Investors Wait in Line to Buy Profitable County Apartments

So you would have to win the lottery to afford a house in Orange County? Take heart because you are not alone: More than two-thirds of the families in the county can’t afford the average house here either.

You would think, then, that apartment complexes would be jammed to the rafters with families who can’t afford to buy a home. And ordinarily you would be right.

But after a boomlet in apartment construction the last two years, there are suddenly a good many more empty apartments out there than renters. Consequently, rents last year--which averaged $585 a month for an unfurnished apartment--didn’t go up very much.

That hasn’t deterred a raft of pension funds, insurance companies and even wealthy individuals with lots of cash, who are said to be looking all over Orange County for apartment complexes to buy.

Many of those investors think that rents are going to start rising again soon; they are betting that a pending slow-growth initiative will choke off construction of new houses and force more people into apartments.

“Institutions are trying to buy apartments as fast as they can,” said John W. Bodenburg, regional manager in Irvine for broker and property manager Norris, Beggs & Simpson.

“They figure housing is going to take a quick dip after the initiative, and apartments will be in much more demand,” he added.

Yet some investors are skeptical. The reason: They fear high rents will eventually bring a public demand for rent control. With Orange County residents still in a rebellious mood, these investors reason, rent control might just be the next big initiative campaign.

“The fact that people went out and got 96,000 signatures in favor of a slow-growth initiative leads me to believe they could get that many in favor of rent control if there was a megaleap of inflation in rents,” said Sanford R. Goodkin, executive director of Peat Marwick/Goodkin Real Estate Consulting Group in La Jolla.

All this is ironic because for a short time last year, you would have had a hard time selling people an apartment complex after Congress abolished many of the tax incentives to build and own apartments in late 1986.

Under the old tax laws, even a money-losing apartment complex could generate enough exemptions to shelter an investor’s other income--salaries, interest and the like--and ultimately make the investment profitable.

No more. Congress phased out those types of exemptions in the Tax Reform Act of 1986, and now an apartment complex generally will have to be able to make money on its own in order to get built.

Seeing what was coming, some developers hurriedly began construction on apartments in 1986, many of which came on the market last year. The vacancy rate in apartments went from the extremely low 2% of the last few years to 3.4% in the spring and 3.6% in the fall, according to a survey done for the Apartment Assn. of Orange County. That resulted in a sufficient number of vacant apartments to prevent landlords from raising rents as much as they might have liked.

Despite that, few apartment house owners want to sell, real estate experts say. Even without the tax breaks, investment returns on apartments can be pretty appetizing, they say.

“Everybody wants to buy one,” said Michael L. Meyer of accountant Kenneth Leventhal & Co.’s Newport Beach office, adding:

“But it’s hard to find good properties because sophisticated owners don’t want to sell.”

The initiative lends a certain urgency to the hunt. It would require developers to build or improve clogged roads before constructing their projects. Supporters say it would slow things down until roads and public services are ready to accommodate the growth.

The building industry says the initiative would stop construction dead in its tracks because its requirements are impossible to meet. The Building Industry Assn. of Southern California has sued to knock the initiative off the June ballot.

But polls show a public frustrated by traffic to be overwhelmingly in favor of the initiative.

One of the county’s biggest landlords is the Irvine Co., which owns 8,436 apartments ranging from the Promontory Point complex in Newport Beach--where the cheapest apartment starts at $1,095 a month--to more affordable units in Irvine.

While the company has long sold parcels of its vast store of Orange County land to builders of single-family homes, it has, in the past, built its own apartments and held onto them.

“For a long time, if you wanted an apartment in Irvine or Newport Beach, you had to go to the Irvine Co.,” said one person familiar with the firm.

Now, the company lets others build its new apartment complexes but continues to own them.

The type of investors looking for apartments range from the real estate units of big insurance companies looking for big complexes and deals of more than $10 million, to small partnerships of investors hunting for smaller units costing a few million dollars, according to Mike Capp of broker Grubb & Ellis’ investment property division in Anaheim. Grubb & Ellis’ own investment banking group is one of those investors in the hunt.

“There’s lots of money chasing apartments,” Capp said. “But they’re all looking for prime property, and there’s not much of that available.”

So one answer, for those who want to get into the Orange County market, is to build your own apartment complex. Between 8,000 and 10,000 units are either planned or under construction this year, about the same as in 1986 and 1987, said Matt Disston of the Research Network, a Laguna Hills consultant. Overall, there are an estimated 220,000 apartment complex units in the county.

More of those units are being built with provisions for converting the apartments to condominiums in the event a rent-control ordinance ever passes, said Brea real estate consultant Alfred Gobar, who is himself an investor in an apartment development.

The problem is that land is becoming scarce and even more expensive, since the most popular apartments tend to be near shopping centers or clusters of office buildings.

“The land is getting so expensive that there’s pressure to put a four-story building on it with much more luxurious apartments,” said Meyer, the Kenneth Leventhal managing partner.

“So there’s a tendency now to design smaller units in order to keep the rents down,” he added.

Meanwhile, the investors continue to search for likely apartment complexes.

Said Disston: “I’ve had calls from Japan, Canada, Texas, the eastern U.S. They all want to know how they can get into this market.”