Apartment Sales Fall as Owners Hold On to Valuable Properties
Sales of apartment buildings have slowed dramatically in Los Angeles and Orange counties since the middle of last year even though demand to buy rental units is robust and rents are climbing.
Owners are unwilling to part with buildings that are generating monthly cash flow and that are rising steadily in value, say authors of a study and others familiar with the real estate market. Also, the post-recession era of good deals on apartments has ended, leaving a substantial gulf between the price expectations of sellers and buyers.
Many in the real estate industry predict rents will continue to rise because of Southern California’s acute housing shortage. Because apartment values are based on rents, prices also are expected to keep increasing. Los Angeles County apartment sale prices still have not reached their 1991 high, yet rents are substantially up from that year.
Monthly sales of Los Angeles County apartment buildings slowed steadily from a peak of 281 in June to 166 in December, according to an apartment study by Brentwood-based Beitler Commercial Realty Services. The slide has continued, with February sales falling 72% from the same month in 2000.
The decline also was steep in Orange County, where apartment sales fell to 310 in 2000, a drop of more than 19% from 1999. This year, only 40 sales have been reported in the county, which would finish the year at far below last year’s total if the current sales rate continues.
“Owners don’t want to sell because they are happy with their apartment investments,” said Beitler broker Alex Nicol III. “They’re enjoying the cash flow, and where else would they put their money if they sold?”
Price Gap Is Widening
The dwindling supply of apartments for sale doesn’t entirely explain the sales slump. The slowing is “probably a natural function of a spectacular multiyear run-up in prices that may be slowing,” said Nicol, who co-wrote the Beitler report. “It seems buyers and sellers are taking a breath.”
Nicol and others familiar with the market say the gap is widening between the prices owners are asking and what buyers are willing to pay, in part because many prospective buyers are concerned about California’s energy problems, the prospect of a Hollywood writers’ strike and talk of a national recession.
“Buyers think prices should be falling because of the energy crisis, but sellers think prices should be rising, so the bid-ask spread is getting wider,” said Jerry A. Fink, managing director of Irvine-based Bascom Group, which owns about 5,000 apartment units in Southern California.
Fink cited a scarcity of buildings for sale, in contrast with what he said was a “ton of properties on the market” a few years ago.
“We’re very much in the market . . . for property now, but we can’t find any,” said Brad Korzen, chief executive of the Kor Group, a Los Angeles-based company that owns about 3,000 apartments in Southern California and 12,000 nationwide.
“Most people are not selling in California, they’re buying, because of the factors that are making the market strong,” Korzen said. “There is little new [apartment] construction, financing is as good as it’s been in a long time because lenders view apartments in Southern California as a good risk, the job market continues to be strong and people are still moving to the state.”
These factors, Korzen said, add up to a limited supply and increased demand that has been pushing rents higher in Southern California year after year.
“If investors can get 7% to 8% per year in rent increases,” Korzen said, “they have an asset that’s increasing in value. So they don’t have any incentive to sell.”
“The owners have apartments that are full, they have a waiting list for tenants, they’re raising rents and to convince them to sell, you’ve got to pay them a big number,” Fink said, “but the buyers want to get good deals at a price that gives them a good profit within a couple years.”
Good deals were the norm at the beginning of the real estate recovery in the mid-1990s, Fink said, when many apartment buildings were available at bargain prices from lenders who had foreclosed on properties in the recession of the early 1990s.
Few Reasons to Sell
After the foreclosed properties were sold, savvy investors snapped up apartments at low prices for a few more years from unsophisticated owners who didn’t know that the market was recovering and that their buildings were worth more than buyers were offering.
“There are no dumb owners anymore,” Fink said. “Now, everybody knows that rents are going up, and owners want top dollar for their properties.”
A large percentage of landlords today are long-term holders who have no reason to sell other than natural attrition, Fink said, such as partnership dissolutions, divorces and deaths.
Fink and Korzen describe their companies as “value-added buyers” that like to find apartment buildings that need some renovation and command below-market rents. Their strategy is to buy, renovate, then hold the buildings long enough to capture a hefty profit at resale.
That strategy is getting harder to execute, partly because fewer such buildings are on the market and partly because more value-added buyers are competing for the same buildings.
“Three years ago, there might have been two or three value-added buyers in the markets where we compete,” Fink said. “Now there’s 20 of them, and they’re all very well capitalized.”
There are forces at work that could boost monthly sales totals later this year, including the prospect of lower interest rates, said Joe Ursino, a vice president at Southern Pacific Bank in Los Angeles, which specializes in loans on apartment buildings.
The Beitler study also identified 15 factors that either influence the apartment market or indicate its health. These included vacancy rates, rental rates, the amount of construction underway, interest rates, operating costs, job growth and financing practices.
For each of the factors, the study compared conditions with those of 1991, which was the last time apartment prices and market activity approached today’s levels.
The comparison was aimed at determining whether conditions are anything like those just before the apartment market crashed in the early 1990s along with the rest of commercial real estate.
For example, the average vacancy rate in Los Angeles County was 5.8% in 1991 and 10% in 1995. Today it’s at one of the lowest rates on record, 3.5%, according to the study that listed vacancy rates as a positive factor for the apartment market.
Better Now Than 1991
On the other hand, apartment owners’ operating costs in 1991 were rising at 3% to 5% per year, but operating cost increases will remain unpredictable in California until the state resolves its energy crisis, the Beitler report said. It lists operating costs as a negative factor in today’s market.
The study rates 11 of the 15 factors as positive, three as negative and one--population growth--as neutral.
Besides operating costs, the other two negative factors are the threat of a nationwide recession and stock market losses that could “cause a ripple effect in the real estate market” by reducing consumer confidence, the report said.
“On balance,” broker Nicol said, “2001 appears to be a whole lot healthier than what we were looking like in 1991.”
Even with the run-up in prices, Nicol noted, apartment buildings in Los Angeles County are selling at a lower average cost per square foot, $73, than the $82 per square foot they were selling for in 1991.
The study views the cost-per-square-foot figures as a positive factor because rents average 25% higher than in 1991, meaning apartment owners are generating a larger cash flow on a smaller investment.
Lenders and investors expect apartments to provide annual returns of at least 7% and appreciate in value.
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Slumping Sales
Fewer Los Angeles County apartment buildings are trading hands as landlords enjoy rising rents and appreciating property values.
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Sales of Multifamily Housing
February: 45
Source: Beitler Commercial Realty Services
