I JUST GOT CULTURE SHOCK: THE MULTIFAMILY REAL ESTATE MARKET IN SOUTHERN CALIFORNIA!!!

By now most of you know who I am. Just to make sure you all understand where I am coming from in this post, my name is Paul Levine and I am a Commercial Realtor in Southern California specializing in Multifamily Housing. I live and work in the greater Los Angeles area and I have been living here since 1969, a long time ago.

I am used to prices here for Multifamily Housing. The prices in Southern California are outrageous, to say the least. Here, you can buy an Apartment Building and you can pay as much as $1 million per apartment in the better neighborhoods like Beverly Hills, Bel Air, or by the beach in Malibu or Laguna Beach. That is definitely the high end and the normal per unit price for an Apartment Building in "normal" communities can range anywhere from $200,000 to $300,000. There are also neighborhoods where you will pay $500,000 plus per apartment in the better neighborhoods. What I am saying is that the range for an Apartment Building in Southern California is wide and varied.

I was just browsing on "The Magic of Multifamily" website and got culture shock. To give you some examples, I found one apartment complex of 10 units for $55,000 per unit, 48 units for $43,750 per unit, and 6 units for the exorbitant amount of $69,000 per unit. These apartments were in El Paso, Texas, North Carolina, and Albany Georgia.

This is all going someplace and I will continue this article tomorrow. But, let these numbers sink in and play with them today and I will give you my take on them tomorrow. Remember, I was a practicing Certified Public Accountant in Los Angeles for over 50 years before becoming a Commercial Realtor so I might just look at things a little different than most real estate investors.

Prices of Apartment Buildings:

The price per apartment and, therefore, the price per apartment building in Southern California is way out of line from the rest of the United States with a few exceptions. I am not that familiar with prices in New York but I am sure that some apartment buildings in Manhattan can put our numbers in Southern California to shame.

If the price of the apartment buildings is so high you are going to have higher debt service and, therefore, your Net Operating Income (NOI) has to be able to support those payments. And, how is the best way to increase your bottom line, increase the top line or your gross rental income? So now, let's look at rents in certain areas of the country.

In Los Angeles, you can rent a one-bedroom apartment in a good neighborhood for about $2,200 to $2,500 per month. A two-bedroom apartment normally goes for about $2,700 to $3,000 per month. I have written before about higher density is needed in Los Angeles because our population centers extend for many miles going North, South, East, and West from Downtown Los Angeles. As an example, from Downtown Los Angeles to San Diego, about 120 miles, you have non stop population centers. Except for a military base somewhere around Oceanside, CA, it's solid housing. So, we have to build up because we cannot build out. There is higher demand right now that there is supply.

Rents in El Paso, Texas, North Carolina, and Albany Georgia do not compare with the rents in Los Angeles by multiples. That's how we get the NOI up to the amount to pay all our expenses, pay our debt service and leave enough for apartment building owners to put a tidy sum in their pockets for a rainy day, and as the song goes, "It Never Rains In California"!!!

Rents in the Southern California Multifamily Real Estate market: They can sustain the prices for Apartment Buildings due to the high rents.

There are so many families and individuals who desperately want to purchase a single-family residence in Southern California for their primary residence but they cannot. With the housing prices so high they need a substantial down payment that they do not have. They do have substantial monthly and annual income and can afford a high monthly payment for housing but they cannot buy a house. These people are paying anywhere from $3,000 to $6,000 a month in rents for a luxury place to live. This is not unusual at all in Southern California.

Moreover, a new phenomenon has occurred and is occurring in Southern California and the demand for it is so big that companies, construction companies, are opening every day to satisfy this need. Homeowners are converting their 2 and 3 car garages into studio units and renting them out. A 3 car garage is approximately 600 square feet and that is the size of a nice-sized studio apartment or a smaller one-bedroom apartment. I know of an instance where someone who has done this is renting out their converted garage, in a nice neighborhood, for (drumroll please) $1,800 per month!!!!! That was 5 exclamation points!

So, everyone from around the United States who doesn't understand how apartment owners in Southern California can buy and pay for an Apartment Building at the outrageous prices that we have here, there is your answer. As outrageous as the prices are here, the rents are even crazier! It does make sense to own and operate Multifamily Housing in Southern California because the numbers prove it. Remember, I was a practicing CPA for over 50 years before becoming a Commercial Realtor and I've done tax returns and filled out Schedule Es and I have even been amazed at times as to how the numbers work out.

