Space for small investors
Commercial real estate, traditionally a reliable haven for small investors, has shown its dark side in the last year.
Real estate values have come down from their peak around 2006 and operating costs have frequently increased as tenants of such properties as apartment buildings, stores and warehouses have moved out or fallen behind on their rent.
Selling property has also been a challenge because some would-be buyers have trouble getting loans and others are waiting to see whether prices will fall further before they’ll consider making a purchase.
But with the market unsettled, opportunities are popping up for small investors with the nerve to take some risk, industry observers said.
You may think that investing in commercial real estate is just for the wealthy. But if you can afford to buy a house, you can afford commercial real estate. A recent cruise through Southern California listings showed a San Bernardino structure previously used for auto repair selling for $149,000, and a duplex in Hollywood for $550,000. Of course, prices can also be much higher.
Investors should bear in mind, though, that being a landlord during a recession can be a trial.
The time-honored appeal of commercial property -- that it can provide owners with steady income from rents -- is being tested as economically stressed tenants pay rent late or come up short.
“Renters are paying a little less and paying a little slow,” apartment owner Jeff Serber said.
He estimates that the prices he can charge for units in his buildings in Hollywood and West Hollywood are down about 15% from a year ago.
A lot of small retailers are struggling too, said landlord Louise Dedeyne, president of the Studio City Shopping Center Assn. She is giving her half a dozen tenants on Ventura Boulevard a break by absorbing more than 35% of overhead expenses, such as parking lot security, that she could legally pass along to them.
“I wish I could give them more,” she said of her tenants. “I just can’t afford to give them a better break.”
Empty storefronts not only don’t generate rent but also are a drag on surviving businesses because they don’t generate foot traffic and can make the neighborhood depressing. Still, Dedeyne endeavors to keep her standards up, declining to rent to retailers that she thinks don’t fit the mix of her center
“I’ve had prospective tenants offering everything from cannabis to mopeds,” she said.
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Filling apartments
Keeping apartments rented these days is a challenge too, said Los Angeles landlord and apartment manager Alisa Gonzalez.
To attract tenants, she’s had to make substantial concessions such as a month of free rent and reduced security deposits. The market hasn’t been this hard on Los Angeles landlords since the early 1990s recession, she said.
To keep units occupied, “we’ve really had to reduce the rents,” Gonzalez said. That includes rents for current tenants.
Some are experiencing financial hardship. Others are noticing that rents are falling and are demanding a break. In most cases, she gives in, figuring it might cost more to re-lease the unit to someone else.
“Some tenants say they want a $500 rent break and we say $100 and they settle,” Gonzalez said.
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‘Run your numbers’
Investors considering buying income properties should be careful to add up all the costs of ownership -- some of which might not be immediately apparent, Gonzalez said.
“Run your numbers,” she said. “It’s not always a positive-cash-flow business.”
Expenses include insurance, property taxes and maintenance. New owners often budget for everyday maintenance such as landscaping and trash collection but forget about some expensive long-term costs of maintaining a building in desirable condition.
“Eventually the appliances start zonking out,” Gonzalez said.
Then there is the matter of properly setting your rent, said Gonzalez, who owns Empire West Property Management in North Hollywood and oversees almost 1,000 units. Find out what other landlords are getting nearby and price accordingly, she said.
“You can ask for $2,200 a month, but if all that area is getting is $1,800, it’s not realistic,” she said.
Hollywood landlord Serber followed a traditional route for small investors, buying a six-unit apartment building about 12 years ago. About three years later he was able to sell it and buy 20 units. He kept expanding, and today he and his father, David, own a total of about 140 units.
Serber, whose main business is operating carwashes, stopped buying property about two years ago when he decided the market was overheated. Now that the recession has forced prices down, he’s about ready to buy again, he said. “I think there is opportunity now,” he said.
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Hitting bottom?
With the recession battering prices in so many neighborhoods, commercial property buyers are on the hunt for substantial bargains, said Dana Brody, a real estate broker at Grubb & Ellis. They are often disappointed, she said.
“Buyers think prices should be like 2003,” Brody said, referring to the last big drop in real estate values. They have been hearing a lot about the nation’s economic woes, she said, and assume that if they wait a while longer they can get commercial real estate at the deep discount they desire.
Not surprisingly, owners tend to have higher opinions of their properties’ value and are often reluctant to put them on the market, Brody said. “People who don’t have to sell don’t want to get into the mix and get lowball offers,” she said.
Those who are trying to sell in this market tend to be people who purchased property near the peak and can’t keep up with their loan payments, or people who bought years ago and want to get out of the real estate business.
So the market remains slow, with many potential buyers waiting for signs that it is near its nadir. “A lot of those people will miss opportunities,” Brody said. “No one knows if we have seen the bottom.”
But Richard Ziman, who manages a $630-million real estate investment fund, said it’s not necessarily a bad idea to wait.
“The easiest way to screw up is to buy prematurely,” said Ziman, who sold his previous real estate company for more than $3 billion in 2005 near the peak of the market.
Ziman’s advice for buying in the current environment is to calculate how much it would cost to build the target property from the ground up -- the so-called replacement cost -- and offer that amount. Pretend the land it’s on has no value, he said.
“I would buy mobile home parks,” Ziman said. “In these times I’ve got to believe those guys have really good occupancy.”
Also on Ziman’s preferred list are industrial buildings with secure tenants and small retail centers anchored by grocery or drug stores. But not mom-and-pop retailers, he said.
“Mommas and poppas are dying,” Ziman said.
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Credit is key
The head of one of the region’s largest brokerages catering to individual investors thinks transactions will pick up after credit becomes more readily available.
“Buyers and sellers are not that far apart. People want to buy; people want to sell. The biggest issue is financing,” said Harvey Green, president of Marcus & Millichap, which specializes in selling properties such as apartments and stores.
During the recent boom, lenders were asking for down payments of as little as 5% on commercial properties, but now they’re more commonly calling for 35% down or more if they are willing to lend at all, Green said. He hopes that the flow of credit will resume in six to nine months.
“Once financing loosens up, you will see the market take off very quickly,” Green said.
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Investment tips
Los Angeles real estate mogul Richard Ziman has made fortunes buying and selling commercial properties and now oversees a $630-million real estate investment fund. He offered a few tips for smaller investors:
* Be detached: Real estate is an investment, not a relationship. “Don’t be emotional.”
* Forget the land value: Figure out what it would cost to rebuild the structure from the ground up -- the so-called replacement cost. “That’s what you should pay. Discount land at zero.”
* Beware of mom and pop: Retail properties that house mom-and-pop stores and other small businesses are having difficulties collecting their rents.
* Look at malls: Consider shopping centers anchored by drug and grocery stores. People have to eat, even in a recession.
* Think industrial: Industrial properties have a strong track record and may be worth buying now if they have secure tenants and you plan to hold on to the property for a few years.
* Seek discounts: Look for troubled commercial property loans for sale and try to buy one at a 50% discount. Make sure the loan is on a property you actually want.
* Steer clear: Avoid markets where there is still a deep gap between what buyers and sellers think property is worth. “The Westside still has to come down another 20%-plus.”
-- Roger Vincent
