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Published: February 01, 2008

By Amanda Nagler, Coldwell Banker Commercial WESTMAC

Driven by the city's attractions and overall beauty, Los Angeles is renowned for its constant population growth and continuous influx of new residents. In fact, over the last few years, the market has added thousands of new residents and even greater gains are anticipated between 2008 and 2010. The LA market also experienced employment growth in 2007 (albeit slight), which has helped to maintain these current population increases. What continues to fuel the local Los Angeles apartment market is that a good portion of these new residents seek out rental units instead of purchasing the area's costly homes.

Currently, the Los Angeles apartment market is ranked sixth nationwide, up three spaces from 2007, according to a recent report from NAI Global, a network of independent commercial real estate firms. The market's high housing prices (particularly when compared to the rest of the country) and the overall national housing market crisis (housing sales have dropped substantially throughout the entire state of California, with an overall 36 percent decrease in 2007) are causing the continued high demand for rental units.

While the housing crisis is severely affecting the overall national and state economy, it is actually benefiting investors in apartment buildings in Southern California. Along with the influx of new residents, existing residents priced out of the Los Angeles market or who have experienced foreclosure are now renters again. Apartment building owners are seeing the Net Operating Incomes (NOI) of their properties increase as rental rates increase with demand. This has caused investors to continue to see LA as a safe investment choice for apartment buildings and investors should remain "on the hunt" for securing LA apartment properties in 2008 due to the expected continued upside in the market.

Generally, Los Angeles has been a very tight rental market with low vacancy rates. According to commercial real estate industry market data company Reis, LA showed a low 3.5 percent vacancy rate in their most recent report covering Q3 2007 and those numbers are expected to decrease further in the coming year. However, what remains especially tight are the Class B and C properties due to overall affordability of these units vs. luxury Class A rental units.

The overall value of an investment of a standard B/C apartment building in Los Angeles remains excellent as the national market is going through a period of change. According to Costar findings, the average price per unit of older rent control properties built prior to 1979 in Hollywood and Silverlake (an area of huge growth and appreciation in the past five years), is roughly $125,000 in 2007. While the volume of deals closed has dropped, the price per unit has remained relatively flat. Likewise, in Santa Monica, a prime area of historically high demand and high prices, the volume of transactions has dropped but values are even up slightly and averaging a high $243,000 per unit. Again, the fundamentals continue to support the product and fuel the projected upside.

On the other end of the spectrum, there has been an increase in Class A rental product, which is emerging from two sources: new luxury apartment construction and condo units transitioning into rental units due to the housing crisis. Most recently, unfinished or not-yet-started condo developments and condo conversion plays are the two types of investment products that are suffering the most in LA as developers and converters are unable to obtain financing for projects purchased before the housing market crisis was identified. In fact, both of these areas have almost halted completely opening doors for apartment developers as banks remain comfortable financing new apartment projects and sales transactions due to strong Southern Californian rental fundamentals.

Construction of rental units remains up at 4 percent. In fact, according to a recent Marcus and Millichap research report, there are 4,700 new apartment units slated for construction in 2008. Generally, these new units are luxury products and are being constructed anywhere from Santa Monica to downtown Los Angeles. Historically less affluent areas are experiencing gentrification and builders are projecting rental rates comparable to affluent areas such as Santa Monica with these new high-end products. It remains to be seen if these projected rates of over $3.50 per square foot will be achieved in some of these growing areas. Regardless, this will create even more competition for B and C class properties.

High demand of rental units feeds the city's on-going struggle with housing affordability in Los Angeles. One of the solutions city officials are implementing is the requirement of minimum affordable apartment and condominium units in new developments. While requiring affordable housing in new developments helps lower-income residents, the requirement has decreased overall land values. Unfortunately, sellers have yet to adjust their pricing expectations on their land which is starting to thwart further development. Land is hard to come by in LA, as it is mainly an infill development market, so high values prohibit developers from doing their job, furthering the affordability and housing availability problem.

Because of high demand for apartments stemming from the above factors, rental rates are expected to continue to grow across the board in 2008. Reis has tracked and reported a 2007 YTD average of 1.3 percent growth in rental increases in LA but that number is projected to be over 6 percent in one year's time. Anecdotally, Coldwell Banker Commercial WESTMAC has seen average asking rents at just over $1,500 per month, up from previous years and confirms the LA trend of increased rental rates from year to year.

On the flipside, to the affordability crisis, the two areas of Hollywood and downtown LA, neighborhoods that have historically battled high crime rates and other negative factors have experienced huge appreciation and popularity in this housing surge. Downtown Los Angeles, for example, is the home of one of the largest developments in the city's history called The Grand Avenue Project. This project, coupled with the LA Live Project by the Staples Center, will eventually support the several thousand new rental and condo units built downtown in the past five years. The Grand Avenue project is a $3-billion plan to remake the Grand Avenue area into an LA city center that will include a large park. LA Live is currently under construction with the first phase complete. Adjacent to the Staples Center arena, LA Live will feature a six-block entertainment destination with theaters, restaurants, broadcast studios, luxury high-rise hotels and residential units.

The Hollywood market growth is being led by four major developments that are breaking ground in 2008 or are underway. At the famous Hollywood and Vine intersection, there is a five-star W Hotel and Residences being built by Gatehouse Capital Corp. Adding to that growth is Legacy Partner's high-rise luxury apartment project next door.Clarett Group is planning Blvd6200, a $400-million, mixed-use project down the street involving 1,000 new apartments, retail and dining venues. Additionally, a 20-plus-story mixed-use project is in advanced planning for Sunset Boulevard, across from the famous Sunset Gower Studios.

With ideal weather, nearby beaches and mountains and a hot restaurant scene, Los Angeles is a place of immense overall upside. Major developments in once-forgotten areas are testaments to its popularity. While 2008 will likely be a year of transition due to rate cuts and uncertainty that comes with a presidential election, LA's apartment market will stay strong.

Amanda Nagler is a commercial real estate broker specializing in
multifamily at Coldwell Banker
Commercial WESTMAC in L.A.
1515 S. Sepulveda Blvd.
L.A, CA 90025 (310) 478-7700 nagler@westmac.com

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