The Real O.C.

Those lucky enough to hold Orange County multifamily real estate know that times are good. Investors and renters want what Orange County owners have: rising rents, high returns, and equity that's growing at a rapid pace.

Compared to the overall Southern California market, Orange County is small but valuable. In 2004, just 4,300 units traded hands compared to 24,000 units in Los Angeles and 8,500 units in the Inland Empire. The O.C.'s average sale price of $138,217 per unit, however, surpassed Los Angeles and the Inland Empire by $18,093 and $43,775 per unit, respectively. Occupancy also rarely dips below 95 percent, regardless of whether the property is oceanfront or inland, Class A, B, or C. On the sales side, listings are experiencing multiple buyers, offers, and counteroffers, in part because of tremendous support from lenders.

COASTAL COUNTY: Its 42 miles of waterfront land, low crime rate, and healthy multifamily market make Orange County a prime pick for investors.

“Just as investors are eager to invest in Orange County apartments, lenders are equally eager to lend on them,” says David Susank, vice president in the Irvine office of Johnson Capital, a national real estate capital advisory firm based in Irvine, Calif. “The perceived risk of lending on apartments in Orange County is low relative to other property types and other markets. Apartments in general have fewer delinquencies and defaults than other property types. This, coupled with the strong real estate fundamentals in Orange County, fuels the intense demand we see from lenders and investors.”

Still, multifamily transaction volume dipped in 2004, when many people were essentially in a holding pattern with their assets for a few reasons, including the presidential election and speculation that interest rates might make a big jump.

Ocean Views

Though the high cost of coastal properties can favor the larger buyer, the friendly lending environment in Orange County has helped all levels of investors enter this multifamily sub-market, which features 42 miles of waterfront land—the jewel in Orange County's multifamily crown.

The coast represents the overall best product, highest rents, and most attractive quality of life. Renters who can't afford their own home are more than willing to pay the $1,400 per month required for a Class A studio apartment one mile from the beach.

“If we had our choice, we would always buy coastal because people are always going to want to live there. The problem is that there are just not very many of those deals to be had,” says Aaron Pacillio, acquisition manager for Pacific Property Co., a strategic investment firm that since 1998 has acquired approximately $1 billion along the Pacific Coast, virtually all value-added properties. “In any given year in Orange County, maybe one or two large deals over 75 units will be coastal.”

In Line for Irvine

Irvine has its own corporate base and has been building amenities to become one of Orange County's most attractive live/work/play environments. It has also become a hot spot for new amenity-packed luxury multifamily projects.

One such development is The Plaza-Irvine, a joint venture between Opus West and Geoffrey H. Edmunds & Associates and the first high-rise condominium project for the Irvine/Newport Beach area. The Plaza-Irvine will total two 15-story towers at the corner of Jamboree Boulevard and Campus Drive by late 2006. Each tower will have 101 for-sale luxury condominiums ranging from approximately 1,100 to 4,300 square feet.

“This is a whole new product for the marketplace that evolved along with the area's housing demand and lifestyle requirements,” says Paul Marshall, Opus West's senior vice president of real estate development in Southern California. Since releasing units at The Plaza-Irvine, Marshall reports they have secured 80 buyers.

“This is the kind of place that people want to live,” he says. “From an investment perspective, it is also a fabulous place to hold property for the long term. Capital wants to be invested in dynamic, well-diversified, and insulated markets. Irvine represents all of these.”

Watermarke Apartments and Townhomes is also in Irvine's airport area. The project started delivering an inventory of 535 units in early 2003. Floor plans range from 620-square-foot studios to 1,500-square-foot three-bedroom units and two-story townhomes.

Average rents in Irvine sit at $1,200 for a one-bedroom, one-bath unit and $2,200 for a two-bedroom, two-bath unit. One-bedroom units at the Watermarke start at a $300,000 purchase price. A condo at The Plaza-Irvine starts at $500,000 and can top $3 million. In terms of trade activity and volume, however, Irvine cannot compete with central Orange County.

Center of the O.C.

FRENCH COUNTRY: Bordeaux, a 200-unit multifamily community in Newport Beach, Calif., was developed by Irvine Company Apartment Communities.

