Small Investors Build Presence in Apartment Sales

Individual investors are buying apartment buildings in Southern California in greater numbers this year as the region’s growing demand for housing, the rising prices of single-family homes and the lack of new construction make apartments look like a good bet to produce steady returns for years to come.

Experts say sales of apartment buildings also have been getting a boost in recent months as small investors, jittery about the stock market, have diversified into rental properties as a hedge against stocks.

Nearly 50% of the apartment complexes sold in Los Angeles, Orange, Riverside and San Bernardino counties during the first six months of this year have been in the size range of five to 19 units, according to a report from Marcus & Millichap, an investment brokerage company. That is up from 40% during the first half of last year, the company reported.

Sales of these small buildings are a sure sign of growing participation by private investors because such buildings are far too small to interest real estate investment trusts and institutional investors such as pension funds, said Harvey Green, an executive vice president with Marcus & Millichap in Encino.

“We have seen an influx of first-time investors as well as those who were involved in the last cycle and have been sitting on the sidelines since then,” Green said. “We’ve seen a lot of movement in the smaller end of the marketplace.”

The Marcus & Millichap report noted that 66% of the buildings sold this year were built during or before 1960, compared with 53% during the same time last year.

Green explained this as the result of the “trickle-down” manner in which real estate markets typically recover. He said sales picked up and prices rose first in the higher end of the apartment market--just as sales and prices of single-family homes recovered first in the higher end of the residential market before moving down to moderate and lower-priced neighborhoods.

Those rising single-family home prices, Green said, are another factor driving the apartment market. As home prices rise, he said, apartment dwellers--especially those earning more modest wages and living in moderate and low-priced units--find it harder and harder to make the move from renter to homeowner. That means apartment owners are assured of a stable tenant base.

Investor interest in apartments seems to have accelerated recently, said Stephen Duringer, president of the Orange County Apartment Assn.

“About six months ago people began to get a little jittery about the equity markets, so they started taking some of their money out and shifting it to real estate,” Duringer said.

One investor who recently bought an apartment building, 22-year-old Raymond Brenneman, said he was quite familiar with the pros and cons of the stock market versus real estate before he decided in July to invest a $34,000 inheritance as a down payment on a 10-unit, $180,000 apartment complex in Long Beach.

Brenneman said he worked as a stockbroker until August, when he quit the business to concentrate solely on real estate. Although he still has money in the stock market and still believes in it, Brenneman said, he likes the monthly cash flow an apartment building generates.

The Long Beach building is Brenneman’s second apartment complex. He bought his first, a four-unit building in Silver Lake, two years ago when he was still a student at USC, where he earned a degree in political science.

“I had $8,000 at the time and was trying to decide what to do with it,” Brenneman recalled. He considered stocks and mutual funds but chose the apartment complex because of the regular income it would generate, $600 a month after expenses. The Long Beach building, he said, generates $1,700 in monthly income.

According to Duringer of the Orange County Apartment Assn., buyers have found willing sellers in other small investors who see a chance to let go of properties that they have been holding onto for many years, waiting for values to return.

“The typical investor in a five- to 15-unit building has been an older owner whose needs are shifting and who wants to get out,” Duringer said. “The small investors have this market all to themselves because most of the REITs won’t touch the smaller buildings.”

Dan Faller, president of the Apartment Owners Assn. of Southern California, echoed Duringer’s analysis. “Instead of pent-up demand, we had pent-up supply,” he said.

Lending trends provide another sign of the accelerating pace at which small investors are buying apartment buildings, said Joe Ursino, a senior vice president at West Los Angeles-based Southern Pacific Bank.

Loans on small apartment buildings constitute 70% of the bank’s lending volume, which grew from $260 million in 1996 to $300 million in 1997 and is projected to reach $400 million this year, Ursino said. Southern Pacific makes loans of $100,000 to $3 million, with the typical loan usually about $375,000.

