Costs Put a Lid on New Apartments

High construction costs, limited land and reduced tax incentives are hampering development of new apartment units in Southern California at a time when housing demand and real estate values are climbing.

The slow rate of development is in dramatic contrast to the last real estate boom cycle, when thousands of new apartment units in all price ranges hit the market. Today’s building pace barely surpasses that seen during the doldrums of the last recession.

But construction of new apartments has picked up in Los Angeles and Orange counties, with some new and noteworthy complexes now being built.

Lincoln Property Co. has two large complexes under construction in Los Angeles County and two others set to break ground soon. Irvine Apartment Communities is investing more than $300 million in new construction, most of it in southern Orange County, and Sherman Oaks-based PCS Development has spent $25 million in the last nine months to buy and remodel the former Oakwood Apartments, which reopened Aug. 1 as the Premiere.

But with the number of new apartments hovering at about 4,000 per year in both Los Angeles and Orange counties, the pace of new apartment construction pales in comparison to the heady days of the 1970s and ‘80s, when tens of thousands of new units were being built each year.

Just how few new apartments are being built today compared with earlier times is illustrated by figures from the Construction Industry Research Board in Burbank.

According to the group’s figures, the number of permits issued for multifamily housing (including apartments, condominiums and townhouses) peaked at nearly 53,000 in Los Angeles County in 1986. The peak year in Orange County was 1969, when nearly 20,000 multifamily permits were issued, but the number of permits issued remained steady in the county at 10,000 or above in half the years between 1970 and 1990.

Ben Bartolotto, CIRB research director, said the number of permits largely mirrors the actual number of units built.

On the other hand, the pace of building definitely quickened after 1993, when multifamily construction hit a 30-year low of just under 3,000 units in Los Angeles County and just under 2,000 in Orange County. The trend has been the same in the Inland Empire during the 1990s, where permits dipped to a few hundred per year in Riverside and San Bernardino counties after surpassing 10,000 annually in both counties during the 1980s.

Despite the recent rise in construction, experts say L.A. and Orange counties can forget about returning to the building pace of their peak years.

“I can’t imagine that we’ll ever see numbers like those of the 1970s and ‘80s again,” said Walter Hahn, an economist with E&Y; Kenneth Leventhal.

Hahn said the prospects for new apartment construction are limited in both counties by the relative scarcity and high price of land and other factors. For example, he said, many of the apartments built before 1986 were paid for by syndicators who developed them primarily as tax write-offs until the Tax Reform Act of 1986 chased them out of business.

While today’s development picture seems to prevent any huge surge of new construction, it has created a window of opportunity for developers who can afford to buy land and build apartments.

According to Dennis Cavallari, a senior vice president with Lincoln Property, the high prices for land and construction represent substantial barriers that favor those who can afford to develop, because they limit competition. The region’s steady population and job growth, a growing demand for housing and the relatively high price of single-family homes also favor apartment developers, he said.

“I think this may be one of the best apartment markets in the country right now because there is such a large population base, the barriers to entry are so great and relatively little has been built in recent years,” Cavallari said.

Lincoln has nearly completed construction on a 170-unit building in Marina del Rey, has begun construction of 350 units in Santa Monica and will begin construction within several months on two other projects totaling more than 300 units in Woodland Hills and Westwood, he said. Combined construction costs will surpass $100 million for the four projects.

Cavallari and Hahn both said the high cost of land dictates that developers must build higher-priced apartments. According to Hahn, a two-bedroom unit must command at least $1,000 a month in order for the investment to pay.

“Land costs are too high to make lower-priced apartments pencil out,” Hahn said. “Just about everything being built right now are luxury apartments and upper-priced units, just below luxury apartments. That’s especially true in Orange and San Diego counties.”

With land costs so high and vacant sites at a premium, some developers are turning to remodeling existing complexes.

Among these is the Premiere, the 372-unit former Oakwood complex that PCS Development bought last year for $11 million.

Paul Jennings, chief executive of PCS, said the company spent about $14 million rehabilitating and modernizing the building, where rents range from $800 to $1,900 a month.

