Local apartment sale prices fall, as vacancies rise.

Certain low-end buildings yield healthy cash returns

Apartments in the Los Angeles area are enduring relatively high vacancy rates and falling in price.

Some apartments in the outer reaches of L.A. County are down in price by 65 percent since the late 1980s, while decreases of 30 percent or more are common in closer-in neighborhoods.

The big question is: When will the bottom be hit? And persistent worries for all apartment owners are crime and how long until an economic recovery props up prices again.

But some local industry experts said, with apartment building prices down, now may be a good time to buy.

"You can buy an apartment today, and earn a positive cash flow," said John Gordon, a Pasadena-based apartment investor who specializes in the San Gabriel Valley. "We haven't seen that situation in 10 years."

For the strong of stomach, apartments in poor sections of Los Angeles can offer 10 to 24 percent annual returns on cash invested, said Gordon and others.

"But crime is a problem, and it can deter investment," warned Gordon. "I know a lot of my friends are talking about getting out of the business and moving away from Los Angeles. I don't know if that is because my friends are like me -- in their 50s -- or because crime is really worse."

Dan O'Connell, head of the Tarzana-based Apartment Building Appraisers and Analysts appraisal firm, concurred that apartment prices are way down -- but warned that an upswing in prices still may not even be on the horizon.

"We have seen prices, in extreme cases, fall by 50 percent in outlying areas, such as the Antelope Valley. In closer, more-established areas, we have seen prices fall by as much as 30 percent," said O'Connell. "Each year, it seems, we are told recovery is two years away. It all comes down to jobs, and I see nothing to make me think we are going to have job growth here."

Still, those willing to buy and hold might be in on the investment bonanza of the 1990s, said Bernard Haddigan, senior regional manager with brokerage Marcus & Millichap in Encino.

"If rents hold up, now is absolutely the time to buy," said Haddigan. "We are seeing deals with 20 percent cash-on-cash (return on down payment) returns. We just sold a high-quality building in Santa Monica, prime location, for 10 percent cash-on-cash annual return. It is getting pretty hard to lose money on these deals."

Haddigan said in the Palmdale area some apartments are down in price by 65 percent from their 1980s heights. "Some buildings that sold for $50,000 a unit are going for $17,500 a unit," he said.

An apartment building near the GM plant in the Panorama City section of Los Angeles recently sold for $10,000 a unit, said Haddigan.

By Haddigan's reckoning, if a buyer is willing to sit on a property five to eight years -- and collect handsome rents all the while -- a big killing might be made towards the end of the century. "If rents rise, and the economy improves, look out," he said.

But in the mundane of here and today, two things are pushing down apartment values, concurred apartment experts.

First, cash flows are diminished, due to lower rents and higher vacancies.

The City of Los Angeles recently reported an apartment vacancy rate of 7.7 percent, compared with 6.6 percent a year earlier.

In the late 1980s, it was sometimes difficult to find empty apartments in the Los Angeles region's better neighborhoods. But today, seemingly every apartment building is festooned with a "for rent" sign. Too, more tenants, newly jobless, are simply not paying rent.

Secondly, the "gross income multiplier" is lower. The gross income multiplier is the number used to multiply with annual gross receipts to arrive at the amount a buyer is willing to fork over for an apartment building.

For example, if an apartment building yields $50,000 a year in gross receipts, and sells for $500,000, the gross income multiplier is 10.

In the real-estate heydays of the late 1980s, apartments were routinely selling for gross income multipliers of 10. But in today's market they can fall to seven, even in good parts of town, and less in bad parts of town.

In combination, the decreases in rents and gross income multipliers have hammered apartment values. As a result, an apartment building today may not only throw off less rent, but it will also be valued less for the rent that it does throw off.

With rents down, and vacancies up -- and the economy still in the tank -- O'Connell warned would-be apartment buyers to expect to work for any profits.

"I don't expect an increase in apartment prices anytime soon," he said. "Interest rates are low. But if they go up, that will hurt apartment prices. Anyone who buys now had better be able to manage the property well, and be prepared for more decreases in rent."

Crime and tenant problems are more severe today than in years past, said experts. "Crime is becoming a bigger and bigger factor in where one buys," said investor Gordon. "It used to be just a few small pockets in town where you wouldn't buy due to crime, but now it is whole sections of Los Angeles."

Added O'Connell, "Today you see much more tenant abuse of property. You see drugs, graffiti, overcrowding. A lot of people are hesitant to buy into these problems."

Still, the same lever-action that is depressing apartment values -- lower rents times lower gross income multipliers -- could provide leverage on the upside in the late 1990s, proffered Haddigan of Marcus & Millichap. "Let's say rents go up by 20 percent, and the gross income multiplier goes from seven to 10. Then a $500,000 building could become worth $850,000."

Already, a new breed of apartment buyer is moving onto the apartment scene in Los Angeles. This new breed has more of a small-business-operator mentality than did the mom-and-pop or successful-dentist investor of yesteryear.

"The new buyers, they have crews that come in, lay down new carpets, have things painted; they stabilize a building," said Haddigan. "You don't see as many doctors or dentists buying apartment buildings any more. They don't have confidence in the real estate."

The new buyers are buying for the cash-flow, and running the apartments as heavily managed businesses, screening tenants and providing maintenance on the properties, said Haddigan.

"We are selling lots of apartments this year, things are moving," he said.