To access the article Jan discusses below, please click here: A Bull Market in Rental Housing - WSJ This article from the Wall Street Journal makes the case that buying apartments should yield attractive returns today. It is true that prices are down from their peak and the outlook for future increases in rental income is positive. However, the article sidesteps the single largest challenge for apartment investors--the market is overheated. In Los Angeles, there are hundreds of wealthy individuals and families searching for small properties to buy for all cash. They have pushed down capitalization rates, defined as initial cash flow from operations divided by purchase price, to the 5% to 6% range. Even though interest rates are low, the initial cash-on-cash return for apartment investors in California, defined as cash flow after debt service divided by the buyer's down payment, is in the low single digits.
For a very long term investor who has lots of extra cash to invest, buying apartments does indeed represent a valid investment investment strategy. However, for professional investors and others with limited resources to invest, buying apartments in Southern California at full retail value should be considered with skepticism. At the moment we prefer to make short-term loans to opportunistic investors who are buying assets from banks. By taking a strategy that is far off the main beaten path, and focusing on loans that are too small for real estate private equity funds, we cut the competition by 80 to 90% vs. the competition to buy apartment deals. With less competition comes better risk-adjusted returns, in our view. This is not to say that we won't buy any apartments...only that there needs to be a very unusual situation in order to entice us to spend time chasing an apartment acquisition, given today's high prices relative to cash flow.