Southern California is a ‘Mixed Bag’

By Christopher Hosford, Contributing EditorSouthern California’s multi-housing market is a mixed bag. Project owners are holding their own with rents and occupancy, but only by default since little is being built. Mixed-income development isn’t thriving; the money that once flowed from redevelopment agencies has been siphoned off to help fuel the state’s battered finances.Projects once planned as condominiums are being converted to rentals. And the few investors out there are being lured to existing mixed-income projects for the stability of their income stream.”There is so much fear in the market that most of the people who used to be buyers have gotten out,” says Dana Brody, associate vice president with the West Los Angeles office of Grubb & Ellis. “The smart people know that there is the possibility that properties could decline in value, so they’re looking for higher cap rates and stabilized returns.”The Los Angeles area is expected to weather the recessionary storms relatively well compared with the rest of the nation, according to Marcus & Millichap. The commercial real estate brokerage firm projects that the area will see “reasonable” rent gains in 2009, with strongest increases projected for Santa Monica, Beverly Hills and West Hollywood as some contracts requiring owners to lease to low-income tenants expire. Job cuts and resultant turnover, meanwhile, are expected to help owners reset rents to market rates.In addition, those areas with a high proportion of working-class renters will continue to see vacancies in the low 3 percent range, the firm says. Such areas as the South Bay/Long Beach submarket fall in this category, with a similar phenomenon occurring in class-C complexes across the area.The market for buying and selling, however, is not as robust. Brody notes that with so few buyers around, the ones who are left—the guys with all the cash—are in the catbird seat, demanding and getting favorable terms. There have been some bright spots, Brody notes. Grubb & Ellis closed a deal in January for a 14-unit rent-controlled property in Sherman Oaks that sold for $2,750,000, or just under $200,000 per unit.That deal represents a switch of emphasis, she says. In past years, market-rate properties were considered the more desirable purchase, but today the focus is on rent-controlled developments that deliver smaller but relatively guaranteed income streams. “You know these kinds of renters aren’t going anywhere,” Brody says. Because condo sales are tight, many new properties are converting to rental properties. The ones that continue on to sales will likely do so at a 10 percent to 20 percent discount.Overall, Marcus & Millichap projects a slightly rising vacancy, to 5.7 percent in the Los Angeles market in 2009. Asking rents will rise slightly to $1,516 per month, with effective rents at $1,457.A relatively strong Orange CountySouth of Los Angeles, renter demand in Orange County will remain strongest in Newport Beach and Tustin, with vacancy rates in the mid-3 percent range, according to Marcus & Millichap. Supply will increase, the firm says, as unsold condos come to market as luxury rentals. This includes the 250-unit Avalon Anaheim Stadium project in the Platinum Triangle, with one-bedroom units starting at $1,595 per month, two-bedroom apartments beginning at $1,895, and three-bedroom units at $3,150.Orange County expects to see about 2,900 units come online this year, compared with 1,034 last year. Vacancy will rise almost a full point to 5.9 percent by year-end. Average and effective rents are expected to grow 2.9 percent and 2.3 percent respectively, to $1,634 and $1,574 per month. Nevertheless, the signs of relative strength come at a cost, with most new construction halted and pending projects moribund.”I’ve been working for 10 years on the Newhall Ranch project by Lennar, which was supposed to include 25,000 units,” says Randy Jackson, president of The Planning Center in Costa Mesa, Calif. “They were just getting ready to break ground on the first piece of it, due to open in two years, but now it’s in receivership.”That project would have comprised communities of all types on undeveloped land west of Interstate 5. The first phase of that project, Landmark Village, was approved last year by the Los Angeles County Planning Commission, but the project filed for Chapter 11 bankruptcy protection last summer.Jackson says the economy will eventually force developers, planners and architects to rethink the type of new construction that is viable in the Southern California market. He foresees