Entitlement Process Adds Risk to MF Development

LOS ANGELES—The multifamily sector is still going strong and rent growth is accelerating, but developers should still exercise caution, said speakers at last week's RealShare Los Angeles' “Multifamily Momentum” panel. Overzealous development in a high-land-price market could lead to developers not achieving the returns they had hoped for, the speakers said.

Moderator Mike Rovner, president of Mike Rovner Construction Inc., said there's lots of demand, but not much supply in the multifamily market. He had the panelists present case studies of multifamily properties they had developed, which ranged from redeveloping a property to make it feel like new to renovating according to workforce rents to creating mixed-use projects.

David Nagel, president and CEO of Decron Propreties Corp., said his firm's goal is to take a class-B property and turn it into an A- with the use of lighting fixtures, finishes and amenities such as gyms. “If we can provide the L.A. Fitness experience, we can raise rents and achieve a healthy ROI of 15%. With that, if you're raising your rent by 25%, you're turning over your entire tenant roster; maybe 10% will stay, but the rest are all new.

Robert Hart, president & CEO of TruAmerica Multifamily, on the other hand, develops workforce housing. “My philosophy in workforce housing is to renovate according to workforce rents.” He said working through tax-increment financing issues is part of the game.

Bill Cockrum, CIO of Genton Property Group, said long lead times stemming from long entitlement processes are one of the risks of multifamily development in L.A. “It's hard to develop anything in South Pasadena. We're figuring out how we can add value, and we've developed a relationship with the City. We are trying to find unique niches rather than broad strategies,” including a Four Seasons-brand for-sale tower in L.A., he said.

Jason Pendergist, chief lending officer for Luther Burbank Savings, said the lessons he learned from the last cycle are that lenders must understand their customers, their business plans and their motivation for building in a particular location, such as commute times and school districts. “We as lenders need to understand all of you as developers. We ask a lot of questions, but it's for a reason—we don't want to partner with the wrong deal.”

Rovner asked Pendergist for his interest-rate prediction over the next couple of years, and Pendergist said he echoes Ethan Penner, chairman of Mosaic Real Estate Partners, from the “View From the Top” panel, who said he doesn't see a huge rate increase and that interest rates will be low for a long time.

When asked where we are in the multifamily cycle, Nagel said rent growth seems to be growing and that Southern California is earlier in the cycle and hasn't recovered as much as Northern California. “We still have a few innings left. We're buying at mid-4%s, and we need to buy at mid-6%s. Hart said he is seeing more rational returns, and Cockrum said we are at mid-cycle. “The supply side depends on the market. The capital markets have tremendous sources of capital, both debt and equity. It feels a little nervous, but there's room to run and it still feels healthy. We capitalize so we can withstand adversity.”

Steve Erdman, president of Canfield Development Inc., said that land prices are rising, so new development may not get the returns they want. “They need to get $2.50 to $3 per square foot in rent, but how much can rent grow and how much can people afford? You need to be a little cautious.” Rovner added that high-liquidity contractors are in high demand, which drives up prices.

Rovner asked the panelists for their concerns for this sector, and Pendergist mentioned the looming student-loan debt, which is second only to housing debt. “Nearly half of all student loans are deferred in some way, and there's a 23% delinquency. The good news is that each loan only averages about $25,000, which is like the cost of a car. It should be payable because these graduates are now employable.”

Hart pointed out that we need to see some wage growth in order to see very high demand for housing, and Nagel said, “I worry about what I don't know.”