The Los Angeles City Council adopted important renter safeguards on Friday, including one that establishes nationwide just-cause eviction provisions. As a result, the city’s apartment stock is now the second-largest collection of regulated housing in the nation.

 

February 1st, 2023 | Los Angeles, CA

 

The hearings over the last week have revealed that renters have more council allies than ever before and that this group is prepared to take action.

Two of the suggested safeguards have not yet been put to a formal vote, but one significant safeguard for tenants has. There are now only roughly 14 grounds for eviction of a tenant due to the development of just-cause safeguards for renters. These laws shall be applicable to all rentals in the City of Los Angeles, including single-family residences and newly constructed apartments, as indicated by the term “universal.” The new rule is now in effect because it was passed with an urgency clause.

These safeguards are comparable to those that presently apply to the estimated 650,000 rent-stabilized homes in the city, but according to the city’s housing authority, these new regulations will also apply to an additional 400,000 units. A housing department official informed the council on Friday that the city will have the largest inventory of controlled housing in the nation, excluding New York City, with more than 1 million units.

The lifting of the eviction moratorium has brought comfort to many landlords, albeit short-lived with this introduction of new limitations on how they can conduct business.

Aaron Cohen, Chief Operating Officer of CGI+ Real Estate Strategies, expressed excitement about the conclusion of the eviction moratorium at the end of January.

But according to Cohen, these additional renter protections that aim to mimic the impact of the eviction moratorium will put a cost on landlords that they shouldn’t have to bear.

“It was never the right solution to me, to say ‘Let’s force landlords to take the burden of this,’”  Cohen said.  “It doesn’t make any sense to me. ” He vehemently disagrees that landlords should be forced to arbitrarily bear this responsibility at random.

Cohen pointed out that even after the moratorium on evictions expires, tenants can only be evicted for failing to pay their current rent, not for any rent they owe during the time between 2020 and the end of the moratorium. Tenants have 12 months to make those payments.

Landlord Joyce Mitchell called into the council’s housing and homelessness committee meeting on Wednesday and stated, “We feel we have no representation with this city council.” She claims that small-property owners of color, like herself, stand to lose everything as a result of the eviction moratorium and additional laws since they have invested their retirement funds in their homes.

According to Mitchell, it’s past time to stop holding mom-and-pop apartment owners accountable for the fact that the city and county elected authorities have done nothing about the homeless epidemic in this community. Mitchell added, “We will be the next wave of homelessness in this city if you continue to treat us this way.”

Although Cohen said he doesn’t expect these new laws to have a significant impact on his firm, he does claim that they raise the cost of doing business in the city, which is counterproductive in a city where more affordable housing is desperately needed.

In contrast to essentially forcing landlords to accept the loss, Cohen urged municipal authorities to really go the route of figuring out ways that charitable organizations pay for unpaid rent in order to help property owners pay these outstanding debts.

The quarterly sentiment index published by the CRE Finance Council shows a significant increase in Q4 2022. This marks the first sentiment increase since 2021.

The report, which includes balance sheet and securitized lenders, loan and bond investors, private equity companies, debt funds, servicers, and rating agencies, found that overall sentiment climbed to 68.6 last quarter. From 61.4 in the third quarter, which was the lowest level since the survey’s start in 2017. The jump represents an increase of 12%.

Despite progress in the right direction, the index is still in the negative due to the ongoing anxiety surrounding inflation, rising interest rates, and an impending recession, according to analysts with the CRE Financial Council. In addition, lenders and investors may have more difficulties in the upcoming year due to the uncertainties surrounding property valuation.Individual survey response rates were flat to somewhat better, with the biggest gains in the following areas: investor demand for assets, borrower demand for capital, and market liquidity in the CRE debt capital markets.

According to Raj Aidasani, Senior Director of Research at CREFC, members’ expectations for improved liquidity conditions increased by 18% in the fourth quarter of 2022. In Q3, 62% of respondents predicted a decrease in liquidity, while only 8% predicted an increase. However, in Q4, 18% predict better conditions while 47% predict a decline.In addition, the rising rate environment continues to weigh heavily, with 84% of respondents anticipating rates will have a negative impact on the industry in the current quarter, compared to 98% in the prior quarter, according to Aidasani.

