Some investors are refinancing or selling their holdings and sitting on the sidelines, waiting for those who are overleveraged to get caught in an interest rate squeeze.

“Patient Money.” That’s what Sperry Van Ness Southern California regional manager John McDermott calls it.

Increasingly, he’s seeing longtime investors follow the example of a recent transaction he helped broker: a client who purchased an apartment building in the late 1990s had enjoyed the rapid property appreciation over the past few years. Sensing a coming opportunity, this client recently took advantage of historical low interest rates to refinance the property, pulling $3.6 million on a mom-recourse 10-year fixed loan at 4.96 percent. And what is he doing with that money? For now, nothing.

“He’s put that money in the bank,” says McDermott, who also national director of office and industrial properties for Irvine-based Sperry Van Ness. “He now has some very patient money where he can cherry pick deals. We’ve not been able to find him anything that satisfies him because he has such patient money, and we’ve put a bunch of properties in front of him.”

In short, McDermott adds, “He believes tomorrow will be better.”

Increasingly, investment brokers say; investors are looking to refinance their existing properties or are outright selling their holdings, in the process looking to amass a war chest for that they believe is a coming opportunity. Specifically, some brokers say, these investors believe others are overleveraged. More importantly, some of these property owners have taken out adjustable mortgages in order to buy more property for their money.

The danger of this strategy has always been that as interest rates raise these property owners will find themselves unable or struggling to meet their debt obligations. Indeed, recent reports have found that 70 percent of Southern California refinancing are going to adjustable mortgages, as compared to 30 percent nationwide.

“Clients are hoping they can grow the rents over time to keep up as interest rates rise,” McDermott says. “My opinion is that interest rates will rise faster than rents can.”

And therein lies the opportunity for the patient money, some believe.
“The qualified savvy investor today is either refinancing their existing properties to build a war chest or selling their property to get their equity out for the same war chest,” McDermott says.

“Most of them are professional owners who bought in the ‘90s, took advantage of the REO market then, experienced huge appreciation and equity growth and enjoyed the ride we’ve seen from then to 2003 and 2004,” he adds. “These are people who can now sell high and will hold that money to buy low, whether that’s here in Southern California or other parts of the country.”

To be sure, not everyone buys this scenario. Brad Schroth, president of Professional Real Estate Services (PRES), a Newport Beach-based real estate investment firm, believes continued appreciation—although slower than in years past—will short circuit patient money’s strategy.

“The investors I have seen are not going to lose their money because they’re limited partners in these things,” he says. “They’re buying with 10 different partners so if they put their $200,000 into a building, maybe it goes down to $100,000 but they still own it. “Some very well-heeled people are buying this stuff and they won’t bust if the market flies on them,” he adds.

Indeed, Schroth says, if anything, commercial real estate has gotten hotter over the past 90 days with buildings continuing to appreciate at a rapid pace. “The money is driving it, private money that absolutely wants to get into the game.”

McDermott counters that much of this activity is being driven by money that must be placed, namely by real estate investment trusts. “REITs are buying everything they can because they raised the money and they have to spend the money,” he says. “It’s not their money and they have a whole different strategy.”

Joe Berkson, a senior investment associate with Marcus & Millichap’s Newport Beach office, agrees with PRES’ Schroth and goes a step further, He cautions that while some people may be selling and cashing out, it’s too early to say that represents a widespread trend.

“There are some people doing that,” he says. “But I don’t know if it’s telling us anything. Inventories have been increasing in a short period of time and that certainly occurs for a reason. The reason is perhaps some people think that maybe the market has topped.”

On the other hand, he speculates, the increase in inventories may make it easier for investors who are looking for 1031 exchanges, especially for investors seeking to upgrade from a lower-class property to what they perceive as a better opportunity.

Reza Etedali, principal with Irvine-based Reza Investment Group, says it’s natural that some people will get skittish, given the high-flying status of the market over the past several years. And some may well have missed out on some opportunities as the market has continued to hum.

“That’s been going on for a couple of years,” he says. “People have taken some of their chips off the table. I would say a lot of them are frustrated because they’ve missed a lot of deals over the past two years.

