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Why multifamily developers are having a brutal year in LA
With lending drying up and profit margins gone, LA developers put their pencils down
Several months ago Schon Tepler, a Los Angeles-based multifamily developer, received all the necessary city entitlements for what would be the firm’s latest project, a 30-unit apartment building in Koreatown, a trendy Central L.A. neighborhood that for years has ranked as one of the city’s hottest areas for new construction. But now the firm has no intention of actually constructing the project it entitled.
“It just doesn’t make sense to build,” said Artem Tepler, one of Schon Tepler’s two founding partners: In this year’s economic climate — and considering the city’s steep new transfer tax — the firm calculated that the project costs would essentially end up equalling the building’s market value. “We would be all in at $440,000 on a unit that’s worth $440,000.”
Instead of going through with the original plans, the firm is considering an overhaul, taking out a parking garage and changing the one-bedroom units to two-bedroom units that would qualify as affordable housing. It could be one of the firm’s last Los Angeles builds: After spending their entire 14-year career developing dozens of apartment projects in L.A., Tepler and his partner, Paul Schon, are — at least for now — no longer looking for new projects in L.A. at all.
“We love this city, and we want to do bigger projects here,” Tepler said, “but at this point it’s just becoming harder and harder to do business here. It’s easier to get on a plane and do a build in Texas than it is to do it in our own backyard.”
In the summer of 2023, it’s a common Los Angeles refrain: While ongoing projects around the city are still finishing up, the city’s development climate has become notably bleak. Many firms are simply no longer interested in building here, and the multifamily pipeline is quickly drying up.
“Development right now is really at a standstill,” said Juan Aguilar, chief investment officer at L.A. County-based Alliant Strategic Development. “Even in a supply-constrained market.”
Double whammy
It’s not just L.A. In the topsy-turvy post-pandemic era, in which economic uncertainty has been lingering for years and high interest rates have put up barriers to access to capital, multifamily developers are pulling back around the country. This is true even in boomtowns like Denver and Austin, where years of feverish construction is running up against cautious lending and a more tepid demand for new inventory.
“Nowhere is easy,” said Sean Burton, CEO of Cityview, an L.A.-based firm that’s recently made a development push into Colorado.
But L.A. was hit by something of a perfect storm. Inflation and the post-pandemic real estate rush drove the area’s high labor and land prices even higher. The recent crisis affecting regional banks — traditionally an important source of multifamily financing — hit Southern California particularly hard. The city’s notoriously slow and complicated approvals process only continues to add cost and uncertainty to most projects; so does a barrage of often disingenuous environmental lawsuits.
“It’s easier to get on a plane and do a build in Texas than it is to do it in our own backyard.”
And then there’s the new taboo in L.A. real estate: Measure ULA, the industry-loathed transfer tax on property deals in the city above $5 million. The tax, intended to raise money to help with the city’s acute homelessness crisis, was approved by L.A. voters last fall and went into effect in April. And while even many of its detractors agree it was well intended, plenty of L.A. multifamily developers are specifically citing the transfer tax, which effectively adds a four- or five-and-a-half-percent surcharge to any major land deal, as the reason they’re giving up on new projects in the city.
“I think developers are feeling like they’re getting squeezed on all sides, and it’s very difficult to make deals pencil in today’s market,” said Burton. “ULA, in many ways, was the straw that broke the camel’s back.”
It’s possible the tax won’t stick around for the long haul: A hearing over its legality is scheduled to begin in October, and considering its poor results so far — in its first few months it brought in far less money than anticipated, while also getting widely blamed for stifling the market — it’s also plausible that city leaders could attempt some amendments.
But in the current environment, even developers who do still want to build in L.A. are finding that many institutional lenders have become flatly uninterested in providing capital, turned off not only by Measure ULA and tight margins but the city’s recent history of enacting left-leaning initiatives: Throughout the pandemic, L.A. passed some of the country’s strongest tenant and rent protections; other controversial local initiatives — like a proposed wildlife ordinance that’s already drawing howls from luxury brokers and property owners, could be on the way.
“Even if it ultimately goes away,” said Rachel Parsons, a director at Berkadia’s Irvine office, of the transfer tax, “the sentiment of capital is just kind of a big red X on L.A. because of everything that’s happened over the last couple years.”
It’s all added up to a development pipeline that’s been hit at every stage of the process: Fewer property deals closing, fewer project applications being filed — and fewer apartments actually getting built. Over the past decade, according to Berkadia data cited by Parsons, L.A. County saw an average of between 10,000 and 11,000 unit starts per year. (City of L.A.-specific data was not available.) This year to August the county had only seen around 3,000, she said, and the numbers have been dropping every quarter. Parsons is predicting the rest of the year will bring hardly any.
Cold front
Some L.A. developers are still finding ways to pursue new projects, including smaller builds that don’t rely on institutional capital.
“This year everything changed,” said Dan Gatsby, whose namesake real estate investment company focuses on building co-living projects with between four and 10 units, especially because of interest rates.
But unlike some of his friends who develop larger projects and have given up, Gatsby — who typically deals with properties below Measure ULA’s $5 million threshold — is still looking for new deals in the city, including one property in Venice where he’s been waiting on the seller to lower the price for a year. He’s also changed the way he operates, he said, cutting down on costs by hiring subcontractors instead of general contractors, pushing hard for quicker completion times and pursuing some projects as build to rent instead of build to sell.
“So now we have to hustle more. It’s not like before — you can’t lay back and make money,” Gatsby said. “It’s a penny business. You have to crunch the numbers.”
“So now we have to hustle more. It’s not like before — you can’t lay back and make money.”
Some large firms are also adapting.
Alliant Strategic Development, which primarily builds workforce and affordable projects, has come to terms with the current difficulties of the market and traditional lending, Aguilar said, and instead has been looking for more creative financing options. Last year it began applying for a state program that incentivizes affordable multifamily developments by offering recycled tax-exempt bonds, a model that requires more patience than traditional financing, the executive emphasized, because it can take months for the government bonds to come through.
But Aguilar said it’s already been paying off: As of earlier this summer the firm was close to securing a quarter billion dollars’ worth of financing for four new apartment projects in the San Fernando Valley.
“This was probably the best thing that happened to us,” he said of the program. “Because we’re closing deals when no one else is closing deals.”
Experts agree that L.A.’s downturn will not last forever: The region’s strong economy and inherent desirability — the weather, the beach, the entertainment industry — ensure that rental prices and demand for apartments will remain relatively high. While the industry often gripes about local politics, in other ways city and state leaders, increasingly aware that they’re grappling with a housing crisis caused largely by a building deficit, are making progress, pushing for streamlined approvals and other pro-development policies.
But given the city’s frigid near-term forecast, many L.A. developers can’t afford to wait.
“It’s not the end of the world — we’re not like trees, we can move,” said Tepler. “But it’s sad … My peer group is all developers, and everyone is thinking that. They’re all basically pencils down on the City of Los Angeles.”
Tepler added that his firm does have one 400-unit project in the permitting process, which he expects will be greenlighted within a few months. It’s in Austin.