The dense central cities of Anaheim and Santa Ana, and close neighbors Garden Grove and Buena Park, are leading the Orange County multifamily investment pack. These are the built-out cities that surround giant demand-generators such as Disneyland and California Adventure. The majority of their housing demand comes from service workers—a group that accounts for more than 30 percent of Orange County's 1.5 million-plus civilian employees, according to the 2001 Census. This equates to tens of thousands of employees in the central county who, by economic necessity, must live close to their jobs. Renter competition for the area's mostly 1950s- and '60s-built B and C multi-family product is off the charts.

In Garden Grove, Pacific Property Co. just purchased Rancho Valencia, a 245-unit, Class B apartment complex built in 1969, for $37.5 million. The average 1,000-square-foot units make the one- and two-story project a unique low-density property for the market.

“Garden Grove has been at about 98 percent occupancy for the last six months,” says Pacillio. “After completing a minor repositioning at the project, we increased rents from around $1,120 to about $1,250 per month. This would normally drive occupancy down about 10 percent, but here we've seen almost no resistance.” In Orange County, where the average home price is $600,000-plus, only about 10 percent to 20 percent of its residents can afford to buy a home, Pacillio says.

For an average Class B apartment in downtown Anaheim, an investor can expect to achieve around $1,100 per month in rent. In the investment market, these units are trading at $140,000 per unit and at a 5.75 percent cap rate.

Nearby Santa Ana is experiencing similar success, gaining momentum from Anaheim and by way of its own bullish development. Overall vacancy in Santa Ana sits at 3 percent, and its value build-up is strong at an average of $130,000 per unit today, compared with $60,000 per unit just five years ago.

One of the most recent development highlights in Santa Ana has been Santiago Street Lofts, a transit-oriented live/work community that will provide ground-level work space topped with two stories of residential lofts. The 108 units range in size from 1,500 to 2,200 square feet. Among other amenities, the project is located next to the Santa Ana Train Depot. Developers Lennar and Urban+West+ Strategies expect to complete the project this year; individual units went up for sale at the end of March.

Looking South

Like the coast, southern Orange County along the Interstate 5 corridor follows its own investment pace. The area has some room for new development and vacancies can fluctuate. As new projects come on-line and wait to be absorbed, vacancy rates can go as high as 5 percent. New construction also has pushed the average price-per-unit to $185,000, slightly higher than Anaheim and other mid-market areas in Orange County. The average monthly rent in the submarket is $1,250 for a standard two-bedroom unit.

Home to Walt Disney Company, Boeing, Albertson's, St. Joseph Health Systems, nine beaches, 35,000 acres of regional parkland, and world-renowned retail center South Coast Plaza.

Southern Orange County is also more closely tied to San Diego, which worries some. “The condo conversion market in Orange County is heating up, and we may be following San Diego's trend,” says Susank. “I am beginning to see lenders shy away from condo conversion opportunities in secondary and tertiary submarkets of San Diego because of concern that the market has saturated. Absorption in these outlying locations has slowed in recent months.”

The initial stages of an Orange County condo conversion phenomenon wouldn't tarnish fundamentals too terribly. On the upside, conversions will have a good value composition against the median O.C. home sale price of nearly $600,000. Conversions also will be more competitively priced than new construction units at projects like The Plaza-Irvine and Watermarke. On the downside, converters care little about cap rates as they relate to operating expenses, a reality that has driven cap rates on many San Diego apartment deals down to an average of 4 percent.

Orange County Options

That said, investors continue to flock to Orange County, where value, rents, and occupancy are still rising and capital is still cheap and liquid. One of the only falling figures in Orange County, in fact, is cap rates, down from 6.23 percent at 2003's end to 5.33 percent one year later. The wild card is what will come next.

“It's not hard to imagine some fairly significant increases in the yield of the 10-year treasury over the next 12 to 24 months,” says Susank. “If we don't see commensurate rent growth, there could be issues going forward relating to refinancing balloon payments.”

Pacillio believes that if rents increase by somewhere around 6 percent or higher, investors could potentially make up for cap rate erosions over a several-year period and still have a valuable Southern California investment property. His company is now under contract on one of Orange County's biggest deals this year—a repositioning property that, even without the company's planned physical improvements, achieved more than 6 percent rent growth during the last 12 months. “That is almost unheard of anywhere in the country, but it is happening in Orange County,” Pacillio says. “That's why investors want to be here.”

