L.A. Multifamily Sizzles and Downtown Development Booms

2016 was a record setting year for LA Multifamily, and 2017 continues strong

Nearly $10 billion was invested in Los Angeles County during 2016, including more than $3 billion in 4Q alone (CoStar), which was spread fairly evenly across the County.  Investor demand remains wide and deep, including both national investors and considerable foreign investment.  L.A. is currently considered one of the best US cities for real estate investments for long-term capital preservation.

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Demand Remains HIgh & Supply increasing but mostly in Class A and Downtown

A strong labor market (especially in the hospitality and healthcare sectors), trends toward urban living, and high housing prices are driving renter demand.  Rents grew approximately 5% for 2016 and rent growth expectations for 2017 are a similar rate (5.4% - Marcus & Millichap). Representing a plus for future supply, the highly contested Measure S was defeated in March, which targeted the practice of changing city rules to permit buildings that are taller or denser than the established restrictions would ordinarily allow and would have imposed a moratorium lasting up to two years on building projects that require zone changes and other alterations in city rules. With the massive housing shortfall facing SoCal, the measure would have exacerbated the problem, further restricting the needed supply of additional housing units to take the pressure off of pricing and rents.  

New units under construction

Above is a chart of units under construction, showing deliveries increasing into a long-term high, with much of the new supply in the long stigmatized but resurgent Downtown LA (DTLA), so much so that vacancy rates (10% according to one report, compared to County average of 2-4%) and concessions have begun to push up, making lenders more cautious on new projects in the submarket.  

Strong absorption and rental rate growth is drawing new development, but to date much has been in high-end Class A properties. The reasons are simple.  Building and land costs are both very high, so much so that new construction of Class B and C product in nearly all areas simply isn’t profitable.  This is a potential opportunity for value-add investors, since affordability is a huge issue in SoCal and the lack of new supply for lower rent properties will likely continue to drive positive fundamentals for these properties into the future.

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DTLA and other Submarket growth

Here's a view of the new DTLA skyline showing projects recently added and further below a few of the largest projects underway:

Circa, slated for delivery in spring 2018, is a $500 million mixed-use development, and one of multiple large-scale multifamily projects currently under construction in DTLA

Wilshire Grand Center, a 1.6 million square-foot office, hotel and retail tower being developed by Korean Air — now the tallest structure west of the Mississippi.

The 2.1 million square-foot Metropolis Los Angeles, four glassy high-rise towers being developed by Greenland Group, China’s largest real estate developer, which is state-owned.

In addition to DTLA, two of the submarkets seeing the most activity in new development are Hollywood & Koreatown, both of which allow higher density new development and have recent expansions or renovations to Metro stops--LA's public subway system. 

Data from LA City Planning

"Silicon Beach" as it is now termed, which is an area that is welcoming new high-tech developments from Google, Yahoo and many others and includes Venice Beach, Marina Del Rey, Playa Del Rey, and Westchester is currently undergoing a mini development boom.  In addition, outlying areas all around the city including the South Bay, San Fernando Valley, Glendale, Pasadena and the San Gabriel valley are all seeing a run in new development and rehab projects as a result of the rent and pricing pressure.

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Pricing remains rich

Pricing is rich and shows no signs of letting up--with average cap rates declining to the mid-4% range, and many value-add, even rent controlled deals trading into the 3% range on in-place income.  Smaller investors are having to compete with deep pocketed and institutional players on premium assets and the most popular west side neighborhoods, which is driving many into smaller and more "affordable" deals in less desirable neighborhoods in search for yield.  The average price per unit on closed transactions topped over $260,000 in the past year, with the highest on Westside properties, which averaged $530,000 per unit (Marcus & Millichap).

Condo Deconversions are all the rage.

Chicago condo deconversions are trending as multifamily remains hot

A confluence of high rents and employment levels, demographics, and low interest rates are driving a current golden era of multifamily performance. Millennials, who represent the largest generation in the US, are inclined toward renting, both due to lifestyle preferences as well as financial capacity, and along with a buoyant economy, are driving renter demand.

As yields remain very low for multifamily product, developers are searching for new ways to unlock value and capitalize on the booming apartment market.  With construction and land costs at highs and an onerous entitlement process in Chicago, deconversions offer an alternative to new construction to add properties to inventory at costs well below current replacement and with considerably lower risk.  What started a few years ago mostly as a result of bulk investor purchases of broken condo deals from the last downturn has now escalated into a full-on trend in the Chicago market, with news of new deconversions almost weekly.  

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Recent activity

- Strategic Properties purchased both Clark Place, a 133-unit condo tower at 2625 North Clark St in Lincoln Park for $35M, and the 30-story, 207-unit Bel Harbour condo building at 420 W. Belmont Ave. for $51.5 million

-  A local investor group purchased a 101-unit Buena Park property at 732 W. Bittersweet Pl. for $16.2 million

 - Owners at 1660 N Lasalle St. rejected a $141M offer by Chicago based developer Centrum Partners for all 492 units

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Unless a homeowner association (HOA) has already made a collective decision to sell, the process of acquiring the bulk of units can be quite difficult and timing consuming.  Getting a large group of folks with different motivations and goals to jointly agree on anything is challenging, as anyone who follows the gridlock in Congress can attest.  While the laws governing the HOA dissolution process vary by state and local municipality, the legal mechanism is typically fairly easy if and when the investor is able to acquire 100% of the units.  The problem arises when the developer is not able to acquire all units and owners remain who hold out for higher proceeds.  In Illinois only 75% of owners are generally necessary to compel a sale from the remaining owners.  However, resistant owners can slow down the process with legal action, sometimes for years.