The CREFC Board of Governors’ prediction for the Fed’s benchmark policy rate received a 5% median response when asked about it in the survey. 24% predict the rate will be higher than 5%, while 29% predict it will fall between 4.75% and 5.00%.

Knowing when and where to pivot is critical in 2023 as unpredictability and market rebalancing is to be expected.

According to a new Hines study, each cycle has its own peculiarities, so investors, owners, and operators shouldn’t totally rely on what happened in the past.
The firm wrote: “Recognizing what is different and what may at least rhyme with previous cycles can provide insight into how to navigate what is both challenging, with regard to existing holdings, and opportunistic, with regard to the potential to deploy capital in a more sober and attractive pricing environment.”

The “shortage of broader seller capitulation thus far,” which GlobeSt.com has also referred to as a lack of current price discovery, and the rising pricing pressure of financing (if it is even available at all) are two elements at play. Defensively maintaining capital and hunting for possibilities will differ by global area.
Although the industrial and multifamily markets’ bidding pools are narrower than they were at the beginning of 2022, they are still healthy. “Commodity Class A office is fairly illiquid at the end of the year” in the United States.

According to Hines, there are two main signs to pay attention to. The change volume of transactions usually always comes first. “We can observe the historical association between volume and price rise with a longer time series of transaction volume in the U.S. spanning numerous cycles,” they stated. Unfortunately, the link occurs at the same time rather than before, but the stabilization of transaction volume and ensuing increase during previous cycles has been a solid sign that prices hit a bottom and should start to rise if volume continues to return, says the author.

According to information obtained by GlobeSt.com from a number of sources, there is already an expectation that transaction volumes may start to change shortly because there is a lot of capital sitting on the sidelines ready for deployment. However, just like markets, that will probably differ greatly by region. Focusing on regional transaction numbers is more likely to indicate whether certain markets are likely to present an opportunity than sticking with keeping an eye on national transaction volumes.

The second indicator is an increase in traditional debt availability. According to the Federal Reserve’s Loan Officer Survey conducted in the third quarter, “57.6% of respondents reported tighter underwriting standards for commercial real estate loans, including loans for construction and land development; 52.9% for non-farm, non-residential loans; and 39.7% for multifamily properties.” When banks reported lowering their requirements in the second half of 2021, all three categories registered a significant increase from a year ago.

This may be the most advantageous method of obtaining capital in the current economic climate.

With inflation being chased by interest rate increases from the Federal Reserve, the present economic situation has been challenging. The Fed has indicated that additional rate rises are still expected, even though some of the pressures may have passed their peak. Lenders to corporations are taking the risk-averse approach, tightening their requirements and reducing the available leverage.

According to the managing director and head of net lease real estate at Angelo Gordon, Gordon J. Whiting, a mortgage lender will typically give 75% to 80% of the loan-to-value of the property. Whiting adds,  “In today’s macroeconomic conditions, it’s much harder to get access to capital, it’s harder to get a loan, and you’re only getting 60%.”

Capital is still readily accessible for sale-leaseback transactions at very competitive rates despite the fact that the corporate loan market today is less liquid and more costly. While we’ve seen somewhat of a decline in property values, the return to a corporation is still higher.

Renting Can be Beneficial for a Business 
While rent is a costly expense, it is entirely deductible as an operating expense, unlike a loan’s interest. Additionally, the seller often has the chance to negotiate control for 20 years with extensions. Whiting continues,  “The rental will be lower than what they’d have to pay in financing.” On top of that, a longer lease period provides better value to both the buyer and the seller, making that aspect easier to negotiate.

There is added benefit in securing a strategy with certainty, especially given the uncertain nature of the future and the possibility of rising interest rates. Many would agree, doing a sale-leaseback and paying off some of the more expensive or adjustable-rate debt is preferable. The more liquidity you have on hand, the simpler it is to deal with unforeseen events.Working Capital is Paramount Today

Sale-leasebacks are an excellent source of purchase financing, especially given the current state of the market, which in some cases is conducive to strategic add-on acquisition prospects. Profits from sale-leaseback transactions can be used by businesses to support new acquisitions or platform expansion. The money from a sale-leaseback that was completed at the time of acquisition might be used by sponsors to reduce their capital costs for the transaction.

