MATT DISSTON : Apartments in the 1990s : O.C.’s Soft Market May Be Ready to Rebound
Like many real estate consultants in Orange County, Matt Disston once worked for the Irvine Co., the huge Newport Beach-based property owner and developer. Disston, 38, a resident of Trabuco Canyon, left the company in the early 1980s to start the Research Network in Laguna Hills with Pamela Wooldridge, his former boss at the Irvine Co. Since then, the company has grown to four employees, in addition to the two owners, and has worked for more than 800 clients.
Business often gets better for consultants like Disston during a downturn. As Disston says: “We do well when people have questions. People have questions when there’s a lot of change. And there is certainly a lot of change during a recession.”
One of the businesses going through the most change is the local apartment business. In the early 1980s tenants could scarcely find an apartment in Orange County. Now, in some areas where a lot of apartments have been built, vacancies occasionally reach higher than 20%.
But a lot of apartments were built on the assumption that the county’s strong economy would keep people coming in and its high home prices would force them into apartments. Eventually, it was thought, the market would return to the tight vacancy rates of the early 1980s and apartments would become a smart investment.
In a recent conversation with Times staff writer Michael Flagg, Disston, a UC Berkeley graduate, said there are clear signs the apartment construction boom is abating and good times for landlords--tough times for tenants--could be right around the corner.
Q. Apartment rents are flat and vacancy rates are relatively high, at least by Orange County standards. What’s going on out there?
A. Apartments are suffering the same financial crunch that all other forms of real estate are, which is why the business has slowed down. That’s exacerbated by the large amount of new apartments on the market, which has driven occupancy rates down a little bit--not to a critical point, because we’ve never been below 95%, but lower than we’ve been in a while. Even so, 95% occupancy is a rate they’d love to see in a market like Phoenix. But we have some submarkets in southern Orange County, like Laguna Hills and Laguna Niguel, where occupancy rates have been much lower.
Q. Why the problems in South County?
A. That’s where the vacant land is, and so that’s where most of the new construction is.
Q. What’s that mean for landlords?
A. A lot of competition. Most of the stuff that’s come on the market has been right in the $600 to $900 (a month) rental range, so there are a lot of apartments available in that price range.
Q. Is that considered an average or normal range of rent for the county?
A. That’s a pretty moderate range, since the average rent we found in our survey of the local apartment market this year was $773 (a month). The problem is, that hasn’t changed much in the last three years. And if you take out inflation, effective rents have actually gone down in the last year.
Q. Then there’s a lot of free stuff landlords are offering in order to get people to sign a lease. That has to be considered too, doesn’t it?
A. If you add in the discounting for the inducements landlords are offering tenants, which can be anywhere from one month’s free rent on a six-month lease to giving you a small appliance or even putting better appliances in the apartment, it really amounts to about a 15% discount on that first year’s rent. That’s a significant discount, and the proliferation of those inducements means rents are actually down at least 3%, and as much as 7% or 8% in some markets. There are complexes now giving away trips to Hawaii if you sign a lease.
Q. Given the cost of buying a house here, which is one of the nation’s most expensive markets, you’d think that the apartment complexes would be a little fuller, wouldn’t you?
A. To understand apartments you have to understand the person who rents an apartment. Typically, there’s very little dedication to an apartment; it’s a short-term housing solution. They’re either going to move or they’re going to buy or they just got divorced and moved out of the house. It’s a transient kind of housing solution. On the other hand, one of the major attractions of living in an apartment--and there really aren’t many, since most people were raised and had the expectation they’d spend most of their life in a single-family house--is living close to work. That’s why one of the softest markets in the county--the area around Laguna Hills--is starting to bounce back in a big way. There seem to be enough jobs at the Irvine Spectrum and elsewhere around Laguna Hills to make those places work destinations for renters and a reasonable commute.
Q. How long has the oversupply of apartments in the county been a problem for landlords?
A. For the last several years we’ve looked at this 5,000 to 7,000 unit-per-year construction pace that we’ve had since about 1985 and said: “This has got to slow down.” We expected to see construction drop in 1988, and again in 1989. But it hasn’t. We began to doubt somebody’s sanity, because somebody was still going out there and buying land and going through the entitlement process and trying to bring units out of the ground while we were watching occupancy rates slide and rents stay flat. It didn’t take a rocket scientist to figure out you weren’t going to make any money on these projects.
Q. Why not?
A. You were overpaying for land. I’ve seen land in North Orange County selling for $40,000 a unit, and keep in mind you don’t make any money on an apartment project when you charge $1 to $1.05 a square foot, which is about what rents are these days, on a project where you’ve spent more than $27,000 a unit for land. Land prices have gone out of sight. What finally slowed construction is that there weren’t any sites available that anybody could afford. So by this year we did see a downturn in the number of units developers were planning.