Seller perspective.

From a seller's perspective, many condo owners find it more compelling, due to high rent levels, to rent out their units rather than sell.  The higher the percentage of condos already operating as rental units in an HOA, the simpler and more natural the full conversion to apartments.  While condo pricing has improved, there remains an imbalance in the market, and owners are finding that they can achieve higher sales prices by bundling their units with other owners and participating in a bulk deconversion sale as opposed to an individual sale.  Moreover, many older condos that converted in the 90s and early 00s have significant deferred maintenance and inadequate reserves, and condo owners see the bulk sale as an easy exit to avoid these large and looming expenditures. Developers are often better positioned to execute these repairs more efficiently and at a lower cost than an unwieldy HOA.  

What to look for in potential deconversion projects.

For developers and amateur arbitrageurs looking for bulk sale condo deconversion projects, older buildings where sales lag because too many units are on the market or dated finishes or features can often be good candidates. Other signs, aside from the combo of deferred maintenance and inadequate reserves, include small condo projects with few units and disorganized HOAs or the presence of a high number of existing rental units.  Many boards have begun to realize the potential of this this path and are hiring brokers to market their bulk sale, which is evidenced by the high number of new listings for deconversion opportunities. In our experience, however, yields are so low in broker-marketed transactions that often most, if not all, of the added value resulting from deconversion is already priced into the deal, removing the appeal, since the risks remain.

How long will the trend continue?  

Many cranes are in the air in and around downtown, and the supply of new deliveries is expected to outpace absorption this year and 2018, which may lead to lower rents and higher concessions and vacancy, dampening the deconversion trend downtown.

However, north side neighborhoods such as Lakeview and Lincoln Park will likely continue to be good opportunities, since new multifamily development in these markets has lagged and high income renter demand remains.  More broadly, across Chicago, despite budgetary issues, cultural amenities and strong employment opportunities will continue to attract the brightest from the Midwest and beyond. The more significant negative signal to watch for is increasing interest rates, which would push up yields and squeeze the current pricing spread driving deconversions. 

"Keep Austin Weird"

Capital value growth rates similar to Toronto, Vancouver and some 2nd tier cities in China.

Austin has exploded in the past seven years, driven by a potent combination of high population growth and low new development volume.  The tech sector has boomed, attracting new high and low-income earners (about 150 net migration per day, and counting...), which has triggered high demand for real estate.  On the flip side, new real estate development has been relatively restricted due to low-density zoning, low height restrictions and high environmental boundaries (not withstanding the above photo!).

With the warm Texas weather and 0% tax rate, people are still coming and this shows no signs of slowing down.  Since 2012, single family home values have increased +100-140% in some neighborhoods, and commercial properties have recorded similar gains.  Simply put, Austin is one of the best real estate markets in the country for income and capital value growth if you can find the right property.

The bad news is good real estate deals are hard to find.  Most properties are bid up substantially, with income barely covering a loan payment (if at all!).  And since occupancy has been so high, landlords have deferred maintenance, and thus in most cases assets need work.  Pricing can get out of hand; competition for properties is extremely high, and even the smaller assets in high demand locations sell for 4-4.5% yields.  Most accretive deals are off market and incredibly difficult to find.

But we are home to the best restaurants in Texas, the best BBQ (maybe), the best music scene, and a population of some of the most open minded and tech-savvy citizens in the nation.  All at the doorstep of Hill Country.  We've added 8,600 hotel rooms in the past several years - plenty of room for SXSW and the ALC Music Festival.  Come visit!

• Fun Austin Facts - The city's slogan is "Keep Austin Weird"...it is the fastest-growing, youngest, safest big city in the U.S (average age is 28) and has one of the the highest percentage of millennials of any US city....Austin has the largest urban bat population on the continent!?

• Residential hotbed - Apartment rents have grown 5-8% per year since 2012 and while moderating, rent growth is expected to remain elevated above the US average and Austin remains 96% occupied. We are a top 15 exposure for multi-family REITs. There is a chronic lack of affordable housing anywhere near the CBD and transit routes.

• "Silicon Hills" - Tech jobs are creating booming office demand. In 2016 Austin had the highest office net absorption in the country as a % of inventory, 1.6% vs. 0.2% national average, according to JLL. Whole Foods is headquartered here, and Amazon, Facebook, Google and AthenaHealth have all leased large blocks of space in the past 24 months.

• The Domain - One of the largest mixed-use developments in the country, operated by Simon and Endeavor Real Estate, continues to grow at a rapid pace. Class A office rents here are now what they were downtown three years ago (low $30s/SF). Other prominent redevelopments are the Seaholm Power Plant, Dell Medical Center and Mueller Airport, driving growth and attracting more national interest.

• Fundamentals - Over 150 people move to Austin per day on a net basis, driven by good jobs, warm weather, and corporate relocations. Analysts expect 8-10k household formations per year for the next several years. Not bad for a city the size of Madison!

We will be posting the best tidbits and charts in the months ahead.  Please bookmark or sign up for our mailing list so you are updated with the latest posts.