Many major Western metros haven’t seen a concentration of development recently. With lower interest rates and compressed cap rates, these areas now offer ripe opportunities for developers to look at a project with a fresh lens.
By Marty Friedemann, Vice President, Senior Underwriter with Parkview Financial
Many of the most creative multifamily developments that Parkview has underwritten lately have been from developers looking at product or areas that are often overlooked. They continue to demonstrate time and time again that there is always opportunity even in the seemingly unlikeliest of places as long as one searches. One developer may move further away from the central business district, while another looks to redevelop an outdated project into something that fits modern needs, and yet another uses innovative financial solutions to overcome challenges and to keep its development pipeline in an acceleration mode.
Perhaps the most common way to find opportunity is to go where others aren’t looking. In Los Angeles, the geographic band from downtown Los Angeles to Santa Monica has been very active while in the past it was largely disregarded. Recently, developers have taken a strong interest in moving south of the 10 freeway in Los Angeles. For example, mega projects such as Sofi Stadium and the redevelopment of the Baldwin Hills Crenshaw Mall have recently made news headlines. Smaller apartment projects are starting to spring up as well in the area, despite the fact that these are communities that haven’t seen widespread for-market development since the 50s. The market fundamentals are there. The surrounding communities of Culver City, West Adams and Jefferson Park are hot beds of activity, with new restaurants and new multifamily developments starting to break ground.
With that said, Parkview closed on a $29 million construction loan for 4242 Crenshaw. The project is a mixed-use property comprising 124-units of multifamily with 93,640 rentable square feet and 6,000 square feet of ground-floor retail in the Leimert Park neighborhood of south Los Angeles. We triangulated value from the developments at high interest submarkets such as West Adams and Jefferson Park as well as the Sofi Stadium area to get comfortable that the Crenshaw project was going to increase in value in the future. The submarket rents are currently much lower than that of the average for Los Angeles, but that is because there has been so little development. When new development does occur, demand is high. In many ways, it is the high rents in the rest of Los Angeles that are driving demand into these often-neglected submarkets. But to go into an area like this requires vision and a willingness to stand out from the crowd. There were no direct comparables in the area and generations of developers have eluded building in Inglewood. That will change quickly though, as new projects big and small near completion.
As communities change, some properties in the area will need to be redeveloped to fit current market needs. For example, we have worked with a few developers who were able to buy outdated hotels or resorts and transition them into workforce housing. The exciting thing about this adaptive reuse product category, is that it is one of several ways to provide new market rate housing while simultaneously providing a solution that addresses the residential rental crises. The transition from a hotel to workforce housing is also relatively easy from a construction point of view. The hotels that are targeted for adaptive reuse are typically well-located and underutilized in their current forms. As rental rates continue to rise, more opportunities to reposition properties will make sense to developers, cities, and investors.
For the developers that aren’t willing to move out of their comfort zone geographically, we have seen a lot of interest in ground leases as a way to inject “equity” into a transaction. I am most familiar with ground leases being used either by government agencies to retain future rights to land while extracting value from it today or being used by triple-net landowners who lease their land to credit tenants. However, we at Parkview, have seen a new trend of this alternative form of ground lease being used to help borrowers buy multifamily development sites that are otherwise prohibitively expensive by allowing them to offer to buy the land at a negotiated percentage of the stabilized value of the project, and then lease the land back to the developer in return for a ground lease payment for 99 years. While this may sound complex, what it effectively means is that a developer can get 20 to 30 percent of a project’s stabilized value lent to them at competitive interest rates. The ground lease proceeds must be used to build the project and often times the loan documents look a lot like construction loans. While most developers would prefer to own their property as fee simple, this increasingly popular structure will enable previously non-feasible projects to be built.
Tenants are always price conscious, and they are usually willing to compromise on many things in order to get apartment rent that they can afford. There are still many areas of every major metro throughout the western states that have not seen a concentration of development recently. With lower interest rates and compressed cap rates, these areas now offer ripe opportunities for developers to look at a project with a fresh lens.
Western Real Estate Business
Vice President, Senior Underwriter