Are LA apartment building prices entering a bubble?
Recently, prices for apartment buildings in Los Angeles have been increasing rapidly. 12 months ago, you could find buildings in improving neighborhoods for less than 10x annual gross rents. Now, the range is more like 10.5-11.5x for larger buildings and up to 14x for smaller buildings.
Inventory in all asset sizes is also very slim and anything priced reasonably is drawing large numbers of offers. Some clients I’m representing on a fourplex transaction in West LA won an auction by beating out 11 other offers, ending up at over 12x the annual rents. I just called on a duplex listed at $389,000 in Silver Lake and found out it went under contract at $470,000.
So the question has to be asked: Are we in a bubble?
Now, anyone who claims to be able to answer that question definitively is full of shit. Pricing is impacted by all kinds of variable which are very hard to predict, including interest rates, employment, the performance of the stock market, etc.(An aside: If you are able to predict any of those factors with any degree of certainty, you should be running a hedge-fund, not reading this piece.)
So the best we can do is look at the balance of the probabilities. Here’s why I don’t think we’re in a bubble:
- Interest rates are going to stay low for a while. The Fed is actually looking at ways to stimulate the economy, because the employment numbers have been so low recently. So the odds that rates will rise seem low. (Rising rates would push prices down, because it would cost more to borrow money to buy buildings.)
- The rental market is hot. We have a tenant breaking a lease on a $1500 one bed in a gentrifying but certainly not gentrified area. We put it on Craigslist and had 10 appointments scheduled that day. Stories like this abound.
- Employment is bad but hopefully improving. There are still a ton of recent college grads sleeping on their friends’ couches or back at home with their parents. As they (eventually) get jobs, their first major expenditures will be on moving out and getting their own places.
If you do expect rents to continue rising and you don’t expect rates to increase, I think you have to conclude that we’re not in a bubble yet, because the underlying fundamentals of the apartment business (the rents) are improving and the means of financing acquisitions (debt) should remain cheap for some time.
Good analysis. Are you finding on bigger buildings 5+ that the increasing prices are resulting in down payment requirements more in the 35% range instead of the 25-30% area? That alone can take out some buyers.
Matt
06/12/2012 at 3:56 pm
For larger properties, the amount you have to put down is pretty much dependent upon the debt service coverage ratio.
As the prices increase relative to the rents (cap rates coming down), you do start to compress the DSCR. If it gets to 1.2 or less, the bank will usually require a larger downpayment.
More on this whole issue tomorrow…
mjkagan
06/12/2012 at 4:10 pm
Is LA multifamily in a bubble? Absolutely. The market is completely disconnected from fundamentals/reality. The cap rate compression is just insane, the numbers don’t work and 95% of brokers would make an Enron exec blush.
How many more run down 1960s vintage buildings with fantasy land 25% expense ratios and tons of deferred maintenence are coming online this week?
I’ve looked at 150+ deals in the past couple of months, virtually all are garbage.
For what again? A couple points on your money if you’re lucky and came to the table with a huge down payment. To pick up an fairly illiquid asset with high transaction costs when you want to sell. Uh huh.
Oh, that’s right, California (the bankrupt state) is go go go 24/7, it’s going to appreciate like 57 trillion percent next week, the sky’s the limit!!!11ONE!!
No thanks. Best of luck to everyone gambling in this market, don’t get too greedy, take your profits while you can.
dumpster_muffin
11/15/2012 at 1:35 pm
It’s definitely true that there is a lot of over-priced stuff out there. But I can tell you definitively that I am finding stuff to buy that works, even for me (and my capital is expensive). Focus on rent control units where the rents are below market. It’s the secret of LA real estate.
mjkagan
11/15/2012 at 1:40 pm