This article was posted on Tuesday, Oct 16, 2012

It’s the economy, stupid… (James Carville, 1992)

The National Economy
For the third consecutive year, the US economy remains stuck in a painfully slow recovery as a series of issues quell economic growth and business optimism. A global economy in tatters, unemployment rising to 8.3% last month (the latest jobs data on individual states saw an increase in unemployment rates in 44 states, with only 2 enjoying a decrease), election year fiscal politics and an increasing number of weakening economic indicators converged as the perfect storm to stall and impede economic growth and further erode business and consumer confidence. In addition, the U.S. faces a “fiscal cliff” as many policies sunset this year. These policies include the “Bush tax cuts”, as well as rates on estate and capital gains taxes and the alternative minimum tax (AMT) that will automatically apply to millions more citizens. The Congressional Budget Office has warned that the economy could potentially go into another bad recession if Washington fails to intervene in a timely fashion.
The UCLA Anderson forecast (June 2012) predicts US GDP and job formation will remain weak in the near-term, mirroring conditions that have prevailed for the last two years. The report also notes that poor workforce development and the inferior quality of our educational system is seen as a major contributor to slow growth. Further, in each of the previous 20 recessions, GDP returned to its previous peak within two years. A recovery with exceptional GDP growth requires greater-than-normal employment growth. Given current lags the report states, this recession could take 7 or 8 years.
So where are the jobs?  It’s the economy, stupid, again…

The California Economy
The California unemployment rate An Exit Strategy That Defers Tax Liability and Increases Cash Flow
by Anne Baber, Investment Real Estate Broker
(still the third highest rate in the nation) held steady at 10.7% in July with 25,000 jobs added.  Los Angeles County’s jobless rate also remained at 11.2%, although private sector employment fell by 25,000 jobs. The combined San Bernardino/Riverside counties suffered a double hit, with unemployment jumping to 12.7% in July with 17,600 jobs lost. On a more positive note is that year over year we added 365,100 jobs in California; not nearly enough jobs, but at least we are in positive territory.
The UCLA Anderson current forecast is for continued slow, steadied gains in employment through 2012. The unemployment rate will linger around 10.6% through 2012 and average 9.7% in 2013. The unemployment rate is expected to drop to an average of 8.3% in 2014.
With our State finances in the red and Governor “Moonbeam” Brown and the State legislature forging ahead with the high-speed (questionable) rail to nowhere, it is interesting to note the conclusions of an essay titled “California High-speed rail and Economic Lessons from Japan”. The authors, Nickelsburg and Ahluwalia (economist with the UCLA Anderson) conclude that “there may be good reason to invest in CHSRL, including the possibility that CHSRL is the optimal infrastructure investment for a growing population; but the economic argument – the jobs argument – does not seem to stand on solid ground.” So where are the jobs? It’s the economy, stupid, again…

The National Apartment Market
One bright spot in our economy is that the nations apartment rentals are once again expected to be the best-performing commercial sector. For the third year in a row, absorption of existing units is far outpacing completions of new units. As a result, vacancies continue to drop and rental rates continue to rise. Vacancy rates peaked in early 2010 at 8% and dropped to a healthy 5.4% in 2011. The vacancy rate for the second quarter of 2012 measured 4.7% representing a 20-basis point decline from the last quarter. Effective rents across most markets now meet or exceed their prior peaks.
The outlook for the multi-family market seems quite positive, as tenant demand appears likely to continue driven by the unbundling of households that doubled up, continued weakness in the for-sale housing market, and the huge Echo Boomer generation just entering their peak renter-household-formation years of their 20s and 30s. Even as new construction ramps up, the strong and increasing demand for apartment residences still will outstrip supply.

The Los Angeles County Multi-Family Market
Locally, the multi-family market continues to improve and is headed in the right direction. The bottom of the market was during the middle of 2009, as clearly illustrated in the Trend Report below. Since that time, the number of transactions has steadily increased and the dollar volume of those transactions has trended higher.  Since the second half of 2009, the cap rates have trended downward and the Gross Rent Multipliers (GRM) have remained above the 2009 levels (see chart below).

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Source: CoStar, Inc
(The Copyright report contains research licensed to AOA Commercial Brokerage)

The multi-family market recovery is “top-down”, i.e., there is a market divergence between the quality of assets. The market has firmed up for class “A” and “B+” larger assets in better markets. The cap rates are decreasing and real prices (cost per unit) have increased. However, class “C” and smaller assets cap rates are still flat to deteriorating,
especially in tertiary markets. As anticipated, the demand for Class “B” assets has increased and will continue to do so for the near future.

