May 2023
Brad says residential real estate in Los Angeles is resilient because there is a shortage of inventory, this city is affluent, and people are coming to terms with the fact that interest rates are around 5-6%. Although this is an obvious increase from the zero percent environment we were in for so long, it is still a decrease from where it was in late 2022 (around 7%).
Brad and Chris also discuss the importance of small and medium-sized banks in creative financing. For example, First Republic Bank has been known as one of the best banks for real estate and development. However, now that concerns are mounting around First Republic, Brad says this could potentially slow some deals and development projects.
Brad also explains the recent Measure ULA tax and how it may slow the real estate market in the City of Los Angeles while benefiting surrounding areas like Calabasas and Beverly Hills as the mansion tax does not apply to them. Therefore, Brad says this heightened tax may actually cause revenue to leak from the City of Los Angeles and ultimately, home buyers and tenants may suffer the costs as sellers and landlords will increase their prices.
Finally, when it comes to investment opportunities, Brad recommends listeners to consider investing in single-home family properties in Eagle Rock as it is an undervalued neighborhood, and they are exempt from the Tenant Protection Act of 2019.
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Watch previous episodes here:
Ep. 31 What You Need to Know About LA's New Mansion Tax
Ep. 30 Aging in Place: A Guide to Growing Old in Your Own Home
Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Brad Keyes of Keyes Real Estate. We're here to get a State of the Union on the real estate market. There's a lot of things going on. And you know the real estate market looks a lot different today than it might have, you know, a year ago or two years ago, kind of because of interest rates.
But that's not the whole story. So, Brad, thank you for joining us.
Thanks for having me, Chris. I appreciate it.
What's your perspective on the real estate market today? I know that you have expertise outside of single-family and commercial and all asset classes and really interesting perspectives. So give our listeners some thoughts about real estate right now.
So real estate in Los Angeles I want to talk about Los Angeles specifically is interesting because it is very resilient. I think we were talking about that earlier. Clearly, the interest rates that exist right now drive sales and price. However, in the residential market, at least in Los Angeles, there is such a shortage of inventory that we are almost you know, I feel like we have normalized a new uptick in interest rates. Some say we've gone up 1700 percent in interest rate hikes in the last last year.
It has been the fastest rate hikes have ever gone, you know, from zero to call it five and a quarter of the Fed funds rate, you know, which is which is the interesting part. So any time you're starting at zero and going to 5%, which.
You're exponentially getting bigger.
Which is normal for most periods, just the last 15 years, rates were held at zero. So yeah.
I think we got very spoiled. I mean, I know that when you talk about 3%, interest rates or 2% to 4% interest rates. Yeah, I mean, that's like free money and you know, I hope you got something. If you didn't, I don't think it's the end of the world. I think that we are not in the interest rate environment that we were in in November when things really, I mean, really became apparent that, you know, just we could not control this inflation beast.
And certainly things were slowing down. I just I had a property listed in November that I just listed this week, and I had eight offers this week. And I had it was dead in the water in November.
So November, we're talking five months ago. Zero offers, barely anybody coming through the door. You took it off the market.
It’s just a totally different animal. I said, look, let's just wait. And we did. And eight offers this week. Wow. And rates are down a little bit. I mean, I would say, you know, you're probably looking at five and a half percent for the mortgage for this type of property versus closer to seven then. And that certainly makes a difference. But it doesn't make that much of a difference to explain why you're getting eight offers.
Except for that there's just such a limited inventory.
Yeah, I was talking with somebody. I mean, this is almost a year ago and we were talking about the inventory thing. Let's say that there's a thousand buyers out there for a home and 500 of them can qualify at rates at 4%, 300 of them can qualify at rates at 5%. 150 of them could qualify for rates at 6%.
There's only like 70 homes on the market. So if you still have 150 or 200 qualified buyers, it's twice as much as inventory. And so.
Yeah.
That's why, that's why prices have remained resilient.
It's truly wild. I mean, you know, when we list properties, we're always checking to see what's on the market. It is very rare that I see, you know, we work in Pasadena, in the Palisades, we're in Eagle Rock and the Palisades, that we will see more than one competing property in a week. I mean, it's been a while.
Okay. And when I say competing property, I mean, you know, relatively similar, bedroom, bathroom count, 20%, give or take in size, you know, very, very directly comparable. And it's hard. It's hard. And what's weirder is that every month, you know, there was like a lull in the market at the beginning year, at the end of the year, last year, every month, we're still having price appreciation.
Yeah, because people are really coming to terms with this isn't stopping. Residential wise, residential wise.
Yeah. Residential seems to be extremely resilient, partly because inventory, people are coming to terms with the fact that, yeah, rates are higher than where they were. Right. They're, they're no longer three or three and a half percent or four. It's now in call it the mid-fives up to sixes potentially, but that's not astronomically high compared to where they were in the past.
