Steep appreciation of rental buildings expected to taper. (L.A.'s Homebuying Craze -- How High, How Long?).

For the past few years, it's been easy money. With interest rates low and the area's housing stock getting ever tighter, investors of L.A. apartment buildings, especially the smaller ones, have seen the value of their properties double in just two or three years.

But those only now looking for a piece of the action--and away from an uncertain stock market--shouldn't expect the gravy train to continue, at least not at the levels of recent years.

"The smaller apartment market has been getting the most attention out of reallocated assets' said Dean Zander, associate partner at Hendricks & Partners apartment brokers. "The demand I have for sub-50-unit buildings is as great as it's ever been."

The average price paid per apartment unit in Los Angeles County last year was $73,000, up seven percent from $68,500 in 2000, according to Marcus & Millichap. But in other areas appreciation has been much greater. In the South Bay and West Los Angeles, per-unit prices in 2001 were 19 percent and 18 percent above 2000 levels.

Hollywood apartments that were bought for $70,000 a unit three or four years ago are now selling for $100,000 a unit, according to Seth Polen, senior associate at Marcus & Millichap.

"In 1997, an apartment might have sold for $157,000 a unit--now it can sell for $200,000 a unit or more," said Laurie Lustig-Bower, senior vice president at CB Richard Ellis. "The people who bought in the mid- to late-90s, who are selling now, are making quite a pop."

Smaller properties abound

Fueling the interest in ownership has been an apartment vacancy rate that has remained at or below the four percent level for the past four years. As with single-family homes, low interest rates are fueling the push into apartment building investments, as has the area's overall housing shortage.

Roughly 734,000 of the 1.6 million apartments in L.A. County are in complexes with less than 20 units, according to 2000 Census figures.

Smaller buildings are affordable to those smaller investors looking for safer alternatives to the stock market. Many are after a safe income stream that does not require extensive knowledge of triple-net leases or have the repair and maintenance issues of commercial or retail properties.

"Buying an office building or commercial property takes a lot of sophistication. Any mom 'n' pop can buy an apartment building," said Lustig-Bower, although she noted that a landlord's income stream can be sharply reduced by disputes or litigation, even involving a single tenant.

The county saw rent increases of nine percent in 1999, 12 percent in 2000 and five percent last year. But rents are only up two percent this year. "A lot of buildings that were sold in 1997 or 1998 were upgraded and brought back to market at higher rents," said Zander.

Recently, Polen sold a nine-unit Miracle Mile-adjacent building that had been bought for $850,000 in 2000 and spruced up for $1.3 million in May. "And it still cash-flowed," said Polen, noting that rents were raised accordingly.

Countywide rental rates are expected to increase another two percent next year, according to Marcus & Millichap, while Lustig-Bower predicted a three percent annual bump for the next five years on the Westside.

Leveling off

There are drawbacks to owning rentals. Any new rent control ordinances could reduce expected returns. The city of Los Angeles, for example, puts a 4 percent cap on annual increases for apartments built before 1978. The city also enacted a Code Enforcement Program in 1998 with a goal to inspect each apartment complex every three years.

"Every time I get a call (from a client whose building was inspected), it's a bill for $40,000," Lustig-Bower said.

Interest rates pose another risk. If rates were to get much lower, renters could start buying, lowering rates in the process. Conversely, a jump in rates would make financing more challenging for apartment buyers, cooling off that market.

Michael Carney, a professor of finance and real estate at Cal Poly Pomona and director of Real Estate Research Council of Southern California, also raises concerns about the economy. "With equity investment on the downslide, nationwide unemployment will continue to rise," said Carney. "Will L.A. County be immune from that? I don't think so."

Amid any possible downturn, however, Carney expects apartments to fare better than single family homes. "The rental market will stay strong for the next year," he said. "A lot of people will quit thinking of buying a house and they'll rent for awhile."

While no one is predicting a drop-off in apartment valuations anytime soon, the level of future appreciation is a trickier question.

"We're at the threshold because the economy is weakening, so I don't think well be able to see dramatic increases from here on out in the near future," said Lustig-Bower. "You're buying a safe haven. Don't buy these because you think you're gonna get rich quick."

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