadow market, such as Riverside, the projects are going to get built."
Fifield categorizes his Chicago-based company as one of the mid-sized developers that won't be building for sale in 2008. Fortunately for Fifield Cos., the current economic environment in California actually matches what the company considers its expertise to be: high-rise, podium apartment buildings and office buildings.
"We actually came to California to do high-rise podium rental housing," Fifield said. "We couldn't get anything done because the land costs were run up by the condominium speculators. So we had to put that aside."
Instead, Fifield Cos. developed two projects aimed at the top of the city's condominium market. Fifield sold 1200 Club View, a 21-story condominium development located near the Los Angeles Country Club with units priced at $2,000 per square foot, to Dubai-based Emaar Properties for $98.5 million at the end of September 2007. Club View represented the second high-priced residential property in top-tier markets sold to foreign investors within the past several months.
In April, London-based The CPC Group, a subsidiary of Candy & Candy, purchased an eight-acre site in the Beverly Hills Triangle from New Pacific Realty for $500 million. This year will be a different animal for Fifield, as it will be for other developers, who build condominiums. While large companies like AEG and Related will go forward with for-sale product, Fifield said mid-sized companies like his, that have the good fortune to be diversified enough to develop office and apartment buildings as well as condominiums, will do that.
"We will pick up an apartment deal in West Los Angeles or Marina del Rey and keep our staffs busy enough and wait until things stabilize," Fifield said. "It's not just the credit crunch that is impacting this market. Most people believe that California is in a recession because it is so real estate-dependent."
