Apartment Market Strong Despite Downturn

Demand for apartments weakened slightly in Southern California in 2001, but experts say the apartment market has suffered less than other types of commercial real estate and remains a favorite choice for investors seeking stability in a time of uncertainty.

Rent growth slowed last year as demand slackened and landlords in some high-priced buildings started offering a month’s free rent to entice tenants--a phenomenon unheard of in the heady days before the recession.

But overall, according to a variety of industry sources, the outlook remains positive for apartment investors because the need for living space is still strong, few new units are being built and the percentage of empty apartments has stayed comparatively low by historical standards.

The number of sales of apartment buildings in 2001 increased to 1,856 in Los Angeles, Orange, Riverside and San Bernardino counties, up slightly from the year before, according to a report by Marcus & Millichap, a brokerage specializing in investment properties.

Investors also paid more for apartments in 2001--an average of about $67,861 per unit in Los Angeles County, up from $64,271 in 2000. In Orange County, the average price per unit climbed by $3,000 to $83,514 and in Riverside and San Bernardino counties it rose by $7,300 to $50,137.

A sign of the continuing popularity of apartments with investors is that the number of potential buyers exceeds the number of properties for sale, said Harvey Green, president and chief executive of Marcus & Millichap, an Encino-based real estate brokerage. He explained that many owners prefer to hold on to their apartment complexes for the continued cash flow, even though they could make a substantial one-time profit by selling.

Prospective investors see Southern California apartments as a safer bet than other classes of commercial real estate, said broker Dean Zander of Hendricks & Partners, because demand has remained steady, vacancy rates have not soared as they have in some office and industrial markets, and few new apartments are being built.

“The recession has made apartments look a lot more attractive by comparison,� Zander said. “People are taking their money out of underperforming investments and putting it into apartments.�

Despite the recession, Zander said, many investors still believe they can make money on apartments by managing them more efficiently or by renovating them and raising rents.

“We’ve seen a big increase in demand for older apartment buildings,� Zander said. Many buyers believe they can earn a higher return by acquiring older “Class B� properties, he explained, because big institutional investors such as pension funds, insurance companies and REITs have bid up the prices of modern “Class A� buildings so high that such properties generate a smaller return on investment.

Among those banking on the buy-and-renovate strategy is Irvine-based Aslan Realty Group, which was formed in early 2001 by partners Tom Rakow, John Schafer and Joe Cahill to acquire complexes in Southern California.

Aslan owns four properties totaling 859 units in which it will have about $72 million invested when renovations are finished, Rakow said. The company buys its properties in joint ventures with institutions and affluent individuals as its partners, he said, and it expects to invest $50 million to $100 million per year in Southland apartments for the next four or five years.

Many other investment groups have been buying Southern California apartment complexes for years and remodeling them in expectation of raising rents, but the Aslan partners say there still are plenty of opportunities to profit through renovations and more efficient management, primarily on older properties.

“If we were buying Class A properties, we might be a little more concerned about how the economy has affected the rental market,� Cahill said. “But considering that we’re buying the properties we are, we feel confident of our strategy.�

Cahill’s remark reflects a consensus among brokers, buyers and other observers: Higher-priced complexes are bearing the brunt of the recession’s effect on the apartment market.

“There is less demand for $2,000 one-bedroom apartments on the Westside [of Los Angeles] than there is for $900 one-bedroom apartments in the [San Fernando] Valley,� Zander of Hendricks & Partners said.

Landlords at some of the most expensive Westside buildings--where one-bedroom apartments rent for more than $2,000--are offering such enticements as a month’s free rent on a one-year lease.

Brokers who specialize in the Westside markets, such as Hooman Ghaffari of Grubb & Ellis and Kitty Wallace of Sperry Van Ness, say such enticements are by no means widespread but they were unheard of when the economy was booming.

“Basically, anything over $2,000 is getting tougher to rent,� Wallace said. “My clients in Palms and Mar Vista have no problems whatsoever in renting their units, but the upper-end units are taking longer to rent.�

Before the recession and the dot-com crash hit the Westside, Wallace said, landlords would have 20 prospective tenants for a luxury apartment and could count on raising the rent as much as 25% for a new tenant. Now, far fewer tenants line up, and landlords are keeping rents flat or even lowering them.

Ghaffari has seen rent decreases of 15% to 20% during the last five months for new renters in some expensive Westside properties. “I don’t think the ‘B’ market will see anything like that,� Ghaffari said. “I think there were a lot of people who were stretching to afford those high-end apartments, and a lot of them are looking for lower-priced places now.�

By contrast, rents continued to rise in the moderately priced neighborhoods that many investors find so attractive. “We raised rents about 5% last year on our occupied apartments and about 12% to 15% on the units that became vacant,� said John Gordon of Pasadena-based Fertig & Gordon, which manages 900 units in the San Gabriel Valley.

Rents range from $500 to $600 for one-bedroom units and $700 to $900 for the two-bedroom units his company manages, Gordon said.

Despite the economic slowdown, he said, “most of our vacant units rent within a week.�

Even with expectations that the recession will continue for much of 2002, Green of Marcus & Millichap said investors realize that jobs eventually will return the population will continue to grow, and construction of apartments will not keep up with demand.

He said the slight decline in the number of renters looking for apartments, which pushed vacancy rates up by less than half a percentage point throughout Southern California, reflected “classic recessionary patterns of doubling up, moving home or moving to lower- rent areas.�

That pattern, Green said, will reverse itself when the economy recovers.