Multifamily - Is it the stronghold in commercial real estate?
July 21st, 2009 by Ray RodriguezIn this month’s featured article of my Apartment Investors’ News Brief, Commercial Property News (CPN) discusses the weakening fundamentals across the board in commercial real estate as a direct tie to economic woes. Although the growth in vacancies lost some momentum in the first quarter of 2009, it is anticipated that vacancies will continue to rise across all sectors of commercial real estate.
Nationwide, CPN points out that office, industrial, and retail sectors of commercial real estate are experiencing a minimum vacancy factor of at least 12%, with the highest occurring in the office sector, north of 15%. The stronghold in commercial real estate thus far has proven to be multifamily with the lowest nationwide vacancy factor of 7.3%.
Although the economy is suffering and consumers are cutting back on spending, people still need a place to live. Would-be home buyers with large enough down payments can no longer qualify for home loans due to several reasons including subpar credit scores, tax returns showing too little income after write-offs, and stricter lending requirements. The apartment rental market is also continuing to be fed by past homeowners who have lost their homes to foreclosure.
This is not to say that a lower vacancy factor in multifamily is without cost. The current vacancy rate underwritten by lenders for multifamily in Los Angeles is between 5% and 7% depending on the area. This is as much as 4% higher than the vacancy rate of 3% some lenders underwrote in 2006. An additional factor to consider that the CPN article does not mention is the slide in rents throughout the nation. Clients first began reporting to me in late 2008 and up to this point that rents have been on a rapid decline in their buildings. I have seen rents in prime parts of the Westside and the San Fernando Valley fall as much as a few hundred dollars per unit type. The effect has not been as drastic in the working class neighborhoods, but still noticeable with 2 bedroom units falling by as much as $50 to $75 in areas such as Van Nuys and Panorama City. Rents are dropping for several reasons including the rising unemployment rate, friends and family moving in together to save money, and recently purchased REO properties establishing new lows in rental comps.
Although the vacancy rate is lowest in multifamily it still poses a significant challenge to landlords because they have had to bring down rents to keep their buildings full. This has had harsh consequences for buyers who overpaid, particularly during the peak of the market in 2006 and 2007. Those investors hit especially hard are buyers of non-rent control buildings in prime locations in which the rents are completely maxed out. These owners have unfortunately been watching their NOI’s slide down.
The media rules the minds of many through preaching fear. Despite the reality of today’s market, there are still opportunities to make wise investments and better yet, less competition going after the same deals. It is just important to realize that a conservative approach to measuring value is a must. Buildings need to be evaluated with a 5% vacancy, 38%-40% operating costs, and a buffer for further drops in NOI. The days of aggressive equity build-up are over. We are back to real cash-on-cash returns and strong cap rates as ways of evaluating a sensible investment. Buyers should expect investing in real estate to be a long term approach to building wealth and have multiple exit strategies in mind for the future.
Currently my team is working high cash flow deals throughout different parts of the San Fernando Valley, mainly in working class areas. We also have opportunities in prime locations of the Westside and San Fernando Valley with attractive cost per unit and cost per square foot numbers.
As always, I welcome your comments, questions, and concerns. Happy investing!
Sincerely,
Raymond A. Rodriguez