Whiting believes that the market uncertainty and potential for future rate hikes are additional sources of risk and that a sale-leaseback should be considered as soon as possible. He adds that we are in a situation where you’ll wish you had done it the day before rather than the day after.

A little encouraging news on inflation, but probably not enough to cause the Fed to change its course just yet.

The usual metric that is used, the Consumer Price Index for All Urban Consumers (CPI-U), actually decreased by 0.1% in December 2022, increasing by 6.5% from the previous year. This is a decrease from the 7.1% change year over year in November. Numerous publications claim that the decline was consistent with mainstream projections.

Overall, that’s a great indicator since it indicates that prices are actually starting to decline rather than merely slowing off. Things become more chaotic as you go deeper. Energy expenses decreased by 4.5%, which was mostly the result of dropping gasoline prices. However, the price of food, which cannot be disregarded, increased by 0.3% between November and December, which immediately puts a strain on the wallets of typical customers.

After rising by 0.2% in November, the core inflation index—which measures all goods except food and energy—rose by 0.3% in December. Inflation was even worse in this regard.Shelter, or houses and multifamily buildings, was a significant factor. In November, it had increased by 7.1% year over year, and in December, it had increased by 7.5%. Fuel oil (for buildings that use it to heat) and energy services both stood out in the 12-month price growth rate at 41.5% and 15.6%, respectively.

The Federal Open Market Committee is expected to raise the target range for the fed funds rate by 25 basis points at their upcoming meeting, Oxford Economics predicted in an email. “The December CPI is another small step in the right direction, but it doesn’t alter our forecast,” Oxford Economics said. The Fed will want proof that they have stopped inflation and that it is returning to their 2% aim, so this probably won’t be the last rate increase this cycle. The reaction to the December CPI in the financial markets and Fed Funds futures was rather modest.

And as Bill Adams, chief economist for Comerica Bank, said in emailed remarks, “Inflation should continue to decrease in 2023, allowing the Fed to suspend rate hikes this spring and begin to progressively cut rates in the fall.” However, the economy was already deteriorating towards the end of 2022, and in 2023 it would probably go through a slight recession.

One potential worry for the CRE housing sector is that housing costs continue to be a significant contributor to inflation and outsized growth. This may make customers angry and bitter, and it might even prompt requests for further control.

The current shift in many markets toward steady and even declining rents has an impact on multifamily investments and individuals who own apartment buildings.

In addition, landlords are in a unique position compared to other run-ups because inflation is currently rising faster than rents, which could provide difficulties for buyers when working with their lenders.
According to Jamie Berenger, chief credit officer at A10 Capital, the multi-family industry has seen a disproportionate amount of capital invested recently when compared to other asset classes. This sector is seen as a safe haven for real estate investment.

Buyers had to anticipate large, ongoing rental rate growth in order to “pencil” agreements,  according to the increase in capital-chasing transactions, she claimed. Should they materialize, a fall in rent growth predictions could lead to extended or, in more extreme cases, missed business plans.
A lack of rent growth will put pressure on stabilized (takeout) indicators, especially on transitional assets secured with bridge loans, which will create a divergence between lenders and borrowers in the future.

Rents are rising faster than expenses.

We are going to continue to see a cooling in the multifamily market, especially in the places that were overheated in 2022 (Florida, Tennessee, Nevada, Arizona, etc.).

Rents and sales will continue to decline as the economy continues to be affected by inflation and interest rates, which Bechtel predicted would likely continue until the third or fourth quarter before the Fed starts to taper.

I believe that a recession is already underway, particularly when you consider benchmarks like a flat or inverted yield curve, long-term U.S. Treasury bonds with a yield over 3%, and negative growth over the last two quarters.

Operating expenses will certainly increase due to inflation, which could have an effect on property values if the landlord is unable to pass these costs on to tenants in the form of higher rent.

