Real estate market niches can lead to profits.

Interest rates are rising, the real estate market is cooling off, so what is a borrower or a lender to do in this environment? There are a few niche areas in this tough market that still produce decent returns at an acceptable level of risk.

Infill condo construction is a viable play at the right price, as the public is always less willing to commute from remote suburban areas. We recently financed $10.4MM for construction of 24 townhouse condo units in Toluca Lake, which is a fundamentally strong market with robust demand. The units were very reasonably priced on a per square foot basis which helped to qualify a much larger pool of potential buyers. Select condo conversion projects still produce some respectable results. We recently funded $2.3MM dollars for a 32 unit condo conversion project in Phoenix. The units were entry level but included $20,000 per unit in renovations and were priced at $125,000 per unit, an attractive price even with interest rates rising.

Another rewarding scenario is acquiring multifamily properties at below market rents and subsequently raising them to market. Most of these properties are mismanaged, thus creating value added plays for investors. We typically build in holdbacks for renovations and earn-outs as cash flow increases. One of our borrowers secured a $2.9MM acquisition loan for a 151 apartment complex in Mesa, AZ. The plan was to apply the borrower's experienced management team and increase the cash flow of this mismanaged property. We turned the loan around in very short time to accommodate the borrower's 1031 Exchange and provided highly competitive pricing.

Single resident occupancy properties (SRO) are another solid opportunity. SRO's are residential properties that are affordable and rented on a short term basis. These types of properties have become more popular in Los Angeles especially since housing costs have risen sharply. We funded $10MM dollars for the refinance of the 476 room Alexandria Hotel in downtown Los Angeles, a property of historical significance. This property will be renovated and redeveloped into affordable apartments. There is strong support from the City of LA for this type of development.

Finally, special purpose properties can prove to be a decent investment in this low cap rate environment. We lent $7MM for a cash-out refinance of a highly respectable auto dealership in Encino, CA. The dealership has been owned and managed by the same family for 50 years. The issue with this loan was that there was a ground lease in place, in addition to the special purpose nature of the property, but we were able to structure the deal at a low loan to value based on real estate value.

The key to making profitable loans in this difficult market is the ability to assess risk accurately and close quickly. Many borrowers find themselves in a bind because their lenders have declined or substantially modified the terms of a loan with a short time remaining before the contract sale date. Borrowers will often be willing to pay up and provide more equity if a lender is able to underwrite and close the loan quickly.

Philip Powers is a Senior Vice President with Security Pacific Bank.