Ursino noted that the bank had hoped to increase its loan volume even more this year, but it has run into competition from other lenders who have noticed the demand for financing of apartment building purchases. Southern Pacific identified loans on small apartment buildings as its market of choice in 1994 and has concentrated its efforts on the market segment since then.

“Our borrower is typically an individual who is a salaried employee or a small-business owner,” Ursino said. “This is often the individual’s first venture into real estate investment, and the investment typically represents a large portion of his or her net worth.” The complexes typically contain eight to 30 units and often, he said, the investor moves into the apartment building to keep a close eye on the investment.

While growing investor interest has been driving up prices, experts say apartments still appear to hold potential for appreciation.

“We’re not in a future-value market yet where people are buying on the basis of projected rent increases,” Green said. “We’re still in a very strong cash-return market.”

Ursino said Southern Pacific will not approve a loan unless the building generates enough cash to pay the mortgage. With financing still plentiful, he said, lenders and borrowers both need to avoid deals that bet on future rent increases to pay the debt.

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Apartment Market Trends

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

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1997-2002 Number of demand for renter-occupied additional Rank Submarket households* rental units 1 Moreno Valley 10,271 2,507 2 Temecula/Murrieta 9,534 2,101 3 Chino/Chino Hills 7,962 1,366 4 Corona/Norco 12,783 2,095 5 High desert 20,696 3,236 6 Mountain Cities 2,474 380 7 Southern Orange County 40,165 5,890 8 Fontana/Colton 28,031 4,069 9 Upland/Rancho Cucamonga 19,416 2,418 10 Walnut Valley 21,009 2,610 11 Central Riverside 19,107 2,219 12 Airport/Irvine area 30,535 3,255 13 Ontario/Montclair 20,242 2,147 14 Santa Clarita Valley 21,175 2,242 15 Coachella Valley 31,231 3,259 16 Riverside submarket 37,970 3,657 17 Northeast San Fernando Valley 44,987 3,845 18 West San Fernando Valley 57,064 4,715 19 Redlands/Loma Linda 13,222 1,086 20 East San Gabriel Valley 57,682 4,438 21 Northern Orange County 52,648 3,770 22 Van Nuys/N. Hollywood 71,108 4,443 23 Beaumont/Banning 5,317 305 24 San Bernardino 36,987 2,075 25 Ventura Blvd. corridor 43,282 2,056 26 West San Gabriel Valley 84,162 3,940 27 Tri-Cities 114,809 5,368 28 Los Angeles corridor 43,826 1,970 29 South Bay North 67,239 2,945 30 Long Beach 105,548 4,291 31 Mid-Cities 91,905 3,701 32 South Los Angeles County 51,723 1,985 33 Coastal Orange County 69,337 2,644 34 Central Orange County 137,683 5,168 35 Twentynine Palms 7,680 261 36 Westside 120,104 4,009 37 Low desert 6,159 195 38 South Bay 67,253 1,514 39 East Los Angeles 49,734 1,111 40 South-Central Los Angeles 119,338 2,543 41 Santa Monica 32,568 615 42 West Hollywood 20,398 267 43 Hollywood 87,968 612 44 Mid-Wilshire 84,842 376 45 Mentone/Yucaipa 4,361 -26 46 Downtown Los Angeles 65,660 -1,160

Percent Rank change 1 24.41% 2 22.04 3 17.16 4 16.39 5 15.64 6 15.36 7 14.67 8 14.52 9 12.46 10 12.42 11 11.62 12 10.66 13 10.61 14 10.59 15 10.44 16 9.63 17 8.55 18 8.26 19 8.21 20 7.69 21 7.16 22 6.25 23 5.74 24 5.61 25 4.75 26 4.68 27 4.68 28 4.50 29 4.38 30 4.07 31 4.03 32 3.84 33 3.81 34 3.75 35 3.40 36 3.34 37 3.17 38 2.25 39 2.23 40 2.13 41 1.89 42 1.31 43 0.70 44 0.44 45 -0.60 46 -1.77

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Sources: National Decision Systems, Marcus & Millichap

*As of year-end 1997