And people have money. Yeah. You know, this is an affluent city. People have banking relationships. I mean, here we are at my financial advisor’s office talking about this. I mean, you know, people get basis point discounts and all sorts of things. You know, you can still get an interest only loan in the 5% range when your payments are not that different than maybe a 4% fully amortized rate or something like that.
It's interesting that you said the interest only because there is all this talk and I hear it more in the commercial space about all of these, you know, five, seven, ten year interest only adjustable rate mortgages. It's called like the loan maturity wall, something in the neighborhood of $1.5 to $2 trillion is coming due to be refinanced or adjusted upwards in the next couple of years. But that could significantly affect the office.
Well, certainly in commercial and office, I mean, that is a real thing, every day the real deal is like a scary headline after a scary headline. And, you know, we deal in office. We have a large office building in escrow in Orange County, and we're trying to make a deal. And we're making a very different deal today than we were when we went into escrow six weeks ago post Silicon Valley, Silicon Valley Bank failing, Signature Bank failing, First Republic. I mean, that was a really crazy event that I don't think the general public really grasps how significant it was.
Yeah, well, we've done a couple episodes on this and it is fascinating how much you learn that these small and medium sized banks, how integral they are and do the creative financing for deals to get done. Because these big banks since 2008, 2009 and all the regulations, these big banks just don't play in those spaces anymore. So First Republic has been known for years to be one of the best banks to go to for real estate development, creative financing. And fortunately, they're still around, knock on wood. But they have been in the headlines lately and definitely doing different deals today.
Well, I can give you a personal example. I have a construction loan with First Republic right now on a property I’m developing in Eagle Rock. And when Silicon Valley went down, I didn't realize how much exposure First Republic had and I went to dinner. I was at sushi, and my neighbor was like hey, did you hear First Republic might be caught up in this thing?
And the whole weekend I was like am I losing my construction loan? What's really going to happen? And of course, you know, that's an emotional reaction to, you know, to a problem. And obviously, First Republic, in order to continue doing business, would have to be sold and someone would probably honor their loans. But it was a scary moment. I mean, I was having a rough, rough weekend.
A lot of my friends in commercial real estate finance were telling me that, you know, this is going to be rough for a while. And I think it's really starting to rear its head, particularly with the combination of the post COVID non office going that we're experiencing. Yeah, I mean, it's going to have a real effect on commercial real estate because not only are interest rates adjusting, but tenants aren't paying the rent because landlords I mean because they can't get their people in the office, they don't even need the spaces.
Yeah, they don't need as much.
And they're also having financial problems from this increase in interest rates. So it's, it's kind of like the perfect storm.
Yeah. So, you know, when you talk about sort of commercial or office in L.A., it's getting hit by those factors. But then there's this mansion tax that's not really a mansion tax because it affects so much more than homes or mansions, above $5 or $10 million. It's multifamily, it's commercial, it's everything in the city of L.A..
And it's on top of, you know, L.A. City already has a documentary transfer tax that is $5.60 per thousand of transaction. So, you know, every million dollars of transaction is $5.60 is $5600 bucks. Now, that's just a documentary transfer tax. This is now a gross receipts tax. Doesn't matter if you make money, lose money, you are paying it. And I, I think it's very misguided and I think it's going to have the reverse effect it wants to. I think that revenue is going to leave the city of Los Angeles because there's going to be dead hand control of properties over $5 million. And I think that cities like Calabasas, which we are in right now, La Cañada, Pasadena, Burbank, Manhattan Beach, Redondo, Hermosa, any municipality, Beverly Hills, any municipality that is not L.A. City is going to benefit 4 to 5.5 percent.
Immediately.
Immediately, because we don't have to deal with this ridiculous tax. Now, there are other municipalities like Santa Monica who has the same called mansion tax for lack of better word. It's good that you explained, it is across all asset classes. It's all properties. Santa Monica has one that I believe kicks in at $8 million. And Culver City has one that kicks in at $1.5 million dollars.
And the Culver City one is the one that I'm warning everyone about. Yeah, it's crazy to put a tax on that and then to think about the implications of that for City of L.A.. I think that this tax that starts at $5 million is just the beginning. Yeah, we'll see it at $4 million, we’ll see it at $3 million, we’ll see it at $1 million. And pretty soon we'll see it on everything.
And then that's eventually I was talking I was doing an episode with somebody with one of my colleagues on this Measure ULA thing. And not that we have a crystal ball, but oftentimes these types of taxes get passed down to the end consumer.
Absolutely.
It's silly with this Measure ULA thing, somebody can make more money selling a property for $4.99 million than $5.15 million because of the tax that, sure, they can just sell it for less money.
Ultimately, the landlord is going to pass their cost on to the tenant or the seller is going to pass their cost on to the buyer. Triple net lease. A perfect example, you know, if costs of sale go up, if there is a way for a seller to pass on or sorry, a landlord to pass on expenses to the tenant, they're going to do it.
