Smaller Projects Getting Their Share of the Gold

They don’t get the ink that big public companies command and they lack the sizzle of technology stocks, but small and medium-size real estate investments retain their allure for investors in Los Angeles and Orange counties despite several years of rising property prices.

Small investors, developers and lenders are betting that construction and renovation of apartments, shopping centers, industrial buildings and other properties still offer the prospect of profit as long as the region’s economy remains sound.

The appeal is such that at least one company, Hanover Financial Co. of Los Angeles, has based its business plan on financing small and medium-size projects typically valued at $5 million to $25 million.

Over the last 18 months, Hanover has acquired assets valued at about $215 million in 25 transactions, primarily in Southern California and as a joint venture with small investors.

Hanover’s strategy is to find developers and investors who want to build new projects or improve existing properties with a view to boosting the value of their investment through higher rents, selling the property at a profit or both.

For a typical project, a developer or investor must raise a down payment, or “equity portion,” of 25% of the construction cost or purchase price, said Hanover President Michael Lowinger.

Hanover forms partnerships with small investors by providing much or most of the equity in the deal, sometimes up to 90%, with the small investor supplying the rest.

Among Hanover’s joint ventures is a 50,000-square-foot shopping center in Valencia called Plaza Del Rancho, a partnership with Tustin-based Kensington Real Estate Group.

Plaza Del Rancho exemplifies the many investment opportunities remaining in Southern California commercial real estate, according to Kensington principal Patrick Galentine. But he said, “So many deals are being offered that you probably have to go through a stack of 100 to find the one that really makes sense.”

Kensington specializes in buying “value-added” shopping centers, office buildings and multi-tenant industrial buildings, Galentine said. The company hopes to add value to its purchases by filling vacant space with paying tenants, by renovating the building or both.

The value-added approach has been around for years, especially among private investors who try to spot properties that can be improved to boost their value.

These private investors still account for most of the deals and ownership of commercial real estate, Hanover’s Lowinger said, “despite the impression that public companies dominate the ownership of the commercial real estate market in the United States.”

Real estate investment trusts and other publicly held real estate companies owned only 7.1% of the country’s warehouses in 1999, 7.4% of the country’s office buildings and 7.9% of the apartments, according to a study by Prudential Real Estate Investors of Newark, N.J. The study showed that public ownership of apartments in 1999 was down from 8.3% in 1998. The percentage of ownership by public entities in the retail mall category is 32.4%.

“There is a great deal of real estate still held by private individuals and private firms that has not been absorbed by the big public institutional investors,” said the report’s author, Robert D. Hess. “The amount of real estate owned by big public investors is not as great as one might suspect from reading the newspapers or even, I suppose, going to industry conferences and listening to the buzz.”

Lowinger said Hanover, a subsidiary of Marcus & Millichap Co., is pursuing the small-investor niche because it represents a huge potential market of individuals and small companies that usually have a difficult time raising equity capital.

Typically, according to Lowinger, small developers and investors have to find a dozen or more other investors to assemble enough capital to make a project a go--often canvassing friends, relatives and acquaintances in search of financing.

Part of Hanover’s pitch to these investors is that it provides equity capital so developers or buyers can concentrate on their projects instead of beating the bushes for funds.

Many prefer the familiar aspects of property ownership.

“I don’t know anything about the stock market, but I think I know a little something about real estate,” said Brian Shirken, a principal at Santa Monica-based Columbus Pacific Properties, which owns shopping centers in Southern California and Ohio.

At George Smith Partners in Century City, managing partner Steve Bram said private developers and investors accounted for two-thirds of the 140 loans and $1.4 billion in financing the company arranged in 1999.

Many of the loans Smith puts together are for private investors who want to “see an upside in adding value” to a property by buying it and improving it, Bram said.

Many of the sellers already have made substantial gains on their holdings, so they are willing to sell at a profit to new owners who in turn expect the properties to continue rising in value.

“The buyers have to convince us that there is an upside before we can sell the deal to the lenders we work with,” Bram said. “There are fewer deals today where we believe the upside is as great as the buyer thinks it is, but there are still plenty of deals with an upside out there.”