In many cases traditional methods of valuation – comps, income, and replacement – are no longer guides for pricing property. Sale prices often exceed most traditional justifications. Properties sell with cap rates that are below mortgage rates so the buyer is already starting in a negative position.
Unless the buyer can add value quickly or factor in appreciation, these are not good financial purchases on paper. The shrewd economic justifications only become clear once escrow has closed and the property has been put into use. Here are a few explanations: Los Angeles is a global crossroads and some properties have international dimensions. These properties are not compared to comps locally but internationally
This is especially true if the Los Angeles site is meant to fill a link in a global chain for distribution, production, or sales. In that regard, what some consider overpriced may be a bargain, especially if you include foreign exchange rates. Other locations are analyzed by the sales they generate. Retailers or quasi-retailers value the site in part by traffic and the amount of goods that can be sold. Many industrial brokers and owners miss the retail component of their building. Los Angeles changes so fast that unless you have a retail eye, it’s easy to miss the demand caused by an expanding population.
Los Angeles has a number of micro markets for trade and ethnicity where pricing is higher than the rest of the city. Examples include several downtown markets for merchandise and a wholesale district near Vernon Avenue for “cash and carry”. There are many ethnic communities that cater almost exclusively to people from one foreign country. Real estate prices increase closer to the center of these communities, but only an insider can discern the difference. Zoning adds another dimension. One simple example is how an old industrial site quadrupled in value when the city changed its zoning to residential. As all cities face housing constraints there continue to be enormous increases in value due to zone changes. Land values around redevelopment areas also exceed market conditions.
Finally, professional investors have a second sense when it comes to recognizing potential. Some use patient money with a long horizon. Others use proceeds from past deals. Some take calculated risks based on many years of investing and developing. Key parcels are particularly intriguing because the buyers understand the extra value associated with these properties. Basic underwriting is still fundamental. But buyers who use traditional methods to value real estate will be at a loss compared to those who have a breadth of contacts and experience to understand very local markets and new product types. As Los Angeles continues to grow, buyers of property will need to take greater leaps from fundamentals if they want to continue investing. While real estate cycles may signal bargains from time to time, the overall demographic nature and the intelligence of shrewd investors will be a constant.