Cap Rates: They mean very little when valuing and analyzing an Apartment Building.

Here in Southern California Apartment Buildings are normally sold at a Cap Rate in the range of 3% to 6% or, very rarely, 7%. But, what does that mean? I told all of you numerous times that I was a practicing CPA for over 50 years before becoming a Realtor and I was an Associate Professor of Accounting for 6 1/2 years as well. What you did not know is that in 1968 - 1969 I was a High School teacher who taught bookkeeping, commercial law, and ALGEBRA!!! So, let’s talk about Cap Rates in an algebraic sense!!!

 When you have a Cap Rate of 5% what you are doing is taking the Net Operating Income and multiplying it by 20 to arrive at the value of the building, 100/5=20. If your Cap Rate is 12% you take the NOI and multiply it by 8.333 times, 100/12=8.333. So the Cap Rate is an NOI multiplier just like you can also value an Apartment Building by multiplying the rent by a factor and that is called the Gross Rent Multiplier or GRM. But, now that I've gone over all of this, I consider it meaningless!!! But, Realtors love this stuff!!!

In Southern California, we get much higher rents than the rest of the United States yielding a higher NOI. Then you have to look at the ownership of an Apartment Building as a BUSINESS and that point is soooo important!!! If you have a higher NOI than you can pay more debt service and still come up with a reasonable return on your investment (ROI). In El Paso, Texas, North Carolina and Albany, Georgia the rents are substantially lower than in Los Angeles (by multiples) so the NOI is much lower and debt service and, therefore, the price of the Apartment building, has to be so much lower to make the return on investment reasonable. The valuation of an Apartment Building has little to do with Cap Rates and everything to do with Return on Investment!!!

 So, when I read the following passage on Facebook the other day, "Someone asked me the other day to find them a property with a 10 cap. I said I can do better. I can get you a 12 cap property, in Wyoming. The problem is the building is half full and the population has almost dropped by half as well. How does your 10-12 cap sound now?" It just meant that you will not get a decent return on investment with the current NOI so don't pay so much for the Apartment Building!!!

Conclusion:

Now, I've walked you through just about all the reasons why it is a good decision to buy and build Multifamily Housing in Southern California and I also hope that I have given you other ways to look at Commercial Real Estate. But, there are more reasons and I'll just name a few here.

 The weather is conducive to building a medium to large Multifamily Complex in 3 years where in Boston, for example, with the harsh winters, it takes about 5 years to build that same building. Time is money and interest accrues every day!!!

 The appreciation is better here than in most of our country. When I was writing about "Net Operating Income" and "Return on Investment" yesterday I never mentioned appreciation. With higher rents and the upgrading of our communities that are going on here, you have a decent, if not really good return on investment on the cash flow alone but then you have to consider appreciation. We have one of the highest, if not the highest, appreciation rate in the country, and when you take 3% of a higher number your result is higher appreciation, as a percentage and as an absolute amount, than just about anywhere else in the country.

Someone wrote to me and put it as a comment to my article that there are drawbacks in owning Multifamily Housing in Southern California and a few of his points were somewhat valid like rent control and other rental restrictions. But, you will have those problems anywhere in the country at some point in time and I consider those obstacles a challenge to overcome just like I considered the Internal Revenue Code a challenge to solve that brought out my creativity when I was a practicing Certified Public Accountant for over 50 years!

So, owning Multifamily Housing or Apartment Buildings in Southern California is not such a bad idea even with our higher prices. Your return on investment is better as is your appreciation. And, when you consider the tax advantages and add them to your cash on cash return on investment, you just about cannot lose by investing here. And, by the way, the photo associated with my post today is my model for Multifamily Housing in Southern California with retail on the ground floor and apartments above.

My name is PAUL LEVINE and I am a Commercial Realtor specializing in Multifamily Housing in Southern California. I can be reached just about anytime at (818) 298-4000 or at "PLevineRealtor@gmail.com". I work with investors and with other Realtors who want to get into the Multifamily Real Estate Market. My credentials are unique and my passion is unsurpassed!!!