LOS ANGELES—Cap rates are compressing, prices are up and competition is high, but value-add investors are still staying extremely active in this market; however, the supply/demand imbalance in Los Angeles is also fueling major multifamily development in markets throughout the city. The question of value-add investors competing with new construction product came up during an interview about MWest Holdings' recent acquisition of Emerald Terrace in Koreatown. According to Joe Leon, a JLL managing director that brokered the deal, value-add is unique positioned to compete with new construction because they can withstand lower rental rates and are better positioned to hold through a downturn.

"Because that supply is all class-A or double-A or triple-A luxury product, the rent levels will be significantly higher than our post renovation value-add rents," Leon tells GlobeSt.com. "That is really the value-add proposition. These buildings are for people who want to live in that area and don't want to pay those class-A rents or just can't pay those rents. Value-add is the perfect alternative for that, because you'll still get beautiful units and amenities." According to his research team, value-add units in that market have a $300 to $500 delta in rental rates compared to new construction product. As a result, value-add investors, most of which are getting long-term, 10-year debt, are well equipped to compete when that new product comes online.

Leon also notes the small average unit size of older, renovated units, as another advantage. Using the Vermont as an example, which was actually new construction product, he explains that the smaller unit size brought down the final rental rate, making it more attractive. "That is when smaller units actually become an advantage," he says. "We found that in the Vermont, where the average unit size is 775 square feet, unlike some of the newer product that is 1,200 square feet, and we were more affordable. We were class-A; we were high-rise; we were luxury, but our rents were significantly cheaper. It is a much better value to the renter. It is the same thing with Emerald Terrace. It is going to be a fully renovated and beautiful project when they are done with it." 

However, Leon also says that it might not be a matter of competition. Los Angeles has such a shortage of housing and a high demand, he believes that both value-add investors and developers won't have problems with occupancy. "I think on the big picture side, with occupancies at 97% and 98% in general in Los Angeles, we can handle the supply," says Leon. "The demand is there and the jobs are there. A property like this is going to be perfectly positioned, and yet we are still a value. Most of the buyers are putting on seven to ten year debt, and it is so favorable and so inexpensive that we probably want to go longer term because we are only going to go up from here. That also allows you to weather a cycle because you don't have any debt coming due. The class-A properties might get hurt when you have that much supply coming online. Value-add will be the product that will fair very well because it is more affordable."