T. PATRICK SMITH : Irvine Co. Building for Future : Apartment Rents Static, but Construction Level Still High
T. Patrick Smith is president of Irvine Pacific Co., one of the Irvine Co.’s operating divisions. As such, he runs an empire of 10,000 apartments spread throughout 88 apartment complexes in Irvine, Tustin, Orange and the unincorporated areas of the county, making Smith one of the county’s largest landlords.
In Orange County, only Western National Properties and Regis Homes Corp. are in the same league.
But the apartment market isn’t what it used to be. In fact, experts say, there are too many apartments out there and not enough tenants. Consequently, rents haven’t risen much in the last few years.
That doesn’t mean apartments are cheap, though. Orange County has some of the highest housing prices in the nation, and its rental market is similarly pricey. By last year, the average rent here was $725 a month, according to one estimate.
Still, as home prices go up the Irvine Co. and other big landlords expect to be sitting pretty. That’s because residents who can’t afford to buy a house here will have nowhere else to go. The county’s population is expected to keep growing. And as traffic congestion worsens, fewer Orange County residents are expected to flee to Riverside County in search of cheaper housing.
So a lot of developers are building apartments in Orange County. This year the Irvine Co. alone--which owns one-sixth of the county’s land--will build 2,600 apartments in 11 complexes. Even in a slow year the company usually builds at least 1,100 units.
Smith, who presides over all this activity, recently talked with staff writer Michael Flagg about the local apartment market and the company’s strategy.
Q. Why are you building more apartments this year than usual?
A. That’s just the way the entitlements came. We had a lot of things up before local governments, and it’s just the timing of when the projects were approved.
Q. Do you try to maintain a certain mix of for-sale homes and apartments? In other words, the company has roughly 1,500 for-sale homes built on its land each year. Is there a target number for apartments?
A. Yes. As a company we try to maintain a balance of housing so we can provide housing across the whole spectrum. But there’s no formula. Each village would vary depending on where it is and what the area basically calls for.
Q. You’re not the only people who are building a lot of apartments. There are said to be a lot of complexes under construction these days. Does that worry you?
A. Yes. We have some concern that the apartment market in general is softening. That’s primarily due to the large amount of construction we’ve seen over the last three years. And what’s projected for the next couple of years, which is a lot. Rents over the last couple of years have been flat, and the fact there are a lot of apartments on the market is a big part of that.
Q. Why all this construction? You could understand it prior to 1988, just before tax reform took effect and did away with a lot of the tax incentives for building apartments. But why now?
A. A lot of construction occurred in 1987 and 1988 as a result of the closing out in 1986 of a certain kind of tax-free bonds for apartment construction. That money had been obtained in late 1986 and they built with it in 1987 and ’88. Then it’s also perceived that Orange County is a tremendous market with good long-term growth, and so anyone that could find a site was buying and building with the prospect it’d turn out to be a good investment in the years to come.
Q. They’re building against the expectation that things will tighten up again. And they will tighten up, because land is so expensive it’s hard to find any to build apartments on, right?
A. It is expensive. And commute times are getting longer and longer, and more people just aren’t willing to get on the freeway. That means living close to their work, and that means--in a lot of cases--an apartment, because a lot of people can’t afford to buy in the county.
Q. What are occupancy rates these days?
A. Although the market’s softer than it’s been over the last two years, we’re still enjoying a 96% or 97% occupancy. Our occupancy rates are about the same. We’re pleased with that. In South County it’s going to be a lot softer because of all the construction.
Q. One hears the higher-priced apartments are having the worst problems now.
A. We haven’t experienced that. But we haven’t been able to increase rents much either, and that’s across the board in all our apartments.
Q. When do you expect the apartment market to tighten up again?
A. There’s an awful lot of product expected on the market in the next couple of years. I don’t know. I think it’ll be a steady market, but I don’t see a lot of big increases as far as rents are concerned.
Q. Despite all that, there are supposed to be a lot of investors around looking for apartment complexes to buy. Have you had any bites?