Q. When does the balance start to tip over in favor of landlords again?
AAt the beginning of this year, when we did our countywide survey, I expected the softness in the market to continue for two years, or until 1991, especially in the Laguna Hills and Laguna Niguel area. Then we did the mid-year survey, and we’re all of a sudden seeing units leasing even around here, even though rents are still soft.
Q. Why?
A. I’m not really sure, but one possible reason is that you’ve got a slowdown in the housing market, beginning from about the middle of 1989, because there weren’t any affordable houses left. Even condominiums crept up over $200,000 in 1989. So perhaps all those household formations had to take place in 1990 in apartments. And now most of the houses out there are priced between $250,000 and $350,000, and none of them are selling. There aren’t very many condos because nobody’s come in to fill the void with high-density condominiums. The market pressure hasn’t been there long enough to change the planning. It may change, though, because affordable housing in Riverside and San Bernardino counties--if you come in with houses that sell for under $140,000--sell like hot cakes. Orange County land prices have been bid up to a point where you can’t do that with single-family houses, but you could build high-density condos.
Q. The Orange County apartment market sometimes seems to act contrary to the way you’d expect it to. After Congress gave developers all sorts of tax incentives to build housing in 1981, evidently not much was built here because the vacancy rate was less than 2%. Those incentives disappeared in 1986 with tax reform, and now we have too many apartments. What happened?
A. Keep in mind that interest rates were very high in the early 1980s, and you couldn’t afford to build apartments or anything else, for that matter. Rents hadn’t come up to a point where they would support those kinds of interest rates. If you look at the apartment stock in 1980 and 1981, we actually lost apartments because of condo conversions. We lost about 1,500 units a year. By 1984, when interest rates really came down, everything became feasible again. That’s why, in 1985, we really started to see the heavy supply of apartments come on the market, 6,000- and 7,000-unit complexes.
Q. Let’s talk about the investment side. I’ve seen figures to suggest investors aren’t buying apartments nearly as often as they were, say, two years ago.
A. Yes, buildings were selling at one point. It was mostly the small projects that were selling to small investment groups, the 25- or 50-unit projects, and the large new projects--250 units and up--that were built by a developer and sold to a pension fund. Those were selling. The middle ground--the 50- to 250-unit projects--wasn’t where the market was.
Q. Why?
A. They either didn’t generate enough cash flow to attract a major hitter or the purchase price was too much for a group of small investors to swing.
Q. What’s happening now in the investment market?
A. It’s always hard to sell an apartment building because the management of it is not clean; you’re dealing with people’s homes, it’s very political, and every time you raise the rent a dollar it causes a furor. It’s just not as easy as managing a commercial building. I think a lot of people who bought apartment buildings may have wished they’d bought an industrial building or something else, because managing an apartment building is a full-time job and you have to be very good at it.
Q. One hears that as fewer apartment complexes are built around the county, because of high land prices or whatever, the complexes will start filling up. This will cause rents to go up and eventually turn apartments into lucrative investments, right?
A. Well, when our 1989 and 1990 reports on the apartment market were published, we got calls from irate people who told us we’d just blown their deal out of the water because we’d said rents were still flat and vacancies were increasing, and their investors just walked. Of course, that wasn’t our intent. But it may be that investors just looked around and saw there were a lot of buildings carrying negative cash flows. Why get into an investment that costs you money?
Q. Well, these people you describe as buying apartments--pension funds and the like, and we know there are also some Pacific Rim investors--sound like savvy investors. There must be some appeal in apartments for them, right?
A. Yes, but it’s a long-term hold. That’s what the pension funds and the Japanese are looking at. Anyone who looks at the demographics realizes that apartments are the only alternative for people who need affordable housing in San Diego, Orange County and Los Angeles. That being the case, and now that land values and lack of capital have cut development activity, we’re reaching a point where they may be right. They may have bought in 1987 in an overbuilt market and carried the building for a few years, but now we should begin to see the market rebound.
Q. So when does the market get to the point that rents start rising again?
A. I’m going to stick with the end of 1991. I still think there’s enough supply out there to keep the market as a whole from really tightening before then. And we’ve got slack to take up; we’ve got to get rid of the marketing inducements like the month’s free rent before base values of rents go up. And we’ve got to see occupancy rates increase. If there’s a general decline in the number of units planned by early 1991, I think we’ll see rents starting to go up slowly at the end of the year.
