Positive cash flows spur increase in apartment sales.

Investors buy foreclosed buildings for bargain prices

Plunging property prices have created a classic good news-bad news paradox for apartment owners in Los Angeles.

The good news is that prices have fallen so much that buyers can now make an annual profit, albeit small, just from the rents generated by the buildings. In addition, smaller investors can get into the market because of the lower prices and the lower down payments required.

The bad news for many owners, especially those that bought at the top of the market, is that they've lost their apartment buildings through foreclosure. Those foreclosures have been resulting from rising vacancy rates and dropping rental rates brought on by Southern California's deep recession. Foreclosing lenders are now selling L.A. apartment buildings for prices up to 50 percent less than what the buildings sold for just a few years ago.

"Prices have dropped by 50 percent in some areas, when compared to 1988-89 levels. I'm sure there are a few buildings that have actually dropped by as much as 60 percent," said John Kerin, who heads the Los Angeles office of Marcus & Millichap, a real estate investment brokerage.

Kerin said Marcus & Millichap statistics show the number of L.A. apartment buildings being sold has risen, while prices have fallen. In all of 1992, Marcus & Millichap brokered 183 L.A. apartment building sales transactions for an aggregate sales price of $300 million. As of Sept. 30, Marcus & Millichap had completed 206 L.A. apartment sales for a total of $275 million.

Kerin said sales of local apartment buildings this year represent 65 percent of all transactions handled by Marcus & Millichap's three Los Angeles offices. Historically, he said, apartment sales have represented 50 percent of all transactions; the other half have been sales of office, industrial and retail buildings.

According to Mike Zugsmith of Zugsmith-Thind Inc., a commercial real estate brokerage, the L.A. apartment investment market has turned around completely since the late 1980s.

"People in those days (late 1980s) would purchase a piece of property based on the idea that property could be bought on a negative cash flow because it was going to be worth more money next year and each year after that," Zugsmith said. "They expected to be able to refinance the property and not only take out their initial investment but make a profit."

"They also had the idea that rental rates would continue to climb steeply," Zugsmith continued. "Therefore, no one particularly cared if they bought a building based upon an income stream that was insufficient."

But many of the buildings with insufficient income streams have been repossessed. Zugsmith said apartments now "are selling on the basis of cash flow."

Katherine L. Bergh, a broker who specializes in apartment sales at the San Fernando Valley office of Grubb & Ellis Co., said that, although repossessed properties are a significant part of the market, private party transactions are still being done.

"Brokers may sometimes think they shouldn't work with private sellers because they think the private sellers are going to price their properties too high to sell, but that's not true," Bergh insisted.

She said many private sellers have owned their properties for a long time, so they can still make a profit at today's prices. However, she said, these buildings usually sell for a higher per-unit price because most private sellers aren't under as much pressure to unload the buildings as lenders that are holding large portfolios of repossessed properties.

According to Jona Goldrich of Goldrich & Kest Industries, one of the biggest owners of apartment buildings in Los Angeles, apartment investors have a variety of strategies for making money.

Goldrich said his company maintains ownership of apartments it builds, as well as buying a few buildings built by others. He said his strategy has also been to hold onto the apartments rather than selling them after a few years of appreciation.

According to the Washington, D.C.-based National Multi Housing Council, Goldrich & Kest is the 44th-largest owner of apartments in the United States. The council's latest ranking of apartment owners listed Goldrich & Kest with 17,590 units. The largest Lost Angeles-based apartment owner listed by the council is Beverly Hills-based National Partnership Investments Corp., which is the 10th-largest owner of apartments in the nation, with 45,629 units. Officials of National Partnership could not be reached for comment regarding the L.A. apartment market.

But Jonathan L. Kempner, president of the National Multi Housing Council, said Southern California "has been a weak market, especially in the last year or so."

"The vacancy rate is relatively high and growing higher. Economic conditions have a major impact on vacancies because, when the economy is tough, more people move back in with their parents and more people double up," Kempner said.

According to Kerin, the apartment vacancy rate in Los Angeles County is approximately 12 percent, although it varies within geographic submarkets.

Kerin said the L.A. apartment market has changed dramatically in the past 10 years. In the mid-1980s, he said, the countywide apartment vacancy rate was down to 2 percent. That, along with the development fervor of the 1980s, spurred construction of nearly 198,000 apartment units in Los Angeles County from 1984 to 1989.

Kerin said the boom also spurred syndicates to buy the buildings. But Kerin and Zugsmith both said most of today's buyers are small investors or small partnerships.

"There isn't much big syndication business going on. Probably 75 percent of the buyers are individuals," Kerin said. "Syndication was probably 80 percent of the business at one point in the 1980s. The syndicates were doing 20 or 30 deals at a time, but the syndicates we do see today are more like a couple of people getting together and pooling their money."

Kerin said he doesn't foresee a substantial comeback for big-time syndication of apartment ownership. He said most L.A. County apartment buildings are too old to meet the criteria of syndicates and real estate investment trusts (REITs), which typically prefer newer buildings.

"With the exception of the buildings built during the boom of 1986 to 1989, most of the apartments in Los Angeles County are at least 15 or 20 years old," he said. "Some of the REITs have bought loan portfolios and, in those, you'll see a lot of Los Angeles County apartment buildings. But those are really just loans at this point in time. The criteria of many REITs would eliminate them from owning older units."

According to Zugsmith, most buyers of apartments are small investors, small syndicators and wealthy individuals.

"I think there's a little bit of concern about the stock market; so smart money is trying to use real estate as a hedge against a drop in the stock market. Maybe it's contrasting from what it was a few years ago when smart money was pouring out of real estate and into the market," Zugsmith said.