“Having lost some opportunities, we’re actually seeing them jump back in and going to opportunities like redevelopment deals and repositioning deals,” Etedali adds.

Shaheen Sadeghi, president of Labholdings LLC, a Costa Mesa real estate investment company, has taken a middle-of-the-road approach. Traditionally long-term holders, Sadeghi says he continues to hew to a conservative investment strategy as he acquires properties. At the same time, he’s aware of the buzz regarding “patient money” and is prepared to move quickly if such opportunities develop.

“I think it’s always solid to have cash available just to take advantage of the cyclical times of the marketplace,” he says. “I also feel that even though the cap rates are pretty low, we usually look at cash flow more than anything else. And we’re long-term holders.”

Such a strategy, he says, allows him to acquire properties that he calls “next generation properties,” ones that will undergo “adaptive reuse.” “As land becomes scarce, lots of areas will go through rejuvenation,” he says.

Still, Sadeghi’s been involved in the business long enough to recognize that exuberant times such as these always lead some to make mistakes, especially given the opportunities created by low interest rates.

“We’re doing things on fixed interest rates because we are long-term holders,” he says. “There are probably lots of projects and products out there on an adjustable rate and those will for sure have some sort of fallout at some point.

“It doesn’t mean we’re just going to sit on the sidelines. I think there are a lot of deals to be done,” he emphasizes.

James Flynn, president of Rancho Dominguez-based the Carson Cos., shares this outlook. “We’re not a voracious acquirer of properties,” Flynn says. “But we are selectively buying and are seeing record absorption rates with industrial property. Rental rates are beginning to rise as well.”

The industrial sector has experienced another [nteresting twist, according to Craig Halverson, vice president of acquisitions for Carson-based Watson Land Co. “We’ve seen an unusual amount of capital, both institutional and private, chasing a limited supply of industrial property, and, while we’ve seen some patient money, more investors are remaining very aggressive,” Halverson adds,. “And sellers are taking advantage of the interest by placing property on the market without asking prices—on a for~bid only basis.”

However, some players, already spooked by past memories, are looking at certain trends and feel they’re justifiçd in cashing out, at least temporarily. “Especially the people that got hurt in the early 1 990s,” says Charlie Kennedy, a principal with Irvine-based Healstone.

Key among these trends has been the increase in inventory. As interest rates have risen, so has the supply of properties on the market, a phenomenon that became noticeable about three or four months ago, Kennedy says. Additionally, properties are staying on the market longer, up to one or two months as compared to one or two weeks several months ago.

As a result, some sellers are dropping prices. For example, Kennedy says he recently marketed an 18-unit, all two-bedroom apartment complex that was initially listed at $2.45 million, was priced down to $2.34 million and then again to $2.24 million before an offer was accepted for $2.17 million. That property stayed on the market for roughly 19 weeks.

That seller would like to find an exchange opportunity, but is perfectly willing to walk away as well, believing new opportunities will arise. “People are willing to sacrifice not finding an upleg because the profit is so good right now from the last run up,” Kennedy says. “You can’t go wrong taking a profit, especially the tremendous profit people have been getting over the past few years.”

Despite all this, Kennedy and others continue to believe the market is not necessarily turning, but simply going from an overheated state to a more normal market.
“It’s like going to Vegas and your chips get high real quick and people think, ‘Man, I better leave,’” Kennedy says. “Well, I think you’re still going to make money, you’re just not going to make it as fast.”

Sperry Van Ness’ McDermott says many of his clients agree that there is still money to be made— they just think opportunities are better elsewhere given the low cap rates and intense competition in Southern California. “We’re taking most of our buyers outside of California to Salt Lake City, to Boise and to Bend, Oregon,” he says.

And so, some people will continue to amass their, war chests in hopes of future opportunities locally, McDermott says.

“Two years ago people were refinancing and using the money for lifestyle buys—Range Rovers, trips, etc. Now, they’re refinancing for holding power, and investment potential. In other words, they’re creating vulture funds so when the market gets a little less expensive, they can buy.” —SOCAL