In some circumstances, the increase in expenses is surpassing the rise in rent for the first time in many years, leading to a decline in NOI growth. You might observe rising capitalization rates together with declining sales, which could further decrease values.

Rent Growth Forecast is Being Reduced

According to a story this week by GlobeSt.com, at least two apartment rent analysis organizations recently lowered their projections for 2023.

RealPage has revised its effective asking rent growth prediction for 2023 downward to 3%, with rent movement differing considerably by asset type and by submarket.

Yardi Matrix anticipates all of that growth to occur in the first two to three quarters of the year and has reduced its apartment rent projection for 2023 downward to 3.1% from 3.5%.

Beginning in 2023, Los Angeles will face increasing challenges that threaten to prevent economic recovery.

According to information provided by a major firm, the office vacancy rate increased once again in the fourth quarter, while apartment rents decreased somewhat. Additionally, investment across all asset classes has slowed down due to increasing interest rates.

The L.A. commercial real estate industry is expected to undergo challenges as the economy responds to changes in supply, demand, and pricing going into 2023, according to said research. Difficulties in borrowing money lead to less expenditure, which lowers real estate values while the Federal Reserve keeps raising interest rates.

The Federal Reserve is slowing down the economy in an effort to combat inflation by raising interest rates, but it’s clear that strategy is starting to have an effect on commercial real estate. The market is showing rising vacancy and falling rents, with the exception of industrial rent, which has held steady. It’s predicted that in the new year, each type of property will face its own chances and difficulties.

Office
Landlords are reporting reductions in occupancy rates due to a larger migration to quality assets as well as significant cutbacks in the tech and media industries, which have for years been major drivers in L.A. Larger office tenants are cutting excess space and reevaluating overall workspace needs, but most experts are in agreement that the sector is still on a “slow path to recovery.”

Demand for office space decreased even as the vacancy rate increased 110 basis points from the previous year to 15.2 percent in the third quarter of 2022. At $3.48 per square foot, the average asking rent was just slightly lower (less than 5 cents) than it was at the beginning of the year.

The research stated that landlords will become creative in recruiting tenants to occupy unoccupied space, offering advantageous concessions including flexible lease terms, free rent, and tenant improvement allowances.

Multifamily
Multifamily vacancy increased somewhat by 10 basis points year over year to 3.7 percent in the fourth quarter following a spike in development. According to a leading local firm, typical asking rent decreased for the first time since the pandemic shutdown. This was still 3.2 percent higher than it was in 2017.

The report stated that the change in market dynamics and demand for multifamily housing will persist beyond 2023. Rising borrowing rates, escalating construction costs, and a sluggish economy will influence the rate of growth for multifamily units, which seek stability.

Retail
While the average asking rent increased over the same period, retail vacancy rates were unchanged from a year earlier at 5.4 percent in the fourth quarter, despite some businesses returning to brick-and-mortar locations.

It’s expected that retail will continue to evolve, with the majority of merchants holding less physical selling space in storefronts and more warehouse space for e-commerce, outdoor restaurant dining, and curbside pickup—a permanent change.

Using “seller financing” is one of the most popular ways to put little or no money down when investing in real estate. Although it may be one of the earliest “creative financing” strategies, it seems to be losing favor in recent years, largely for the reasons to follow. All things considered, seller financing out the window, though. Knowing how to use it efficiently in your business might help you close more deals faster and for less money. This post will define seller financing, explain how to use it, and discuss potential pitfalls.

Just as it sounds, seller financing involves the seller providing the financing. In other words, although legal title is transferred, the payment is sent directly to the prior owner rather than a bank, and the property owner serves as the bank.For instance:

I want to buy a specific investment property, but I don’t want (or am unable) to obtain typical bank financing. Although the seller wants $100,000 for the property, he or she is prepared to “carry the contract,” as investors say when they agree to finance a piece of real estate they own. The owner requests a $5,000 down payment and a $95,000 balance with a 30-year amortization period at 7% interest for a $632.03 monthly payment. I accept his terms, and, after performing my due diligence, I close on the property using a title company in my neighborhood. Then, in order to collect the monthly cash flow difference, I search for a tenant  who will pay $1400 a month to rent the property.