A. I get calls constantly. It’s always a broker asking if we’d be interested in selling. It’s the usual run of people, from private individuals to institutions. But (Irvine Co. Chairman) Donald Bren is very emphatic that his apartments are built for the long haul and for the long term. He has no interest in selling them. They’re a long-term investment for him, and he puts a high priority on them. There’s very little distinction between some of our condominiums that are produced for sale and our apartments. In fact, we have two or three projects that were built as condos that we are now renting.
Q. How good an investment are apartments compared to simply selling the land to builders to construct for-sale homes, as the company also does?
A. Apartments are a capital-intensive investment. But I think the long-term prospects for growth in housing is very strong. As you know, the cost of housing in Orange County has become prohibitive for the average home buyer. So apartments have taken on a larger role in filling the gap for lower-priced housing.
Q. So over the long run the apartments could actually be more profitable than selling land outright to home builders?
A. In the long run they’ll make a substantially strong investment. And the purpose of the company in general is to look to the future and have an investment portfolio. And I think the apartments go a long way toward making that an attractive portfolio.
Q. What market are you aiming at these days?
A. I think we try to market to the spectrum. We have student projects at UCI, we have what we call moderate income projects, several HUD projects that are subsidized, right up to the high-end product. Depending on the market area, we try to be pretty diversified. At our apartments in Big Canyon Villas, the rents go up to $3,250 a month. But that’s a unique project and not something you’d typically find in our portfolio, a very high-end market. We probably won’t build another one like it in the near future.
Q. Who’d live in an apartment that cost $3,250 a month? Why not just buy a house?
A. Somebody who doesn’t want the hassle of owning a home. Maybe a retired person who wants to do a lot of traveling and doesn’t want to wind up with the maintenance and capital investment involved in owning a home. There are also people moving into the area who are interested in living here awhile before buying. It’s a limited market, there’s no question about it. But it’s there, just as it’s there in West Los Angeles and Long Beach, only to a greater degree because those are bigger markets.
Q. Apartments are getting a lot more lavish these days, a lot more like condos with the fireplaces and the vaulted ceilings. Is that because more people are looking at them as an alternative to buying a home?
A. Exactly. I think two or three things are involved. People are looking at them as an alternative to buying a home, or an alternative until such time as they can buy. Secondly, there’s a lot of competition, so everybody has to make a better mousetrap. And third, (with) the rents we’re asking, people demand a higher-quality product.
Q. Is there a point at which most people simply refuse to pay rent, a ceiling you can’t go beyond?
A. Absolutely. It’s really a function of for-sale housing, because those prices keep escalating. In Orange County you’ll find rents will escalate because renting’s the alternative.
Q. What do you charge on the average for an apartment?
A. For a two-bedroom, about $1,000.
Q. One would assume your profits would be down when you’re spending more to try and build a fancier and more elaborate apartment than the competition.
A. The amount you invest in the product is up versus the rent you can receive, which is down, there’s no question about that. Rents have not increased substantially over the last two years, and obviously expenses have continued to rise. So the margins are thinner than they were over the last couple of years. And you have to spend a lot on marketing to keep them full.
Q. How much thinner?
A. I don’t know that I’ve measured it per se. Each product is measured on an individual basis, and you have to remember we’re long-term investors. So our front-end return, although it’s extremely important to us, is not the ultimate measure of whether we build a project or not.
Q. So you’re saying it’s not that good an investment up front?
A. I would say our return is equal to that of other developers in the marketplace. A typical project in the Southern California market yields 7.5% to 8%.
Q. You have one big advantage in costs, do you not, in that the Irvine Co. owns about a sixth of the county’s land and so land is not an out-of-pocket cost?
A. We look at our land costs as being equal to the market’s. What we could sell that land for, we consider to be our investment. And as far as any other costs are concerned, we don’t have an edge.
Q. Where does Donald Bren fit into all this? The company says he’s been building a lot more apartments than his predecessors since he took control in 1983, the official reason being that he’s more interested in providing a better balance of housing for all income ranges in the company’s developments.
