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Friday, Mar 29, 2024

Multifamily Owners Divesting

At this time last year some 100 apartment properties were listed on the market in Los Angeles. As of the third quarter of this year, that figure more than doubled. After two years of soaring prices, sellers believe that the market for multifamily investment properties has peaked, and they are rushing to divest their properties while the getting is still good. Not that anyone believes a crash is coming. L.A.’s housing shortage is not expected to abate anytime soon, meaning that the prospects that multifamily properties will yield consistent rental income for owners are still good. But over the past two years, investors have seen their multifamily property values appreciate by 10 percent to 20 percent annually and more, advances that cannot be sustained as interest rates creep higher. “Whether they’re savvy sellers or even the mom and pops, I think there’s a sense we’ve hit the perfect storm,” said Rory Ferlauto, vice president at brokerage Sperry Van Ness. Cap rates are lower than they’ve ever been, interest rates are inching up. If you’re going to be a seller over the next three years, now is the time to take advantage of the market.” Cap rates, a measure of the return on investment for these buildings computed by dividing the purchase price by net operating income of the property, have declined to a record low of about 4.5 percent. With interest rates at or nearing 6 percent, that means the cost of debt for buyers exceeds the return on their investment. “We got to the point where cap rates were a couple hundred basis points below interest rates,” said Jim Markel, chief acquisition officer for Studio City-based DT Real Estate Investments Inc., “and you’re digging yourself into a hole when you take ownership and assume acceleration will keep happening.” DT, which acquires properties on behalf of investment groups seeking relatively short term returns, began divesting many of its properties about a year ago. But the real seller’s rush began this summer, and it has accelerated as the end of the year approaches. According to reports issued by Real Capital Analytics and provided to the Business Journal by Sperry Van Ness, a total of 174 garden-style apartment units and 40 mid- to high-rise style apartment units were on the market in Los Angeles in the third quarter of 2005, listed at an average unit price of $167,515 for the garden apartments and $225,639 for the mid- to high-rise units or cap rates of 4.9 percent and 4.8 percent respectively. By comparison, 84 garden style complexes and 16 mid-to high-rise properties were offered in L.A. in the same quarter of 2004 with average listing prices of $145,825 per unit for the garden-style properties and $209,219 per unit for the mid- and high-rise properties. Cap rates a year ago averaged 5.5 percent and 5.3 percent respectively. “It’s been kind of a gradual thing,” said Jeff Louks, vice president for investments at Marcus & Millichap in Encino. “One (reason) is interest rates, two is (Fed Chairman Alan) Greenspan stepping down and three is the holidays. Buyers start getting ready for the end of the year and they’ve already met their (annual return) goals.” Among the properties Louks is currently representing is a 72-unit complex in Winnetka listed for $17.5 million or $243,056 per unit and a 55-unit Sherman Oaks complex listed at $10.9 million or $198,182 per unit. Traditionally, multifamily investors acquired properties expecting long term appreciation in value and ongoing returns from the rental income of the property. But as property prices increased over the past two years, many investors came into the market purely to take advantage of the returns from appreciation. Shifting return Brokers and others say that, going forward, the returns from these properties will slowly shift back to the income from rents with appreciation slowing to a more modest 5 percent or six percent. Selling prices have already begun to come down a bit, and cap rates are expected to rise as high as 6 percent in the coming year. “We would go out high and you’d have to come down anywhere from 5 percent to 10 percent off the list price,” said Markel of the properties DT divested. The buyers who traditionally gravitated to multifamily investments will continue to do so, brokers say, especially as prices for these properties fall, and the rental market remains strong, as is expected in the L.A. area. Some buyers who are cashing out are trading up to better quality properties where the income returns are likely to be higher. “Historically, there’s always been a gap between the higher quality and the lower quality properties,” said Gregory Harris, senior director of Marcus & Millichap’s national multi-housing group. “But there’s been so much demand in the market for apartments and income property that the gap is no longer there. If the market were to shift, the gap will come back. A lot of my clients are taking this as an opportunity to upgrade their portfolio without losing returns.” But the investors who jumped into the market for the high property appreciation returns that characterized the past few years, are likely to disappear entirely, at least for the time being. DT is studying markets in Las Vegas, Dallas, Atlanta and Houston for future acquisitions. “I don’t really hover over the local market looking for that next deal,” said Markel. “If it comes to me through a broker or one of my agents, I think there’s still some undiscovered opportunity. Other than that, our attention as a buyer is outside of California.”

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