Fred Gortner here from Paladin Realty. We've been devoting a lot of our recent videos to the defensive themes that underpin what we're doing here in Southern California, are our rental apartment strategy here in greater LA. There's a cycle resiliency of the demand for the Class B/Class C apartments that we target because they're really the only infill housing option that's available in the LA metro area to the renters that we target. And so, there's a durability of the rental income and cash flow that we can get in these assets that really is difficult to replicate in other product types or other markets across the country. And what gives us a unique competitive advantage, I think, though, in this marketplace and helps underpin that durability of cash flow is the steep discount to replacement cost that our properties have relative to new construction. And so, what is it that's so unique about the SoCal assets that we target that gives them such a huge cost advantage, and why is that the case, especially in a large gateway city like Los Angeles, where you would think that there would be so much competition here, that that cost advantage would kind of be arbitraged away. And the answer is rooted in a couple of things: number one, it's the unique evolution of the buildout of the existing rental housing stock here in Southern California. And because of that, and the type of assets that typify the existing rental housing stock, there's an absence of widespread institutional ownership, 

It's very unique to L.A. compared to other gateway markets or even most other markets in the US, which are dominated by institutional owners. The third factor: less dominance of institutional ownership means that the market here in LA is dominated by smaller, less sophisticated (we call them "mom and pop" owners). And because of that, there is a resulting abundance of smaller, low density, rundown, poorly performing apartment buildings that create opportunity for us and importantly, create a competitive cost advantage for us. So let's dig a little deeper here and talk about how the rental housing stock was built out. The existing rental housing stock here in LA was largely built out in the decades after World War II, and it was done at a time when land was cheap, plentiful, and available for development. And so, the typical apartment building in the greater Los Angeles area is very low density - it's typically two-story, walk-up building, around a courtyard or a pool, very few amenities, the typical asset size is much smaller than you find in other markets. 85% of the rental housing stock here in LA is 50 units or less, it's much smaller than the 200/300/400 unit apartment properties that typify other markets like Phoenix, Dallas, or Atlanta. And they're older assets - over 90% of the rental housing stock here in LA is over 20 years old. So it's mostly Class B/Class C assets. Because they're low density, they are truly irreplaceable assets. They're significantly underutilized real estate compared to what the highest and best use would be for this land if the land were vacant.

And yet, if you buy an existing apartment building, it's extremely costly, extremely time intensive and risky to tear down that asset, relocate tenants, go through all of the hurdles of development, the lawsuit, and redevelop it into a new high density apartment building. It's prohibitively expensive for most investors. And so, the pricing of these older apartment properties reflect all of this. And because the smaller asset sizes that typify the rental housing stock here in Los Angeles keep the larger institutional investors away, it creates great opportunity for us, because it's just too management intensive for larger institutional investors to build up/scale up a portfolio of any meaningful size - it's just to management intensive. So you've got this large fragmented pool of smaller "mom and pop" owners, they don't realize that their assets are underperforming the market, they view rent control as a nightmare - not an opportunity, if you understand the rules. They don't really have the knowledge, resources, or the desire to invest/make capital improvements to their properties to maximize value. They'd rather actually do the opposite - they'd rather keep cash flow steady - that means keep rents low, that means minimizing unit turnover, which can be costly, and only putting capital improvements in when it's absolutely necessary. And that's a rational objective for most institutional owners. But what it means is there's a sea - just thousands of these rundown properties with a lot of deferred maintenance. And it also means that you have current rents on these properties here, 20% to 30% below where market rents are.

That's what we've called in other videos - the loss to lease, and that is a huge value added opportunity for investors like Paladin who know how to capture that loss to lease. So, the combination of all of these attributes which are really unique to the LA market - and we've invested all across the US over 30 years almost $1 billion in this strategy. What's unique about LA is that there are thousands of these rundown, poorly managed buildings. They are irreplaceable, low density assets that are underutilized - the real estate, and the pricing reflects it, in one of the most supply constrained markets in the US, with huge barriers to entry for new constructions, it's hugely costly. And so, all of those factors combined mean that the assets that we target - these older, smaller, Class B, Class C apartment buildings trade at huge discounts to replacement cost - 50% or more - our renovated cost, post renovation stabilized is 50% or more below what it costs to build a new apartment unit, even an affordable apartment unit here in Los Angeles. That discount replacement cost of 50% or more is truly unparalleled in the US, and as a result, it gives us downside protection that you really can't replicate in other markets where the ownership of assets is broadly held by institutions who take the arbitrage (that loss to lease) out of the market, who narrow as a result, the discount to replacement cost, when buying assets are the norm, and you end up paying 10% to 20% or more for an asset then you really would prefer to, and where the discounts to replacement costs are much lower and at times in a market cycle nonexistent altogether.

And so all of this means that the rents on one of our fully renovated and upgraded units, our pro forma rents that we're achieving are about half of what class A rents are in Los Angeles. And that's what gives us a competitive cost advantage, particularly when times get dicey - steady demand, relatively high occupancies in our properties because we cater to a renter by necessity during all market cycles who really don't have any other affordable infill housing choice without traveling long distances to find affordable housing. And during market downturns, we've actually seen occupancy go up because our assets tend to appeal to the renter by choice, who was residing in more costly Class A apartment buildings - they no longer can afford to live there, and so they're looking for the value in the marketplace - and that's what our Class B and Class C properties are. So it's a pricing advantage, this 50% pricing advantage relative to the class A space. We've never been able to find that in Phoenix, Dallas, Austin, or Atlanta, or any of the other major US markets that are dominated by institutional ownership. It's one of the reasons we've focused this strategy in recent years solely on the Southern California market, because the downside protection that we get is really unparalleled.