Co-Owned Investments Post-Recession
Co-Owned properties include Tenant-in-Common (TIC’s) and Delaware Statutory Trusts (DST’s). While no sector of the Real Estate industry is recession proof, the Co-Owned properties (under SEC regulations) appears to have weathered the storm better than expected.  This is due in part to the historically low loan to value ratio (LTV) of 50%-60%, the transparent/comprehensive due diligence performed by both Sponsors and Lenders prior to purchase, experienced professional management, and the institutional quality of the properties.  However, some asset types are fairing better than others – i.e., multi-family and single tenant properties.
As mentioned previously, the multi-family sector has been far more resilient and in far better shape in terms of fundamentals than any other asset type – particularly office and retail and even industrial. The financing options are more favorable for multi-family properties than most other sectors in commercial real estate. That is because the industry is buoyed by Fannie Mae and Freddie Mac, which provide liquidity to the housing market.  The apartment sector has always been viewed by lenders as having less risk than commercial retail or office properties.
While there are fewer Co-Owned offerings on market than in past years, they are perhaps more attractive with respect to their financials; higher CAP rates and cash flow (average 6.5%).  Also, because of the current lending environment, the properties are scrutinized closer than in previous years and the underwriting requirements have tightened.  In addition, the LTV ratios are lower than previous years at a ratio of 50%-55%.

Using the 1031 Exchange and Co-Owned Properties as a Retirement Vehicle
The good news is that while the market has turned downward, historically, the multi-family market values are still relatively high while interest rates remain at a fifty year low. And yes, there is financing available for multi-family properties. The process takes longer and the buyers must have good credit and financial strength.    If you are looking towards retirement, it is still an excellent time to sell, take advantage of the 1031 Exchange into Co-Owned Investments and position yourself for the next up-leg of the real estate cycle.
While the real estate market is cyclical, we are not in lockstep nationally and market fluctuations give us opportunities in various geographical areas that are better poised for growth. Some areas that have held with respect to multi-family are Texas, the Carolinas,  Colorado and the Mid-Atlantic region  to name a few.

Many economist and lenders believe that multi-family is well positioned for an early recovery ahead of other real estate sectors.  A significant portion of U.S. households will return to multi-family housing as renters due to stricter mortgage loan requirements and the decreasing availability of consumer mortgage financing. In addition, increasing demand for rental housing will come from the 5,000,000 €Echo Boomers€ entering the largest demographic of 18-24 year-olds in the US history.  Even as new construction of apartment buildings ramps up, the higher demand for apartment residences still outstrips new supply.  All of these factors imply that select segments of the US multi-family market are poised to capitalize on surging demand combined with still constrained new product beginning to come on line, ensuring that multi-family properties will be dramatically more valuable in 2016 than 2012!

Advantages of Co-Owned Properties
Flexible size to match your needs
Pre-arranged financing
No management hassles
Potential increased after tax cash flow
Economics of scale
Can be identified and closed in a timely manner
Investment can be diversified into more than one property and/or location

As a Co-Owner, one can reduce management responsibility, defer capital gains taxes, increase both cash flow and tax deductions, increase appreciation potential, have more safeguards with triple net, high-credit tenants and maintain direct ownership. The option of partial ownership gives buyers the opportunity to diversify their real estate holdings by purchasing interests in multiple properties and various geographical locations.  Co-Ownership can get you more while you do less. Accordingly, this arrangement can solve several problems for owners looking to make their lives less complicated.
Anne Baber is a real estate broker with the Apartment Owners Association, Commercial Brokerage Division and has over 20  years experience in apartment house brokerage.  She can be reached at (818) 235-1135 or [email protected].

Free Capital Gains Tax Planning
Seminar & Deli Luncheon
Hosted by Anne Baber of AOA Commercial Brokerage
(Principals only please; no real estate agents)

You Will Discover:
How to Use the 1031 as a Retirement Vehicle
A Proven Safety Net Mechanism for 1031 Exchanges
The Intricacies of How IRS Code Section 1031 Works
The Advantages of Co-Owned Properties (TIC & DST) Investments
An Easy Way to Get More Income While Doing Less Management


For the latest info seminar info, click here.

For reservations and further information please call Sarah Rojas at AOA Commercial Brokerage (818) 235-1127 or email [email protected].

Anne Baber is a real estate broker with the Apartment Owners Association, Commercial Brokerage Division and has 25+  years experience in apartment house brokerage.  She can be reached at (818) 235-1135 / [email protected].

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