Buyers Find Rental Gold in Run-Down Properties
Apartment buyers who take advantage of private and public lending programs are earning substantial profits by investing in low-income buildings too small to interest such larger operators as real estate investment trusts and institutional investors.
Buyers say the demand for affordable housing and the lack of new construction--along with building prices that remain depressed in low-income neighborhoods--enable them to renovate run-down and even boarded-up buildings at a profit.
“I’m still getting [apartment buildings] at a good discount, even today, when everybody says there are no bargains out there,” said Tom Geiger, a Long Beach private investor who began buying small apartment complexes in low-income neighborhoods in 1994, when he quit his job as a loan officer arranging home mortgages.
Per-unit prices remain relatively low in low-income neighborhoods, according to Geiger, even though prices have risen dramatically in other segments of the apartment market. He bought his most recent building, a 32-unit complex in Long Beach, for $23,500 per apartment.
“The main thing I look at is cost per unit,” Geiger said. “The cash-on-cash return is higher for a low-income property. If you buy a building where the rent is $700 for a one-bedroom apartment versus $425 in one of my buildings, that’s 50% more in rent, but the cost per unit for that other building is probably five times as much.”
Despite the low rents in his buildings--an average of $425 for a one-bedroom and $500 for a two-bedroom apartment--Geiger said the buildings are quite profitable, enabling him to pay off loans to private banks as well as funds borrowed from a city of Long Beach program that finances renovations of low-income apartments. He typically spends $3,000 to $5,000 per unit for renovations, borrowing from the city program at interest rates of 2% to 4% over 20 years.
“Long Beach is one of the more aggressive cities” in financing the rehabilitation of low-income apartments, said Greg Kelsey, a vice president with Southern Pacific Bank, a Los Angeles-based private lender that specializes in lending for the purchase and renovation of small apartment buildings.
“We can bring virtually any property back on line, which is a lot of what we do with our loans,” Kelsey said. “The primary factor that would make or break a deal for us would be the individual borrower’s credit, not the property.”
Southern Pacific lends on acquisitions and renovations of apartment complexes of five units and larger, with a $5-million upper limit on loans, but most loans are on properties of 10 to 30 units. Many of its loans are on properties that other lenders would avoid because the complexes are too small or too neglected to fit most banks’ lending criteria, Kelsey said.
“There are plenty of ‘A’ lenders out there willing to lend on ‘A’ properties. We do our share of ‘A’ properties, but we’re comfortable with ‘B’ and ‘C’ properties too,” Kelsey said. “The vast majority of the loans are on buildings in low- to moderate-income neighborhoods, and most are mom-and-pop deals.”
Kelsey said there is plenty of business for Southern Pacific, despite city and other governmental programs, because government programs typically have geographic restrictions or other limits.
The city of Los Angeles offers a program for rehabilitating apartment units, for example, along with a separate program for financing purchases.
Solomon Banks, director of housing for the Neighborhood Revitalization Division of the Los Angeles Housing Department, explained that the city’s rehabilitation financing program is available both for apartments and for single-family homes.
Banks estimated that about 60% of the loans go to finance rehabilitation of single-family homes and the remaining 40% for multifamily--and most of the multifamily buildings are in the 10-to-15-unit range.
The Los Angeles program has been around since 1978 and has funded between 5,000 and 6,000 loans, Banks said.
The program authorizes loans of up to $50,000 for rehabilitating a four-unit complex. For buildings of five units and larger, there is no specific dollar limit, assuming the loan meets certain criteria. Since the program is intended to aid low-income residents, a building might not qualify for a rehabilitation loan if the tenants’ incomes are too high.
“The building owner’s income doesn’t matter, but if by chance the tenants’ incomes are too high, we might still be able to help the owner by submitting the application to a bank, and the bank might fund the loan,” Banks said.
For example, prospective borrowers must already own the building when they apply for the loan and must have at least 10% equity in the property, and the rent from the building must be sufficient to pay off the mortgage as well as what the applicant wants to borrow for rehabilitation.
Geiger has focused on Long Beach in part because of what he calls “an inordinate number of foreclosed apartment buildings in low-income areas” and in part because he likes the Long Beach loan program.
“The city’s program helped a lot. I’m getting rehab money at 2% to 4% [interest]. It’s a lot of paperwork, but once you’ve done home loans for a living, you know how to do paperwork,” Geiger said.
But low-income properties in cities other than Long Beach also hold profit potential, according to Geiger, who said low-income complexes can be renovated profitably even when they suffer from acute disrepair and neglect. He estimated that a third of the units he has bought were boarded up and vacant when he acquired them but are now filled and profitable.
“We run about a 1% to 2% vacancy factor all year long. We attract a lot of applicants because we have clean buildings, and for people in a low-income area, the choices are limited,” Geiger said. He said tenants in his buildings probably earn $6 to $12 an hour on average.
“All we basically look for in applicants is someone who has had a job for two to three years and doesn’t have bad credit,” Geiger said. “I’m finding that just as many people who apply to rent apartments have the same stability as people who apply for home loans.”
Geiger said that, ironically, his portfolio of low-income apartments is the result of an initial investing foray that turned sour when Southern California real estate values plunged in the early 1990s.
He bought his first low-income apartment building in Long Beach in 1989 for $33,000 a unit, then watched as its value sank to $16,000 per unit. At one time, he was losing $1,000 a month on the property, which he still owns and estimates is now worth $20,000 a unit.
Geiger reasoned that values would rise again eventually, but even if they didn’t, he could fill the apartments with tenants and make money on the rents. So he bought more buildings at the bottom of the market, often acquiring foreclosed properties at rock-bottom prices.
“Values have increased some, but they are not anywhere near what they were at the top of the market,” Geiger said. The days of rock-bottom prices may be gone, he said, but investors willing to venture into low-income properties and seek out willing lenders can still find bargains.
