LA Real Estate in Limbo: Operating Through the Unknown

Since the recovery from the Great Recession of 2008 until 2022, real estate saw really good times. Things were on the up and up and people were making money almost without knowing what they were doing. Owning and operating real estate has gotten exponentially more difficult over the past 3 years, where you now have to work twice as hard to preserve what you have. There hasn't been one major isolated shift within the industry that has created a more challenging environment; rather there are several predominant factors that have changed within a short period of time that, together, have pushed real estate into tougher times.

Let's start with the most prominent one, interest rates. Interest rates today can be anywhere from 6-7%, which is about 2 times higher than where they were from 2018 to 2022. The effects of these higher rates can be seen by way of property values and refinance proceeds. When the cost of debt is higher, property values fall as lower prices are needed to offset the increase of the mortgage expense. If a property was worth $2mm when rates were at 4%, it might be worth $1.5mm now with rates at 6.5%. In the same way, if you own real estate and need to refinance out of a loan that is coming due, the new loan may be smaller than the old loan. This results in having to put cash in, in some cases millions of dollars, to pay off the old loan and maintain ownership. If you would rather sell, you may take a loss on the investment.

Then comes the insurance environment. Several years ago, policies were extremely easy to come by, but large tenant lawsuit settlements and environmental risk over the years has changed the way policy issuers handle business. Florida has seen a 5-10x in premiums. California has seen a 2-3x in insurance costs and new policies continue to trend upward. That does not include the upfront repairs and maintenance costs required to secure these policies, which could range from $1,000 to $100,000+ depending on the scope. Many of these policies will also exclude important coverages like tenant habitability or mold, which leave owners with an expensive policy that provides minimal coverage.

Coming out of COVID, we had tremendous rental growth as renters were moving back into densely populated cities. That has now transitioned into a period of rental stagnation or even rental decline, where some cities are seeing worse declines than others. Los Angeles historically is a high rental demand city with limited supply where we have become accustomed to rents increasing year-over-year. There is limited decline in rents in Los Angeles, but few submarkets have seen rental increases enough to offset the increased operating costs.

There are additional factors such as higher utility costs, more expensive repairs and maintenance, as well as stricter City of LA regulations, that are making many owners question the rationale to continue to own multifamily income properties in Los Angeles. In our perspective, this leads to more opportunity for The Goldfinger Group to continue to expand its business. It just requires us to be that much more nimble and nuanced to navigate the higher risk environment, whether that be operating our existing portfolio or purchasing new opportunities. There is still a tremendous amount of untapped potential within Los Angeles real estate as we remain optimistic over the long term; at the same time we must be more cautious today given the factors at play.