Buying Outside of CA Is Trending
CRE at NAI with Sean Dreznin
By Carrie Rossenfeld | Orange County
An increasing number of multifamily property owners are seeing the value in selling their California-based properties and purchasing assets in other states. Brian Heller, senior advisor with Sperry Van Ness (Rich Investment Real Estate Partners), which is headquartered locally, tells GlobeSt.com that owners, particularly those in the Greater Los Angeles area who would normally be sellers, aren’t considering putting their properties on the block because they wouldn’t be able to find another in the area with which to replace it that would yield worthwhile returns.
“[Owners] aren’t motivated to sell because the current return landscape locally has been driven to 3% to 5% cap rates for class-A and -B properties,” says Heller. “It’s difficult to find a viable leg up when cap rates are so low.”
Rising interest rates are also working to lower the leveraged returns, making it even more challenging to justify the low cap rates in Los Angeles, says Heller. “A common theme I’m hearing from all my buyers is that properties in Los Angeles have gotten too expensive, and the returns do not make sense. They would rather sit on cash than pay for what they believe to be overpriced properties in L.A.”
As the market tightens, becoming more of a seller’s market with low inventory and lack of yield-generating assets, many of Heller’s clients are beginning to look out of state even if they aren’t in a 1031 exchange. “Over the past year, but even more so in the last three months, I’ve seen a dramatic increase among those who are selling their properties in Los Angeles and choosing to locate their 1031 exchange property out of state,” says Heller. “As a result, my team and I have been catering to clients’ requests to move money out of state to diversify their portfolio, but mostly to seek higher yields/returns.”
Out of state, it’s still possible to achieve returns in the 7% to 10% cap range, with even higher cash-on-cash returns, depending on leverage, Heller adds. “Even with the addition of management fees to one’s expenses, for a deal out of state that they could potentially manage if the property were owned locally, we are seeing that the immediate returns are still much higher. Because the client is getting much higher returns, they can justify management fees by offsetting them with lower expenses they are seeing out of state, along with the higher cash flows the building is generating.”
Another motivator for purchasing out of state is that buyers don’t want to get trapped in five years when they need to refinance. “So even if the numbers look good now, they have to keep an open mind to the future and what it holds,” says Heller. “If interest rates rise faster than rents can increase, which is very likely, when they go to refinance, the returns will no longer be favorable.”
In addition, buying at these levels becomes risky with cap-rate compression. “Moving forward, returns will need to be generated by rent increases,” says Heller. “If rents don’t increase, property values could go down if interest rates continue to rise.”
The most popular regions for investors to buy after selling their California-based properties are in the Sunbelt region: Texas (Austin, Dallas, San Antonio, Houston), Arizona (Phoenix/Scottsdale, Tucson), North Carolina, South Carolina, Georgia (Atlanta), New Mexico and Tennessee (Nashville). In fact, Heller says Phoenix and Las Vegas have begun to cool down in the last six months, while Texas is rising to the top.
Heller says he doesn’t believe this trend will negatively impact sellers here “because of the fact that most of the people buying here are new money. Our regular clients are finding the market so aggressively priced that almost every deal has new blood in the market. The regular names have gotten less active locally and are willing to look in areas where they weren’t before. The newer blood is looking to get that first property into their portfolio—they usually don’t have investors to report to.”