The seller in the aforementioned situation receives an excellent fixed interest rate on their investment, I get to purchase the home for only $5,000 down, and I never have to interact with a bank.What’s the catch, though? Why don’t these have greater appeal?

Why Doesn’t Everyone Use Seller Financing to Buy?

The due-on-sale provision, which is a legal component of practically every mortgage and provides the bank the authority to demand that the loan be repaid, in full, immediately if the property is sold, is a significant issue with seller financing that throws a kink in the whole plan.

You can now see why seller financing is problematic: since the property is being sold, it doesn’t work well if there is already a mortgage on the property. In other words, if you have a mortgage on a property and use seller financing to sell it, the bank may contact you and demand immediate payment or proceed with a foreclosure.

Will that occur?

However, keep in mind that the “due on sale provision” only gives the bank the RIGHT to do so, not a commitment to do so.The bank might approve of the arrangement and say nothing about it, or they might never learn. However, whenever you sell a property with a due-on-sale provision, there is a significant risk involved. I personally don’t dabble with the due on sale clause since I want to reduce the amount of risk I take when investing in real estate. So, how do I benefit from seller financing?

How, therefore, can the “due on sale” clause be avoided?

As noted above, the risk of using seller financing when the seller already has a mortgage is that it may result in the “due on sale clause,” which could result in the property being foreclosed upon if you are unable to repay the bank the full loan total. In the event that you purchase a home from a homeowner, both of you would lose the property if the homeowner went into foreclosure. There is just one straightforward remedy because, obviously, you do not want to find yourself in this situation:

Use seller financing only if you have free and clear title to the property. (There are a few exceptions; we’ll discuss them later.)

In other words, if the property owner currently owes money on the house, you shouldn’t use seller financing to acquire it from them unless you first settle the debt. To purchase with seller financing, you must locate sellers without a mortgage. In this manner, they can offer the financing without having to worry about facing foreclosure.

The Advantages of Seller Financing
Let’s look at a few of the most frequent perks of employing seller financing, but there may be many.

1. 1. Ease of Financing: As was already noted, using pure seller financing eliminates the need to work with a bank, which for many people can mean the difference between a sale and no deal. Seller financing is a fantastic weapon in your toolkit if you have “tapped out” on the number of mortgages you can receive and need to buy more investment property.
   2. Due to the fact that you are negotiating with seller directly, there are no black-and-white regulations regarding the down payment. As opposed to Fannie Mae or Freddie Mac, who demand 20% to 30% down on investment properties, you are not subject to their strict requirements. As an alternative, you agree on a price with the seller. You won’t know until you inquire and negotiate what the seller wants in terms of a deposit, whether they want nothing or 50%.

• The rules when dealing with banks can be very rigid, but not with seller financing. This leaves room for creativity in transaction structuring. You might think outside the box to find a solution to a problem with seller financing. Rate, period, payment sum, due date, and every other aspect are all subject to negotiation, which can transform a fair deal into an excellent one. Speaking of being inventive, I’ve seen investors work out 0% seller financing terms with the seller.

1. 1. Purchase “Unfinanceable” Properties: On occasion, a property’s condition could be too bad for conventional financing. In these circumstances, seller financing may offer the buyer the opportunity to acquire the property, make repairs, and subsequently refinance into a more conventional form of financing.

• Doesn’t Show Up On Your Credit Report: Chances are that your seller-financed agreement won’t land up on your credit report, which can make it simpler to get additional loans and mortgages in the future, unless the home seller joins up with one of the credit reporting agencies to report the debt (which is extremely rare).