future construction that “looks like single-family homes but is really multifamily, like triplex quads with unique configurations at less than $80 a square foot.”Jackson notes that the healthiest areas of Orange County have such intrinsic qualities as good schools and parks. “Irvine is still holding its own because people can see that where they put their money will maintain its value.”As with other parts of Southern California, investors are cherry-picking condos, reworking them, and putting them back on the market as rentals, Jackson says. Fall of the Inland EmpireMeanwhile, the Inland Empire area, comprising San Bernadino and Riverside counties and the city of Ontario, just east of Los Angeles and Orange County, may be the hardest hit of any Southern California market. “That area has been hit with huge unemployment, and home prices have dropped because there’s nobody to buy them,” says Kent Williams, regional manager and vice president in the San Diego office of Marcus & Millichap. “At the beginning of the downturn, we saw a lot of affordable housing attempts, with people trying to get bond financing. But that takes a long time to push through and interest rates have moved to the point where a lot of these fell out of escrow.”Jackson agrees. “The Inland Empire is particularly dreary,” he says. “There are hundreds of thousands of foreclosures in process or in the pipeline. And the problem with multifamily is you can buy the single-family stuff at 50 cents on the dollar, maybe 40 cents. That will take up two to three years of the market, so attached housing will trail.”The Inland Empire may be the tip of a foreclosure iceberg, but it’s a statewide phenomenon, and the multifamily market is most severely impacted. Overdue commercial loans in The Golden State rose to 0.15 percent in the 2008 fourth quarter, up from 0.08 percent in the previous three months, according to a survey by the California Mortgage Bankers Association. Moreover, multifamily properties have been disproportionately impacted by delinquencies, with that sector’s overdue rate reaching 0.23 percent (up from 0.18 percent), representing 14 delinquent loans totaling $80 million. No other sector of commercial loans was as impacted by delinquency as the multifamily arena.Farther down the coast in the San Diego market, it’s a different story. Here, a high barrier to new construction and low affordability are keeping supply low and prices high. Marcus & Millichap expects just 400 apartments to be built this year in the San Diego area, with asking and effective rents advancing a bit more, to $1,350.”What pressure there is on the apartment market is due to a rise in cap rates and the availability of financing,” says Williams. “I’m not aware of any large projects being built; I think most people don’t think this is a good time to build apartments.”But observers are fairly optimistic about Southern California’s future, as well as The Golden State overall. “California represents a big economy, and we’ll be back in the game,” says Jackson. “When we do, affordable housing will be a big chunk of that. We’ll see smaller, higher-density projects, with developers staying away from the podium stuff.”An exclusive market leaderWhat makes San Diego’s multifamily market tick? High demand combined with a dearth of developable land and high construction costs.According to Marcus & Millichap’s latest National Apartment Index, San Diego climbed six places to the No. 2 slot among 43 markets, mainly due to what is the lowest vacancy rate of any market covered by the firm.
“Despite obstacles, basic multi-housing market fundamentals in San Diego have remained strong,” Grubb & Ellis reports. Area vacancies in September 2008 were at a miniscule 2.3 percent, down from 2.7 percent a year earlier (compared with a national average of 12 percent). Rental rates peak in the area at an average of $1,772 per month in the North County Coastal market, to an average of $1,074 in East San Diego.San Diego multifamily transactions have been concentrated around distressed or bank-owned properties, plus a few well-located sites. Recent deals include:• Bella Terra, 460 units, sold by RREEF to R&V Mgmt. for $69.5 million• Cardiff by the Sea, 300 units, sold by Essex Property Trust to Property West for $71 million• Loma Portal Bluffs, 113 units, sold by Brento Corp. to Watermark Properties for $18.5 million• La Cascada, 140 units, sold by MG Properties to Fowler Property Acquisitions for $13 million.• Villas at La Mesa, 86 units, sold by KW Multi Family to The Apt. Co. for $11.5 millionTo comment, e-mail diana.mosher@nielsen.com.