A. I think he believes strongly that multifamily housing is a good investment. As you know, his strategy is to develop an investment portfolio for the long term. Land is sold for for-sale housing really to provide capital for the investment portfolio. We also develop office and industrial buildings, and that in itself creates a demand for housing. We believe we need to provide housing across the spectrum to go with that.
Q. So you’re in the position of stoking demand for your own product?
A. In a sense, you could say that.
Q. On the other hand, do you run into community resistance to apartments often? Perhaps from homeowners nearby, say, who fear apartments may lower the homeowners’ property values?
A. We haven’t faced a lot of that recently. But typically, because we’re getting permission to build on 400 or 500 acres at a time which are vacant when we start, there aren’t any single-family homes around and no objections.
Q. How has the recent down-sizing of the company, where many services like apartment management are now contracted for rather than done in-house, affected your operation?
A. Well, for instance, at Irvine Pacific we now have a total of 13 employees. With those people we control the entire portfolio, but we can do that only with the assistance of three outside development companies--Regis, Western National and Akins--and four property management companies. We use them on a fee basis. I understand there used to be 350 in this department, although a lot of them used to work on for-sale residential building too, so I’m not sure it’s a direct comparison.
Q. The advantage being, at least theoretically, that you’re more efficient this way?
A. Now we can spend 95% of our time focused on the performance of our projects. Typically you can only spend 50% of your time because you’re involved in administrative tasks. We don’t have that; the administrative tasks are handled by our outside developers and property managers.
Q. Some people familiar with the local apartment market say the Irvine Co. has a knack for putting its new apartments on the market at just the right time, but it sounds like local governments have a lot more to do with the timing than those people might suspect. Is that the case?
A. Ideally we’d like to hit strong markets. But more and more development is governed by your ability to get entitlement for your land. So if you want to hit a certain time frame, you may be very limited by the fact the entitlement can’t be obtained in the time frame you’d like to get it.
Q. So you don’t swing as much weight with local governments, but you’re still a major force in the market itself. If the county has about 180,000 apartment units, your 10,000 gives you about 6%. How do you factor that influence into your business strategy?
A. In the jurisdictions that we predominate in, at one time we would have had an impact. But more and more we see that our competition is in those cities too. For instance, in Irvine where we were once probably the only apartment owner, we now see a lot of land that was sold off to others in the past being rezoned to apartments, such as in the Irvine Business Complex, which has brought in substantially more competition.
Q. Who are your competitors these days?
A. There’s not any one huge company. But most of the companies are represented. For instance, William Lyon Co. has a substantial amount of apartments, Regis Homes has a fair number of apartments, Western National Properties. Even companies that have only a couple projects, that all adds up to substantial competition. Right now, South County represents a lot of competition. It’s a competitive area for us.
Q. What’s ahead? Do any of your strategic plans include high-rise apartments? Are they on the way as the county becomes more urbanized?
A. Well, land values have escalated dramatically the last couple of years, and I don’t think there’s any question the answer is more density per acre. We used to build 16 or 18 units to the acre, in the last two years we’ve gone to 25 to the acre and there are a couple of projects we’re seeking entitlement on that are 45 to the acre in Irvine. They’re four stories high.
Q. And people are moving into these projects?
A. Orange County is becoming more urban. Acceptance is not the problem. Plus, those new projects are two to three years away from hitting the market because it takes that long to build them. I’m not sure people are ready to accept high-rise apartment buildings yet. We’re probably three to four years away from that being accepted.
Q. The figure’s often quoted that about 42% of the county’s population rents, and one also hears it said often that that percentage is bound to increase as owning a home gets beyond the means of many people. Do you think that’ll be the case?
A. The question is, where do for-sale home prices go? That’s really the driving force. Right now it’s said the market is softening, and we’re not seeing the astronomical increases we saw last year. There’s clearly a lot of room for rental housing. It’s a problem of people getting the down payments for a home as much as meeting the monthly mortgage payments.
