COOL DOWN BUT NO MELTDOWN

By Bill Swift
Wiest Realty & Mortgage Co., Inc.

    High rates have impacted the market; however, prices continued to increase into the second quarter of 2006.  Cooling signs are showing up in the form of slowing appreciation, sustained interest rate increases, and decreasing sales volume.  In the case of Apple Valley, Victorville, and Hesperia, 2006 2nd quarter closings dropped from 1st quarter levels.

    Projects of 5 units and greater exhibited a similar long term downward trend. The following chart depicts Adelanto, Apple Valley, Hesperia, and Victorville 5+ unit project closings as a group.

    The numbers for Apple Valley, Hesperia and Victorville show continued investor demand as follows:

    Apple Valley 2-4 Unit Price Trend:

    Hesperia 2-4 Unit Price Trend:

    Victorville 2-4 Unit Price Trend:

    Graphically illustrating the preceding data suggests continued appreciation through the 2nd quarter of 2006.

    5+ Unit projects show no clear pattern regarding gross income multipliers or capitalization rates.  Most properties of this nature are sold with rents that are significantly below market.  Since the area is not rent controlled and many units are occupied on a month-to-month basis, investors have been willing to purchase 5+ unit projects in spite of the need for large down payments to satisfy lender debt service coverage requirements.  There is a pattern, however, regarding price paid per unit and average unit size.  The following graph shows this pattern.  It is based on 2006 five+ unit project closed sales for Apple Valley, Adelanto, Hesperia, and Victorville (as a group).


    List prices relative to average unit size (for projects with average unit sizes under 600 sq. ft.) are generally lower as of mid July 2006 as compared to closed sales for the first half of 2006.  Asking prices for projects with average unit sizes over 600 sq. ft. fall in the same general range as closed 2006 data suggesting a possible flattening of appreciation for the next half of 2006.

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POSITIVE LEVERAGE.
WHY CAN'T I GET IT?

By Bob Blanchard
Washington Mutual Bank

    It’s all about the cost of capital.  Typically, apartment project sales are structured with debt and equity.  Given today’s rates and debt service coverage ratios, the required down payment (equity) generally falls in the 30% to 50% range.  This leaves 50% to 70% for mortgage financing.  The problem arises due to mortgage interest rates that result in a mortgage constant that is higher than the capitalization rate of the project.  For example, let’s say you’re buying a project with a cap rate of 5% and your mortgage will carry an interest rate of 7% with a 30 year amortization schedule.  In this case, your annual mortgage constant (MC) is 7.9836%.  Now assume your bank will lend you 65% of the sale price and you want a cash on cash return on your equity (which is 35% of the sale price) of 3%.  Here’s how to estimate the cap rate you need to pay the loan and your equity.

    This quick analysis indicates you’ll need a cap rate of about 6 ¼% to achieve your cash on cash objective.  Any cap rate over the mortgage constant (about 8% in this case) will result in positive leverage.  This means, the more you borrow, the greater your return on equity.

    Investors have had problems since it is very difficult to purchase properties in the area with cap rates in the required range.  If you can’t get the cap rate you need, Washington Mutual has several programs available that creatively mitigate the current interest rate environment and allow you to maximize cash flow.

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FUNDAMENTALS ARE BACK
IN STYLE — PRICE YOUR
PROPERTY TO SELL

By Pam Wiest
Wiest Realty & Mortgage Co., Inc.

    With interest rates rising, there has been a softening of demand for 5+ unit projects.  The days of multiple offers and the feeding frenzy of 2005 appear to have past.  Keeping abreast of market conditions and current loan rates is essential to effectively marketing your project.

    Let’s look at an example of how a 1% difference in the interest rate on 30 year loan with a 1.2 debt service coverage ratio impacts the bottom line based on a building that would have sold for 12 times gross a year ago.  Also, assume a potential gross annual income of $200,000, a 40% expense ratio, and the same amount of cash down payment available from the buyer.

	The numbers @ 5.75% — Value @ 12 x Gross	The numbers @ 6.75% — New Value @ 11.29 x Gross
Gross Income	$200,000	$200,000
Expenses (40%)	$80,000	$80,000
N.O.I	$120,000	$120,000
Debt Service Coverage Ratio	1.2	1.2
Amount of NOI Available for Debt Service	$100,000	$100,000
Approximate Amount of Loan Supported	$1,428,000	$1,285,000
Equity	$972,000	$972,000
Value	$2,400,000	$2,257,000
Approximate Mortgage Payments	$100,000	$100,000
Cash Flow After Debt Service	$20,000	$20,000
First Year Cash Return to Equity	2.06%	2.06%

    In order to achieve the same yield with the same down payment, the price must come down 6%!

    There’s more to this than rate increases.  Multipliers in the High Desert rival those of Los Angeles and other counties.  In some rent-controlled areas upside income potential is present with similar multipliers thereby giving investors the perception of less risk.  In many others areas, rents are higher and expense ratios lower. Many buyers have out-of-state deals on their mind.  There are several areas in this country with attractive multipliers that appear to reflect great buys.  In short, buyers have more choices now than they did a year ago.

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