With Rates And Costs High, LA Multifamily Investors Shift From Ground‑Up To Preservation Plays

As interest rate concerns and a desire for stability come to the fore for multifamily developers and investors, many are turning away from development of new properties and toward the purchase of existing assets.

Prior to interest rates rising in 2022, Impact Housing was largely working in market-rate development, but when interest rates shifted, the company's strategy changed.

“We saw the deterioration of value on the market-rate side,” Impact Housing CEO and founder Drew Orenstein said at Bisnow’s Los Angeles Multifamily and Affordable Housing Summit on Thursday at the Omni Hotel and Resort Los Angeles. “As such, we made a big pivot to the affordable side.” 

Naturally occurring affordable housing is a popular focus among some investors because it is simpler to assemble funding for, according to Turner Impact Capital Managing Director and co-Head of Housing Brock Miller.

Turner Impact focuses on the segment of the market that encompasses housing that isn’t officially income-restricted but nevertheless rents at below-market rates.

There is also a need to buy and preserve these properties so they can continue to provide below-market-rate units for renters who need them. 

Investors who stuck to market-rate housing often pivoted their interest to focus on stabilized assets and away from new development, SDS Capital Group CEO Deborah La Franchi said. 

“There's a lot of sort of aversion to the new development direction right now, given the cost, given the interest rates,” La Franchi said. “There’s a lot more focus on preservation. Protecting the terms for the investors is sort of paramount right now versus trying to hit home runs.”

The undersupply of affordable housing across the country, combined with the glut of new construction that hit some of the nation’s hottest markets, has shifted the attention of many investors to some of the less financially complex segments of the affordable housing market, Cypress Equity Investments Vice President, Investments Shane Taugner said. 

“That's a reason why I think we've seen so much new capital forming around investing in these affordable strategies, especially in the sort of 80% to 120% of median income range, where the capital stacks tend to be more conventional, less public subsidy,” he said. 

Some owners and investors were concerned about the impact a development pause would have further down the road, especially in a region where housing development has historically not kept up with population growth. 

“It's great to preserve housing with welfare tax exemption deals and do [naturally occurring affordable housing] deals and everything, absolutely, but we need to build more housing,” Orenstein said. “It’s really the only way we're going to get out of the housing shortage.”

Orenstein said developers need to get comfortable with current conditions, including interest rates that stay flat, and figure out how to lower construction costs. That is where his firm is focusing now. 

“The thing that we realized is when things change, they don't necessarily ever go back to the way that they were, and counting on that is not a good strategy,” Orenstein said. 

Owners and investors are also coming to terms with flat rents. Average apartment rents in LA rose by just $5 year-over-year in the fourth quarter to $2,279 per month, according to Colliers.

La Franchi said that the returns will come to developers who can get them by keeping operating costs low and keeping asset management efficient. 

“The returns on real estate are not going to be coming from these 3% annual rent increases anymore,” La Franchi said. “Those nice days are sort of gone in many markets, and what we're seeing is just big challenges at the property management level across the country.”