Curbed had an story yesterday that was 100% predictable: Downtown landlords are having to offer incentives to attract tenants.
Here is why this happened:
- Rents have been going up downtown since the end of the recession in, say, 2011
- Downtown is one of the very few neighborhoods in LA (along with, to a certain extent, Hollywood and Glendale) where you can build huge buildings without having the neighborhood tear you a new one
- Developers generally prefer to build huge buildings, because that’s an efficient way to put out huge amounts of capital quickly
- Seeing increasing rents and lax zoning, developers piled into LA, announcing project after project beginning around 2012 and continuing to today
In isolation, each of these projects made sense. The developers could convince themselves and the banks that their pro forma projections were solid, because they had plenty of rent comps to go on.
The problem is that the projections almost certainly did not reflect the fact that there were thousands of other new apartments opening up. (Why? Because it’s extremely difficult to estimate the effect in advance.)
So, now you have a glut of apartments, which is certain to lead to softening rents. Fortunately, most huge developers are well capitalized, meaning that their projects can tolerate somewhat lower rents / longer lease-up periods. Assuming the economy holds up, we’re not going to see lots of foreclosures by construction lenders. We’ll just see developers and their equity investors making less money than they had hoped.
Incidentally, the above is why Adaptive never went into downtown. We know it’s a highly cyclical market with relatively low barriers to entry. Once we missed the real lows in 2010-2011, we were not interested. Maybe on the next real downturn…