These days, when Larwin Investment Co. considers an acquisition, it scrutinizes the property with a very narrowly defined focus. The folks at Nearon/Ossola Group are doing a lot of their shopping out of state. And at Investment Development Services Inc., officials are sifting through about 100 deals just to find one. With property prices sky high in all sectors of the real estate market, just about every non-institutional buyer has had to reevaluate the criteria it uses and the way in which it shops for acquisitions. Some are just saying no. “People are paying ridiculous prices,” said John Battle, a partner at real estate brokerage Lee & Associates-L.A. North/Ventura County Inc. “A lot of our clients sold into the market last year and they either bought out of the area or they decided to pay the taxes instead of reinvesting.” Last year in the San Fernando Valley, median prices rose 14 percent to $109,000 per unit for apartment buildings, 27 percent to $185 per square foot for office buildings and 20 percent to $210 per square foot for retail properties, according to a Marcus & Millichap report. With the escalating prices, the return thresholds have dropped sharply, so that where buyers could expect a return between 8 percent and 10 percent on their investment just a few years ago, they are now settling for 6 percent or 7 percent, and as little as 5 percent in some cases. “I think they’re accepting lower returns. It’s that simple,” said Tom Festa, a broker at Grubb & Ellis. “There’s so much institutional money that needs to diversify in real estate, or has decided it needs to be there and there just isn’t enough product.” The competition has created a seller’s market that may or may not be temporary. “In the last year, I’ve sold my interest in about half of what I own, and only time will tell if I did the right thing,” said Jerry Katell, president of Katell Properties, who joked that he’s thinking about calling a psychic to see if he should sell the rest of his properties. “I look at cap rates being so low and values being so high, I look at it as an aberration. For the forty years I’ve been in the business, it’s a unique time.” One of Katell’s properties, the Nordhoff Industrial Complex, has been valued at a cap rate ranging between 9 percent and 10 percent since it was developed in the 1980s. “Now, if I wanted I could sell it at a 7 percent cap rate,” Katell said. “Now it’s worth 40 percent more than it’s been in 20 years.” Low interest rates have certainly spurred a lot of the buying activity, particularly for smaller investors. And the value of the dollar, which has dropped markedly in the past year, is inviting foreign investors into the market as well, increasing the competition for trophy properties in particular. But some of the reasons behind the rush to buy real estate may portend a more permanent change in the marketplace. Diversifying portfolios With the collapse of the stock market in 2000, many institutional investors began moving to diversify their portfolios by adding real estate holdings and other so-called opportunity funds emerged with huge war chests to invest. “Between 1990 and 2000, the average cap rate was 8.5 percent,” said Hessam Nadji, managing director of research services at Marcus & Millichap. “That’s been squeezed down to 6.4 percent on a national basis because so much capital flowed into real estate.” Some think that as interest rates rise, smaller investors and foreign players will pull back out of the market, relieving some of the price pressure. But the institutional investors may well be in for the long haul, and their costs for financing will be cheaper, whether or not interest rates rise. At the same time, opportunity funds have created a new investment sector that may also survive the current interest rate cycle. “There’s dozens you’ve never heard of with 100 million to 500 million to invest in real estate, and they’re all looking at Southern California,” said Mark Ossola, a principal at Nearon/Ossola Group. “As more of these pop up, they’re all chasing the same deals, which means one thing, prices go up.” While investors disagree over whether the current market dynamics are cyclical or permanent, they all agree that buying properties takes a different eye than it did a few years ago. “If in certain cycles of the real estate market you can look at 10 deals, the difference is now you have to look at 100 to find one you like,” said David Mgrublian, managing director at Investment Development Services. “Those that can sift through what’s in the market quickly and find out where the hidden value is located are those that are going to be successful and those that don’t have a clue will wallow.” Mgrublian thinks the trick is to stick to the trading areas that you know to adequately evaluate the value of the property. The company’s recent decision to purchase the Washington Mutual office complex in Chatsworth was based on the quality of the tenants that occupy the property as well as what Mgrublian perceived as an attractive location in walking distance of the Northridge Fashion Center. “If you were in New York, how would you figure that out?” he said. “We just know.” Officials at Larwin concur. Even after, like others, adjusting its return criteria, the company still has to work harder to find properties that meet it. “Where the phone used to ring, I’m driving around, shaking hands spending a tremendous amount of time out in the field to create transactions that make sense for the seller and for us,” said Greg St. Clair, vice president at Encino-based Larwin. The company is also focusing on markets it is familiar with and paying added attention to the property features, including things like proximity to freeway corridors and buildings with flexible uses. “So I’m not locked into one tenant,” St. Clair said. “We can keep the buildings full and keep ourselves at a good rental rate that will protect our cash flow down the road.” Many others say they just won’t compete with some of the buyers in the market, and they are looking elsewhere for investments. “What it means to the Nearon Ossola partnership is we’re having to go out of state to look at new properties,” said Ossola. The company has recently acquired a mixed use property in Tacoma and another in Utah. “Because of the competition and the prices of land, we’re actually having to go out of state to find deals that make economic sense,” Ossola said.
