Eyesore Apartments Now Looking Good
Intrepid investors are converting some of Southern California’s worst apartment buildings into profitable properties--including many complexes that were once havens for gangs and drug dealing--through a business strategy that might be summed up as “capital conquering crime.”
From the smallest private investors to the biggest publicly held real estate investment trusts, buyers willing to spend heavily on renovations and pay close attention to managing their properties are turning neglected, deteriorating buildings from barely to fairly profitable and at the same time eliminating what in many cases has long been a neighborhood eyesore.
Thanks to the strong demand for apartments generated by the region’s surging population and stable economy, these buyers say, landlords today can afford to invest in extensive renovations and raise rents at buildings where previous owners often struggled to find tenants and meet their mortgage payments during the recession.
One of the best examples of such a conversion is Cypress Gardens, a 102-unit complex in Hawaiian Gardens, where Irvine-based Bascom Group paid $5.3 million for the building and then spent more than $900,000, or an average of $8,800 per unit, on interior and exterior renovations.
“This was at best a [grade] ‘D’ building when we bought it,” said David Kim, Bascom Group’s operations manager.
“It was the worst property in the neighborhood. Now it’s a solid ‘B.’ ”
The building “was full of drug dealers and drug users,” including gang members, when Bascom bought the complex in May, Kim said.
The company embarked on a four-step program that it follows for just such problem properties: lining up funds from private investors to buy the building and to allow plenty of money for renovations and other expenses; installing a management team to keep a close eye on the property; completing the physical renovations; and launching a “community outreach” program that includes local youth groups sponsorships, a resident watch program and close police cooperation. Sometimes the company even sets aside an apartment unit as a local police substation.
Within three months of Bascom’s buying Cypress Gardens, 70% of the tenants had left. That’s an unusually quick turnaround, according to Kim, who said conversions usually take a year to 18 months.
“I think the drug dealers left so quickly because they were making a lot of money there and went somewhere else where they could do business without being disturbed,” Kim said. “I hesitate to put it this way, but drug dealers are businesspeople too. They don’t want to be in a building where there’s a lot of construction activity or where there’s a lot of attention being brought to the property.”
Kim said the Hawaiian Gardens apartments had a higher-than-average percentage of problem tenants (he estimated about 30%) compared with well under 10% in most of the problem properties Bascom buys.
“The majority of tenants in most buildings just want a good place to live. It only takes a small minority to create the problems that drive the building down,” he said.
Rents at Cypress Gardens now average $700 a month, compared with $480 before Bascom bought it. Kim described it as a “bread-and-butter” building, a modest but well-maintained property catering to middle-income tenants.
“This isn’t rocket science. People will pay the higher rents if they know you’ll replace their carpets, maintain good security and provide a fresh coat of paint when it’s necessary,” Kim said.
As part of its turnaround strategy on such properties, Bascom works with Fair Housing Council officials to ensure that it complies with fair housing laws in setting new house rules and implementing other changes to improve properties.
The apartment complex was in poor condition before the renovation, according to Mary Irving, a Fair Housing Council executive director who worked on the Hawaiian Gardens property. Besides suffering from deterioration and lack of maintenance, she said, the property was rife with health and safety violations, including piles of trash in the parking lot and rat and roach infestations.
“Everyone who lived there was given the opportunity to stay, provided they signed a drug-free agreement and agreed to the new house rules,” Irving said. “A fair number of them were either low-income families, the disabled or the elderly, so the renovations have provided affordable housing for a segment of the population that often doesn’t have any place decent to go.”
Renovations typically extend far beyond a mere fresh coat of paint, however, as another veteran of problem properties attests.
“We’re not here to just paint the building, sell it and move on,” said Bernard Ward, a senior portfolio manager at Avalon Bay Communities, a San Jose-based real estate investment trust that prefers to build new complexes but is renovating existing buildings in Southern California, in large part because of the scarcity of vacant land.
Avalon is spending about $25,000 per unit to renovate the former Westwood Club, a 364-unit building at Sepulveda and Venice boulevards that has been renamed Westside Terrace. Avalon paid about $75,000 per unit for the property, or about $27.3 million. The combined investment of $100,000 per unit compares with construction costs that would probably total $140,000 per unit to build a new complex if land were available at the site, Ward said.
Ward said Westside Terrace had no gang or drug problems but had fallen into disrepair and needed extensive renovations. Avalon Bay has tackled a couple of Southern California properties with crime problems, Ward said, including a 400-unit complex at Warner Avenue and Beach Boulevard in Huntington Beach that the company has turned around.
But Avalon prefers to buy buildings that suffer mainly from deferred maintenance.
“There’s not exactly a lot of raw land for new development, so we look for places that have either had physical problems that the owner hasn’t taken care of and hasn’t had the same long-term commitment we have, or who ran it just for the cash flow,” Ward said.
At Westside Terrace, Avalon is remodeling the entire property, gutting structures such as the 10,000-square-foot clubhouse to add a new fitness center and a business center featuring computers, fax machines and other services.
Ward said spending money up front enables an owner to raise rents and helps to ensure a steady, predictable pattern of expenses.
“We’re a long-term holder and our management likes to see a consistent, predictable expense budget year after year,” Ward said. In a 564-unit complex in San Diego, he said, “we’re ripping every balcony off and re-supporting them, not because they’re falling down today but because we know that in five or 10 years we would have some problems with them if we didn’t redo them now.”
Despite their successes, neither Bascom nor Avalon believes that money is a panacea for converting all problem properties because many are part of entire neighborhoods that suffer from crime and neglect.
“We never invest in a ‘D’ neighborhood. We try to find the worst building in the best neighborhood,” Kim said.
The key to both Bascom’s and Avalon’s strategy is capital, said Ken Morgan of Morgan Skenderian Investment Real Estate Group, a brokerage that specializes in apartment sales and management.
“If you don’t have capital reserves, you’re going to make short-sighted decisions that will cost you in the long run,” Morgan said. “During the period when you’re renovating, you’re spending more money than you’re making. You have to have enough capital that you don’t care if the place is vacant for a while, because it’s going to be better in the long run.”
While companies such as Avalon and Bascom are converting larger complexes, a few small private investors are implementing similar programs on a much smaller scale, according to Greg Kelsey, a vice president at Southern Pacific Bank in Los Angeles.
“We have a few, select clients who buy buildings that are severely in need of repair,” Kelsey said. Often, these are inner-city properties with gang or drug problems. Most of the loans range from about $300,000 to $400,000, with part of that total designated to buy the property and part of it earmarked for renovations.
The delinquency rate on those loans is “amazingly low,” Kelsey said, explaining that “it takes a special kind of property manager” to turn the buildings around. Southern Pacific has purposely pursued this niche of the market, Kelsey said, and feels comfortable making loans on properties that many other lenders would probably shun.