It was hard for most to get there in 2004. Between the election, the war, deficits, terrorism, and rising interest rates, many Orange County investors were in a “wait and see” mindset, and the volume of multifamily transactions above $1 million fell to almost half what it was in 2003. Last year, just 176 deals closed on a total of 4,356 units for a value of $602 million.

In contrast, 2003 recorded 240 apartment transactions above $1 million representing 9,332 units and a value of nearly $1.2 billion.

Transaction activity should increase in 2005 to about the $800 million mark and largely among B and C complexes as sellers emerge from their holding pattern. In today's market, owners need to look at what they own, how long they want to hold it, and what their options are for the long term.

Some in this scenario have chosen to sell while others hold tight, asking themselves, “What would I reinvest in if I did sell?” Those that sell and leave the market have great opportunity in areas where buy-in prices are lower and cap rates are higher.

But those unwilling to leave have a few options: Make a significant down payment on a local multifamily exchange product (under the premise that they will be holding a scarce product with stable rent upside over the long term), or trade into another local product type. In terms of cap rates, retail is Orange County's single most improved product, falling to a 6.6 percent cap rate at the end of 2004 from 7.8 percent at the same time in 2003. Industrial currently averages mid-7 percent and office almost 8 percent, in terms of cap rates, with some upside in vacancies that can be filled and improve the property's value.

“The Orange County multifamily market is booming not only because of its innate strength, but because of a lack of alternative investments,” says Susank. “Though some investors are willing to sell and leave the market, the returns for those who remain still look better than just about any non-real estate investment out there.”

–Shane Shafer is a senior advisor for Sperry Van Ness in Irvine.

–John McDermott is a senior vice president for Sperry Van Ness responsible for overseeing the firm's Irvine, San Diego, and Long Beach offices.

An application process leads to a near-riot.

Bill Harris thought he was doing the right thing for the Hollywood Community Housing Corp., an affordable housing developer in Hollywood, Calif. As the group's executive director, Harris wanted to limit the number of general applications for his newest housing project on La Miranda Avenue so that the development could include as many groups as possible from the diverse community. Little did he know that his approach would almost lead to a riot.

Harris handed 400 applications to members of each of the area's ethnic groups and then held 150 for the general population. On the morning of general distribution, the line formed early, and as the day progressed, the crowd got bigger. Eventually, 3,000 people gathered, pushing and elbowing for one of the 150 applications. “We had police [officers] and police helicopters,” Harris says. “There was some shoving and people got a little excited. Eventually, the police decided people would get hurt and they shut it down.”

Harris chose to disperse the remaining applications a week later at another location, with help from police, and that went smoothly. Still, he can't shake the memory of the first application day. “It speaks to the area's lack of affordable housing,” he says. “It's extremely unfortunate when you see older people competing with younger people for application. Folks aren't always respectful when that many people get together.” —Les Shaver

The apartment market improves in the first quarter. Could rents be far behind?

The apartment market is looking better and better, according to the NMHC's quarterly market tightness index.

In April, the index—which is gauged using feedback from industry executives commenting on vacancy rates and rental fees in their areas—hit 78 out of 100. That's up 13 points from January 2005, when the same index registered 65. (A reading above 50 suggests that U.S. markets are getting tighter, with higher rents and lower vacancy rates, while figures below 50 point to more vacancies and lower rents.)

“We began to gain jobs again in 2004, and I think that's the backdrop to the improvement,” says Mark Obrinsky, chief economist for the NMHC in Washington, D.C., which uses the index to assess the overall health of the apartment rental market. “As people's employment prospects improve, they are more likely to go out” and rent a place to live.

Obrinsky's observations align with those of Julie Smith, president of Bozzuto Management Co. in Greenbelt, Md. “The best sub-markets are those that have benefited from the strong job growth in our region as well as those that have experienced escalating home prices,” notes Smith. “We are seeing very high occupancy rates and opportunities to increase rents just about everywhere right now.” —Amy Rogers Nazarov