Brokers for Complexes Say Times Favor Sellers
Real estate broker Bruce Hanes, 62, has been involved in the sale of 7,400 apartment houses in Los Angeles County over the last 30 years, nearly half of them in the San Fernando Valley area.
Hanes, president of Westlake Village-based Hanes Investment Realty Inc., and his senior associate, Todd S. Schwartz, 37, are also landlords. Between the two, they own five Valley apartment buildings with a total of 233 units.
They talked to The Times recently about market trends in the Valley apartment business.
Question: What is the health of the apartment business in the San Fernando Valley right now?
Hanes: It stands very healthy. This apartment market is the most viable we’ve seen since 1991. Owners, after years of massive foreclosures, are starting to see a return on their investment. Vacancies are down in the area of 1% to 3% at the most, if you’ve got a viable operator. And the turnover rate, which at one time was up to 40%, is now in the high 20% and low 30% range per year.
But the values for real estate are only now coming back to what they were between 1987 and 1990. They fell for a long time.
Schwartz: It’s positive for sellers right now, because there’s a lack of available product. We see between five and 10 buyers for every available property to buy apartment houses. Essentially, what we have is supply and demand out of balance. Importantly, values have increased steadily for the last five years. They’re outperforming other investment opportunities, for example, the stock market, this year. The Nasdaq is down 35% to 40% from its all-time high, but we have apartment values on a cost-per-unit basis, increasing more than 14% this year. So real estate is, by far, the better investment.
But at the same time, we appear to be at a peak or crest in value. What we have are apartments that are selling with very little cash-on-cash return to the investor. Some are break-even and some even negative cash flow on properties that we’re selling.
Q: Why would buyers buy a negative-cash-flow property?
Schwartz: Because investors are looking at future appreciation, the ability to raise rents over time and the fact that we have a lack of apartment construction with so many jobs being created.
Hanes: Statistically, we’re finding that probably only one apartment house is being built for every 14 to 17 new jobs being formed in this state.
Schwartz: And most of these buyers do have portfolios that they started building in the mid-1990s, so their portfolios are able to absorb any losses on buildings they purchase today.
Q: Is there a shortage of apartments for working-class families?
Schwartz: It’s true that of the properties being constructed, most tend to be high-end luxury apartment buildings. The affordability index in Los Angeles indicates that the amount of rent that the average family can afford to pay here is $1,070 per month. But the average rent at these newly constructed luxury apartment buildings [in Los Angeles County] is $1,600.
Hanes: Really the only area that makes sense right now for builders is high-end apartments, due to costs of $80 to $100 per square foot to build [apartments] that rent for from $1.60 per square foot to over $2 per square foot a month. Typically, when builders build high-end product, initially they build it as being apartment buildings, but they build it to condo specs with the idea of converting the building later on.
Q: When did the dynamics of apartment building begin to change?
Schwartz: In late 1980s, especially from 1989 to 1990. During those years, apartment construction virtually shut down. Coming out of the recession, the only construction that made financial sense was that of the larger, luxury-type apartments.
Q: Why did it shut down?
Schwartz: Some buildings were running at 60% vacant. There were families that were doubling up in apartments, and because of the long recession and real estate depression that we had, there wasn’t any incentive to build. A lot of builders went out of business.
Hanes: The market fell apart for all kinds of reasons. People left because of the [Northridge] earthquake, we had a severe recession, we had riots, firestorms . . . over 1 million jobs were lost in the state of California. The military and aerospace industries almost essentially shut down after the end of the Cold War. We had about six or seven factors lined up against us. Unemployment in Los Angeles County was over 10%; it’s now under 3.7%. At the end of the 1980s, we saw the building of more mid-range apartment houses come to a complete stop.
Q: What are some of the deterrents to the construction of new apartment buildings, especially for low-income units?
Hanes: A big one is activism. Some neighborhoods are anti-housing for anything other than a single-family dwelling. The permit process in the various [communities] comprising the San Fernando Valley also has been a nightmare as far as fees and the timing to process permits for a new project. Sometimes the process can take up to and over two years to get a new project started. We’ve seen it take five years in some cases.
Schwartz: Also the incentives are not really there. While there are tax credits for construction of low-income housing, the process is daunting. And then you can get all the way through and still not get your tax credit. They only allow a certain amount per year and there’s a lot of competition to get those tax credits.
Q: Has neighborhood activism increased or remained the same over the years? What are the objections?
Hanes: It has remained very solid and very steady.
Schwartz: They don’t want the traffic and the density and, for the most part, they don’t want low-income tenants. It’s another obstacle to the lower-income housing that we need so badly.
Q: Do you expect the number of new apartment buildings being built in the San Fernando Valley to drop even more?
Hanes: Unless they expand on the periphery of the city and the San Fernando Valley, yes, we’ll see less construction. There’s less available financing as people go into a more conservative mode financially. A lot of things are up in the air right now.
Schwartz: There are some negative pressures happening right now. In addition to rent control in Los Angeles, [which allows only a 3% rent raise per year on buildings built after Oct. 1, 1978], we have real estate investment trusts that are realigning their portfolios and are becoming sellers. Previously, these trusts were able to come in with tons of cash from investors and they were able to pay top dollar for apartment buildings, and that was one of the driving forces to increase the values of apartment buildings over the past five years.
Now they’re becoming sellers, and they’re typically selling to pension funds and large institutional buyers. Secondly, we’ve had six interest rate increases over the past 12 to 18 months. We have the prospect of a religious war in the Middle East. With increasing oil prices, we have the potential for a recession for the first part of 2001.
And then there’s been an overall reduction in available financing for purchases of new apartment buildings. Many lenders are now unwilling to underwrite on negative cash flow properties. They’re concerned about a repeat of foreclosures that they experienced in the early 1990s.
Q: How about efforts to cut through some of the red tape in City Hall?
Hanes: We don’t see anything happening there to speed the process for housing, because a lot of neighborhoods just don’t want that kind of housing. People are afraid it brings in the wrong type of resident, which we don’t believe it does.
Schwartz: It does depend on the location, as far as streamlining. Downtown L.A. is one of the areas where it’s becoming easier to get entitlements to do rehab projects, because there’s a push for revitalization of the downtown area. However, the units being constructed are high-end luxury apartments; there’s very little for low-income housing.
Q: How about owners of apartment buildings. Since the market is cresting, are they selling?
Hanes: Not necessarily. For 10 years, many of them have held on by their fingernails when many of their units were 10%, 20% and some as high as 70% vacant. They’ve fixed them up now, the rents are coming in and many of them have decided to reap the rewards for their efforts.
But we think there’s future bumps in the road that are coming. While a majority have decided to hold on to their properties for the next three to five years, that may well be a mistake, because we may be going into a recession. And still we see it as a strong market due to supply and demand. That’s going to make apartments still a viable purchase at the end of the day.
Q: Where do you see the market five years from now?
Hanes: In downtown L.A., the city has decided to offer incentives parking-wise and otherwise for people to take old industrial buildings with lofts and convert them to apartment buildings. So in that sense there’s been some breathing room as far as rehab is concerned. But building new product still has challenges and unfortunately the entitlement process, once that’s concluded and you have your building permits, your opportunity to build your apartment has passed. It needs to be accomplished in a timely manner, in nine months, as opposed to two to five years.
While we are seeing more new construction than what’s been seen in the last 11 years, it’s nothing in comparison to the new job formation. We see a tight market through the next five years, due to the lack of available land. We see the market in the central areas even tighter than it is today as far as sales and rentals. People will continue to expand and move out to Lancaster and Palmdale, where there’s plenty of land, and people are still willing to commute.
