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L.A.’s ‘Red-Hot’ West Side Story
07.21.15 | See Property >

Record Brentwood apartment complex sale raises bar for rents.

Even though apartment rents in Los Angeles have risen 20% over the past five years, some real-estate investors are betting that rents still have more room to grow.

That partly explains why earlier this month, investor and developer Darius Joe Meraj paid $20.1 million for Villa Montana, a 20-unit apartment complex in the affluent Los Angeles neighborhood of Brentwood. The price works out to more than $1 million per unit, the highest price ever paid in the city for apartments not directly adjacent to the beach. Moreover, the price is four times the $223,122-per-unit average price that Los Angeles apartments sold for in 2014, according to Real Capital Analytics, a New York-based researcher.

The deal “shows how red-hot the west side of Los Angeles is,” said Ron Harris, one of the Marcus & Millichap brokers who represented the seller, California Landmark Group.

But monthly rents at Villa Montana already far surpass the norm. Rents in the 90049 ZIP Code, which includes Brentwood, averaged $3,200 a month in the second quarter this year, up from $2,984 a month in the second quarter last year, according to Marcus & Millichap. The average rent in Villa Montana is close to $5,000 a month, Mr. Harris said.

A marketing package that Marcus & Millichap sent to potential buyers stated that Villa Montana’s new owner would have “the opportunity to increase rental price points by approximately 19% to 20% through aggressive management and by instituting a minor upgrade program to the flooring, countertops and appliances.”

Of course, not everyone believes apartment rents can continue to rise at such a rapid pace, especially in the luxury category. Victor Calanog, chief economist at New York researcher Reis, points out that new construction will likely push up the vacancy rate in Los Angeles to 4.5% by the end of 2015 and keep annual rent growth near the 2014 rate of 2.4%. “For the next five years we’re looking at a decidedly unimpressive rent growth rate in the low 2s,” Mr. Calanog said. “If you are expecting high rent growth, you might be disappointed.”

In past years, the highest prices in Los Angeles were reserved for beach-front communities. But that’s starting to change as more domestic and international apartment investors vie for a limited supply of well-located properties. Villa Montana, for example, is in walking distance of shops and restaurants, and is a short drive to country clubs and major employment centers such as Beverly Hills, Century City, Culver City and Santa Monica.

The founder and president of California Landmark, Ken Kahan, purchased and razed a circa-1950 apartment complex on Villa Montana’s current site in 2003 to make way for the project, which he completed in 2005. That same year, Mr. Kahan obtained local and state approvals to divide the property into condominiums. “We built this 10 years ago as a condo play and could have exited at that time, since the market was very hot,” said Mr. Kahan. “However, we would have paid ordinary income taxes” on any sale proceeds.

As an alternative to condominium sales, Mr. Kahan decided to operate the complex as rental apartments. And by selling the 20 units as a single, income-producing property, he will have the option to reinvest the proceeds via a tax-deferred exchange.

Regulated under Section 1031 of the federal tax code, a so-called 1031 exchange enables a seller to avoid paying capital-gains tax on proceeds from the sale of certain business or investment properties, as long as the seller reinvests those funds in a similar property.

“We weighed the benefits and detriments of vacating the building, rehabbing the units and selling them one at a time through a condominium broker,” Mr. Kahan said. “The effort did not make sense given our options to reinvest the capital via the 1031.”

Mr. Kahan estimates that his cost to acquire the site and develop Villa Montana was less than $550,000 per unit. That means that after collecting rents there for 10 years, he effectively doubled his investment in the project through the recent sale.

Villa Montana’s new owner also took advantage of the 1031 exchange rule. Having sold a commercial property in Manhattan, the buyer needed to invest that cash in another income-producing property of about the same value, thereby avoiding capital-gains tax on the New York sale.

“For Ken Kahan’s money, this was obviously a great deal,” said Eric Sussman, senior lecturer in real estate at the UCLA Anderson Graduate School of Management. “For the buyer, using his own capital derived from a 1031 exchange, and using no or minimal leverage, the price made sense as well.”

Mr. Meraj, the buyer, referred questions to Paul Darrow, a Marcus & Millichap vice president who represented the seller. Mr. Darrow said his client plans to hold the property long term and hand it down as part of a family legacy. Condominium sales, therefore, aren’t part of the new owner’s immediate plan.

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