I'm guilty of that myself. I have properties with triple net leases. When my costs go up, the tenants’ costs go up, period. So how could that not be a foreseeable consequence of this kind of thinking? And then with sales, I think you're going to see buyers participating in the cost of this mansion tax. I think there's going to be offers written where you split the tax, you put the tax on the buyer because you know, it's not totally fair for sellers, it's not right.
And everyone's going to get affected. And I think it's going to make things more expensive. I think it's going to limit supply. And I think it's just totally misguided. Not to mention they don't really have a plan for what they're going to do with the money.
Yeah. So that would that would cause some issues for sure. But, you know, going back to sort of how this could affect the real estate market, more specifically in L.A., you know, it affects all properties above $5 million. There's going to be some people that, you know, aren't going to want to do business in L.A. They'll come out to other, you know, neighborhoods like Calabasas, Pasadena or wherever outside the city of L.A. So those properties became more valuable. So in addition to that, less transactions are likely to get done. So things like 1031 exchanges, movements.
Everything, it hurts everything, anything you can do to stifle transactions is going to have, you know, reverberating consequences everywhere. Yeah, it's unfortunate. I am I have been sick about it. I was very adamant and vocal about it not passing. I was surprised that it passed, particularly after we had already approved a Measure HHH or something.
We just raised $1,000,000,000 or $1.1 billion to combat homelessness. Not $1 of that fund has been deployed. Right. Well, let's just raise another fund without any real thesis on to how we're going to use the money.
Yeah, No, I'm with you. We've got to have, you know, better controls in place and deployment because it's almost seems like we operate in extremes, oh, we have too much money, let's just send it out and here's a tax refund for people versus let's raise a bunch of money and now we're not sure what we're going to do with it, but not to get, you know, political or down the road.
We're here to talk about real estate, although some interesting points that I feel like I could go on a rant about. We talked about some of the issues and risks that we see with regards to real estate, with loans coming due that are going to reset at higher prices, Measure ULA, yadda, yadda, yadda. Where are you seeing opportunities right now?
You know, Oscar Wilde said that a fool knows the price of everything and the value of nothing. There is a lot of value plays in residential and single family, I think, throughout the city. I think that, you know, I live in Eagle Rock, California. I think it's an undervalued neighborhood. I think there's a ton of investor opportunity for single family in that neighborhood because you're exempt from the Tenant Protection Act, which was just passed, although you’re exempt from the Tenant Protection Act, although there are some new rules that came into play that make renting less desirable, I think that, you know, in the last few years with the increased regulation of California, particularly the Tenant Protection Act, which was passed at the end of 2019, single family has become a very acceptable and sought after asset class for investors. And you see it with large, institutional investors. They're buying up everything. Here in L.A. harder because the entry point is harder. You cannot buy a house.
They don't cash flow nearly as well.
They don’t cash flow as fast. But they do appreciate and rent is going up with inflation, with the cost of everything going up, rent is going up. You know, my family owns a home in Westwood. We are raising the rent lockstep with inflation, 6.5%, or 6% last year. So I think there's a lot of opportunity in real estate, in single family, particularly. Multifamily, it's tougher. You know, you have L.A. City now not only has mansion tax, but of course they have L.A. City rent control, the Rent Stabilization Ordinance, and they make it really tough to want to be a landlord. You know, you couldn't evict someone up until this month for, you know, based on COVID.
Yeah.
It’s been a non-issue for a year. I own a rent controlled building. It's been three years since I could raise rates on my tenants, which is ridiculous because I still have to pay for the repairs that need to be made for the maintenance for the building.
If you've got a piece of real estate that is largely vulnerable to an increase in interest rates, but you haven't been able to increase your rents, that affects, you know, serious dollars in your pocket.
Absolutely.
Now that you're potentially, if you wanted to sell it and exit and now if that's over $5 million and it's subject to an additional tax, there's a lot of pain points there.
Yeah, it's unfortunate. And, you know, it makes for, you know, all this regulation makes for bad landlords because landlords, you know, their only real means of saving money would be not to be the best landlord. And I’m not saying that's the right thing to do. But at the same time, if you can't raise rents and then everything else has gotten more expensive, you've got to pay for a water heater. It's not fair. It's not it's not right. It doesn't work.
I feel you on that one. Brad, I feel like we've talked about a lot of really interesting topics today. And thank you for sharing some insight around single family, office, multifamily, different locations between, you know, the city of L.A. and others. I feel like your clients are in good hands and you helped kind of give us some better perspective in terms of the State of the Union on real estate. So thanks for joining us.
Well, thanks, Chris. I really appreciate you having me. Thank you.
Disclosures:
Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and do not represent the views and opinions held by Morton Wealth. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your attorney, finance professional or accountant before implementing any transactions and/or strategies concerning your finances.