• Monthly Income: Obtaining a monthly income is probably the main reason why sellers choose to use seller financing. Many people would simply prefer to receive regular checks each month rather than a single lump sum, just like in the scenario I presented above with the $100 or $1 per month. For older sellers who depend on monthly income to make ends meet and pay the bills, this is especially true. For an older seller, a $100,000 lump sum would only last them so long. However, if that income is financed over 30 years, it will last them much longer until retirement.
• Better ROI: Because the interest they receive from the financing is higher than they are likely to receive elsewhere, many homeowners and investors choose to sell with seller financing. For instance, if a homeowner sold a property for $100,000, they had the option of investing the money in a bank’s Certificate of Deposit to earn 1.5% APY or seller financing their home to earn 8%. What is superior? This idea is well understood by many seasoned real estate investors, who eventually transition their portfolio from a “holding” phase to a “selling phase” by using seller financing to eliminate the hassles of ownership while continuing to generate monthly income by carrying the contract and offering seller financing. The investor then transitions from the “landlord” company to the “note buying” industry.

1. 1. Spread out taxes: The government always wants a piece of your earnings, and selling real estate is no exception. Due to an IRS provision that exempts homeowners from paying taxes on up to $500,000 in profit from the sale of their principal residence provided certain requirements are met, this issue may not be as crucial for homeowners. Investors, on the other hand, are less fortunate and must pay taxes when they sell. For instance, if an investor pays off a rental property mortgage over the course of 30 years, becomes the owner free and clear, and decides to sell the property for $100,000, the investor would be responsible for paying taxes on the $100,000, which might result in a tax payment of close to $50,000. A “recapture of depreciation” tax that the investor will also be responsible for paying might substantially increase that tax bill. As a result, many investors opt to sell using seller financing rather than receiving a lump sum payment in order to postpone the majority of those tax payments. The seller may only have to pay a small fraction of that tax payment each year while the loan is being paid off because the IRS has specific tax regulations for installment transactions, such as those involving seller financing. This brings up the “ROI” issue once more. If an investor sold a property for $100,000, they might lose as much as half of that—or more—to taxes, leaving them with only $50,000 to put toward other investments. Even if they were to make 12% on the stock market, they would only make that on the $50,000 they sold, not the $100,000. They will, however, actually make more money if they offer seller financing at 8% because the interest they receive is on the “pre-taxed” interest.

• Can’t Sell Otherwise: As was said in the section before, many properties are just not marketable to a regular borrower with bank financing. By providing seller financing, a seller may be able to sell a home without having to make the necessary repairs.

Although seller financing might give you as a buyer some great possibilities, you should be aware of the risks and hazards associated with the tactic. This section will examine three of the most frequent worries when dealing with seller financing and provide some advice on how to avoid those potential issues.

1. The “due on sale” clause has already been discussed in great detail, but I feel compelled to recapitulate it here. You must fully comprehend the meaning of the due on sale clause and why it is significant. By attempting to go around this provision, you don’t want to jeopardize your credit or your connection with the vendor. Be aware that if you use seller financing to purchase a home and the property has a mortgage with a due on sale provision, the bank may foreclose on the seller, placing you both in a difficult financial situation. Again, the most straightforward answer is to limit the use of seller financing to assets that are owned free and clear. I only have short-term finance as an exception to this rule. There are investors out there who use seller financing with existing mortgages (often called a “wrap” because you wrap one mortgage over another) despite the due on sale clause because they think they can fix the property up quickly and either sell it or refinance it before the bank finds out and has an issue with it. I won’t advise you to do this; that is up to you and your level of risk tolerance.
2. Higher Interest Rates: Although seller financing encourages tremendous innovation, you will generally pay a higher interest rate than usual.Though some investors negotiate 0% interest seller-financed loans, it is difficult to convince a seller to accept such a low interest rate in today’s lending environment with loans under 4%.Just be sure to run the numbers with the interest rates you plan on obtaining and make sure they work for the deal.
3. Fewer Potential Properties: Although seller financing can be a fantastic win-win situation for both sides, the vast majority of homeowners are either unable (due to existing mortgages) or unwilling to carry a contract and provide seller finance. Therefore, when trying to cooperate with seller finance, the pool of viable offers is substantially smaller.

We’d like to reiterate that seller financing does not justify overpaying for a property, even if it allows you to purchase properties without utilizing a bank. Only when leverage is used appropriately does it remain leverage; otherwise, it simply turns into a liability.