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LA Apartment Owners Want To Sell, But Offers Aren't Matching Expectations

Los Angeles’ multifamily market is seeing rising rents and dropping vacancy, but a number of factors from high interest rates to the city of LA’s looming tax on real estate transactions are adding uncertainty to the market and have the potential to have noticeable impacts on LA multifamily investment in 2023.

During a recent attempt to acquire a property in North Hollywood, New Standard Equities CEO Edward Ring, whose company buys, upgrades and operates apartment properties in California and in the Pacific Northwest, said he saw firsthand how some who are attempting to exit the market before Measure ULA, the city of LA’s new real estate sale tax, goes into effect are butting up against an uncertain market and a buyer pool that expects to get an urgency discount.

Los Angeles apartments

Measure ULA, which adds a 4% tax on real estate transfers over $5M and 5.5% on transfers over $10M, officially became law on Jan. 1, but doesn't start applying to transactions until April 1. Voters approved the tax in November.

Ring put an offer in for a North Hollywood property that hit the market because, he was told, the seller wanted to exit before the spring, when the transfer tax goes into effect. 

“Everyone swarmed on this one property, thinking it was going to be a deal,” Ring said of himself and the five or so other bidders. Instead, Ring said “we came up pretty short in terms of where we thought value would be.” 

He wasn’t the only one. Ring was told that the seller “found out where the market believes the values to be and has elected not to sell.” 

While Ring said he has seen this happen recently in other markets too — markets where Measure ULA doesn’t apply — he says with the pile-on of other variables already putting pressure on the multifamily market, it is certainly a factor. 

Sales volume was down 12.2% year-over-year in the third quarter of 2022, reaching $2.8B, a report from NAI Capital found. That figure was a 33% drop from the second quarter of 2022. NAI Capital chalked the drop up to the general economic uncertainty that has been the overarching theme of the last five quarters. LA County rents continue to rise and are expected to continue to grow but at a much slower pace than in the last couple of years, while vacancy dropped to about 3.4%.

From an investment sales perspective, there is definitely an interest on the part of apartment property owners to beat the clock and sell before the transfer tax goes into effect.

Northmarq Managing Director of Investment Sales Shane Shafer, who is based in the company’s greater LA office, says while it’s too early to really see the breadth of the effects of the tax on sales, he’s anticipating that sellers that had earmarked buildings to sell at some point in 2023 will now look to sell in the first quarter. 

“Those discussions are going to happen over the next week or so,” Shafer said. 

CBRE Executive Vice President Dean Zander said that he’s actively working with several owners that are in talks to sell their properties to nonprofits. One of the exceptions to the tax is for sales to some nonprofits, government groups and housing organizations. 

In total, Zander estimated that his team is actively working on about half a dozen transactions where Measure ULA was a factor in the sale, and in the underwriting phase on “another couple dozen.” 

Perhaps the most dominant pressure on the market is the rising cost of borrowing. Though Ring says that interest rates, from a historical perspective, are “not too terrible,” they’ve definitely impacted the way he does business. 

Ring, like other buyers, is using debt to acquire new properties. He says they used to assume 65% to 75% of purchase prices as debt, now they are underwriting closer to 50% or 55%, because the cost of borrowing is up. That shift means their equity returns are dropping, so their prices have to as well, Ring said. 

Ring says his offers on properties have come down substantially, as his company believes values are down around 15%. 

“That’s a direct result of interest rates,” Ring said. “We're also not winning anything, so maybe we've overcorrected.” 

Zander said that with interest rates up, it’s the time to shine for buyers who had previously taken a backseat. 

“Non-institutional buyers are becoming more aggressive now than they've ever been,” Zander said. “They're not relying as much on agency debt, they're looking at more relationship-based banking debt, and most of them are long-term owners that are looking to get in at a better basis.” 

From where he stands, the private capital, family office investor is becoming more successful in this challenging market and they were much more competitive in 2022 than they were in 2021, Zander said.