Jennings said PCS, which owns about 35 buildings comprising 1,500 units, has also built a 34-unit building in Sherman Oaks and may build another nearby in place of an existing apartment building it owns.

“To us, Los Angeles has proven in the last couple of years to be a very viable market on the macro level because it has solid fundamental economics,” Jennings said. “On the micro level, we see tremendous opportunities in Sherman Oaks and other specific areas that have reputations as desirable places to live.”

Like Lincoln Property, PCS is offering such traditional luxury apartment amenities as spas, fitness centers and a host of other extras. But both developers are also offering some 1990s-style attractions such as built-in computer workstations, high-speed Internet access lines and business centers.

According to Hahn, Southern California’s steadily improving economy has produced plenty of potential tenants to fill these new luxury apartments, where rents can run to $3,000 a month.

Hahn said the high cost of construction means no new lower-priced apartments are likely to be built, but that’s nothing new.

“There is a shortage of lower-priced units in most urban areas of the United States and has been for many years,” he said. “There just isn’t enough land available, even for the higher-priced units.”

Hahn said the problem of high-priced housing cuts across all markets, especially single-family homes, and has a long-term effect on the region’s economy.

“If people can’t find housing that they can afford, then companies can’t attract new workers, and then those companies are either going to leave the area or at least will not be able to grow,” he said.

Los Angeles County is already close to that point, he said, and Orange County isn’t far behind.

“We’re not in that situation yet, but we’re headed there because we don’t have a lot of land left for development,” Hahn said. “Within 10 years, we’re going to be in the same situation as L.A. County.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Apartment Market Trends

Demand for new apartment units in the years ahead is expected to vary significantly by market:

*--*

Current renter # of renter- units as a % of occupied Rank Submarket total hsehlds hsehlds* 1 Downtown Los Angeles 90.38% 65,660 2 Mid-Wilshire 81.99 84,842 3 Hollywood 80.42 87,968 4 West Hollywood 77.24 20,398 5 Santa Monica 71.09 32,568 6 East Los Angeles 63.70 49,734 7 Van Nuys/North 59.94 71,108 Hollywood 8 South-Central 59.39 119,338 Los Angeles 9 South Bay north 59.23 67,239 10 Westside 57.56 120,104 11 Burbank/Glendale/ 57.11 114,809 Pasadena 12 Mid-Cities 56.20 91,905 13 Long Beach 51.83 105,548 14 Ventura Blvd. corridor 47.33 43,282 15 West San Gabriel Valley 45.88 84,162 16 Central Orange County 43.65 137,683 17 LAX 43.42 43,826 18 Coastal Orange County 42.85 69,337 19 San Bernardino 40.75 36,987 20 South Bay 40.63 67,253 21 Low desert 38.86 6,159 22 Redlands/Loma Linda 37.83 13,222 23 West San Fernando Valley 37.00 57,064 24 Airport Irvine area 36.77 30,535 25 Northeast San Fernando 35.84 44,987 Valley 26 Ontario/Montclair 34.94 20,242 27 Twentynine Palms 34.79 7,680 28 Riverside 33.12 37,970 29 South Los Angeles County 32.51 51,723 30 East San Gabriel Valley 31.74 57,682 31 Northern Orange County 31.48 52,648 32 Coachella Valley 30.73 31,231 33 Mountain cities 30.29 2,474 34 Beaumont/Banning 29.31 5,317 35 Upland/Rancho Cucamonga 27.55 19,416

1997-2002 demand for add’l Rank rental units 1 --1,160 2 376 3 612 4 267 5 615 6 1,111 7 4,443 8 2,543 9 2,945 10 4,009 11 5,368 12 3,701 13 4,291 14 2,056 15 3,940 16 5,168 17 1,970 18 2,644 19 2,075 20 1,514 21 195 22 1,086 23 4,715 24 3,255 25 3,845 26 2,147 27 261 28 3,657 29 1,985 30 4,438 31 3,770 32 3,259 33 380 34 305 35 2,418

*--*

Source: Marcus & Millichap

*As of year-end 1997