Why We Like Los Angeles Multifamily
by Mark Hentemann
Los Angeles is a diverse and economy with a growing population. It’s experiencing a severe shortage of rental units, and renters are becoming an increasing portion of the population due to the prohibitive cost of single family homes. Recent interest rate increases are only pushing homeownership further out of reach for most residents. This has resulted in chronic lack of supply.
SIMPLE SUPPLY AND DEMAND
For the next 10 years, the Los Angeles economy is projected to add 60,000 jobs annually, yet add only 10,000 housing units. This failure to meet the housing need is due to several factors: the lack of available land, the city’s difficult permitting process and an anti-development regulatory environment. These combine to make LA a notoriously difficult place to build.
Thus, the gap between supply and demand, already a problem, will only grow.
For comparison, Dallas, a city with half the population of LA, annually builds twice the apartment units. The saying goes, “Most real estate booms die from oversupply.” This seems unlikely in Los Angeles. Even with new supply, occupancy rates are at 96.5%, among the highest in the nation.
These factors have contributed to the steady rise in multifamily values. Even during the real estate collapse of 2008-2011, which saw mass single family home foreclosures, Los Angeles multifamily had a default rate of less than 1%.
A GATEWAY CITY
Another factor in the Los Angeles real estate market has been foreign investment. In the past decade, the rest of the world (i.e. China and India) has becomes more affluent, and foreign investment in U.S. real estate assets has increased dramatically. Despite its political challenges, the U.S. remains the world’s most stable political system, strongest economy, and the dollar its most stable currency. In short, this is where the rest of the world parks its wealth. Foreign investment in U.S. real estate reached a record $351 billion in 2017. And coastal, “gateway” cities like Los Angeles, New York and Miami received the vast majority of this investment.
As the insatiable demand for Los Angeles multifamily grows, there has been an increase in new units being built. However, these new units are overwhelmingly luxury, A-class units. This is not due to need, but because after land, permitting and regulatory costs are factored, these luxury units are the only ones that pencil out for builders. The units most in demand by far are affordable, “B and C-class” apartments, which remains, and will continue to be in severe shortage.
This is what we invest in.
Los Angeles, B and C-class multifamily is the most stable, recession-proof asset class, and it is the most poised for continued price-appreciation.
Our returns bear this out. During the 2008 real estate collapse and recession -- the most severe in 50 years -- our investors tripled their money. The buildings we owned saw increased demand during the recession, due to renter flight from high-end apartments into more affordable ones, and many homeowners turning into renters.
Over the last three years, Los Angeles asking rents have increased by an average of 5.9%/year, occupancy rates are currently at 97.1%, and population is projected to grow 3.5% for the next 5 years.
REASONS TO LOVE MULTIFAMILY
Currently the most tax-favored asset class.
Historically proven to be a hedge against economic volatility and inflation.
Recessions only increase rental demand.
Property value is not economy-dependent: experienced operators can push value upward in any economic environment through increased rents, adding streams of income (storage, laundry, parking), and reducing expenses. These strategies “force” appreciation upward in good economies and even hostile ones.
Multiple engines of growth work simultaneously: rent growth, appreciation, loan paydown, depreciation tax benefit, value-add improvements.
Intelligent use of leverage then magnifies this growth.
Six Fundamentals of Supply and Demand That Multifamily Investors Should Know
“The Urban Institute declared, "We are not prepared for the growth in rental demand." The research indicated that from 2010 to 2030 for every three new homeowners, there would be five new renters. And in 2017, the National Multifamily Housing Council (NMHC) and the National Apartment Association (NAA) weighed in: 325,000 new units, on average, are needed each year through 2030, yet an average of only 244,000 new units came online annually from 2012-2016.”