[00:00:00] Hi, Fred Gortner here from Paladin Realty. When I'm describing our Southern California apartment strategy to prospective investors, I often get asked the following question. They ask, "There must be a lot of institutional investors like Paladin competing for these deals, right"? And the answer, which may surprise you, is NO. And it's an answer that would seem to defy logic, given the fact that Los Angeles, the greater Los Angeles metro area, where we focus, it's a major gateway city of over 10 million people. It's one of the largest and most diverse economies in the world; it would be the 19th largest economy in the world if it were its own nation. And so why is there relatively little competition among institutional investors for the types of assets that we target, the types of multifamily assets that we target in Southern California? And more importantly, why does that lack of competition create value for Paladin? So, let me address the first issue, which is the lack of institutional investors. And in short, it is a very management intensive proposition to scale up an institutional quality, institutional sized portfolio in Los Angeles. And so most larger institutional investors avoid the market for that reason. And the reason behind this is somewhat unique to the LA market, and we've talked about this in other videos, but the LA rental housing stock was mostly built out right after World War II. It was done when land was cheap and plentiful, a very different story than today. Frankly, a very different story since the 1970s.
[00:01:50] And so when you drive around, the typical apartment building in greater LA is low density, it's typically a two-story walkup, with no amenities. And if it has anything, it might have a courtyard or a pool. And most importantly, these are smaller assets; 85% of the rental housing stock in LA is 50 units or less. And so why does that keep the institutions away? Well, the answer is simple; you have to acquire ten times as many apartment buildings in Los Angeles to achieve the same scale as you would in Atlanta, Phoenix, Dallas, or other major US markets which are dominated by institutional ownership, but where the asset size, the typical asset size is 300 units per asset, rather than 30 units per asset. And so most institutional investors just simply find the LA market to be too management intensive. And so what does that mean? That means that the apartment market here is dominated by a completely different kind of investor: an unsophisticated smaller individual or family, or what we call "mom and pop" owners. It is a huge pool. It is fragmented. And these owners usually aren't sophisticated enough to realize that their properties are underperforming the market potential. They view things like rent control as a nightmare rather than an opportunity if you really understand the rules and know how to navigate them. Most don't have the knowledge; they don't have the financial resources.
[00:03:34] And if they did, they don't have the desire to actually invest in their properties to optimize value. What they would rather do is keep capital investment low and keep unit turnover to a minimum in order to save money. And that's actually a rational objective for a "mom and pop" investor, who treats these assets that they've typically owned for decades, like ATM machines. But that's also what creates a great opportunity for more sophisticated investors like Paladin who know how to scale up small asset strategies the way that we've done across multiple markets. And if you drive around LA, you will see that the market opportunity is everywhere. There are thousands of tired, rundown apartment properties, current rents 20% to 30% or more below market. We have yet to buy an apartment building where there is something called a ratio utilities billing system in place or RUBS, which is a way to pass through utility costs. It's one of the most basic things you do as a professional institutional quality asset manager, and it is not here in Los Angeles. So that's one way that you can enhance income day one with an asset. And there are all kinds of evidence of poor management. You don't see the same abundance of value-added potential in other major US markets, which are dominated by institutional owners because smart, savvy institutional owners know how to maximize market potential. And so if the ownership pool is dominated by those kinds of players, it's harder to find that arbitrage between a poorly managed building and a well-managed building.
[00:05:19] But you see it all over the place in Los Angeles. Some other important factors that create the advantage for us, because we're buying from a fragmented pool of these "mom and pop" owners who typically place more value on certainty of closing over the highest bidder. This is because a lot of them are going into 1031 exchanges and sell the property to us, they've already identified what the property is they're going to acquire in a 1031 exchange. If their sale doesn't close, it can disrupt the whole exchange and have huge tax consequences. So they place a lot of value on certainty of closing over the highest bidder. And that's where Paladin, I think, has a competitive advantage because we've been active in this market for 30 years, we are known as a reliable buyer with strong institutional financial backing, we have a reputation for closing transactions without re-trading price, we have a reputation for protecting our broker relationships. One of the things that we do is we allow the listing broker to represent us as the buyer, and to potentially earn a third commission when we ultimately end up selling the asset after we've added value. So a broker can earn three commissions by selling to us. So as a result, we have typically been able to avoid auctions. And auctions typify most institutional real estate acquisitions where you've got institutional players, and all they end up doing is bidding up the price and hurting returns.
[00:06:59] And so we rarely buy assets...in fact, we never buy assets...whenever it enters an auction situation. We will name our price to the broker and tell them, look, if it falls out with your exchange buyer a couple of months from now, if we are still interested, we'll still be good at our price. We've had multiple opportunities. In fact, the majority of our acquisitions in the last year were those kinds of situations where we stayed firm on our price and ultimately a month or two later, the opportunity came back to us on a negotiated basis, at our price. Avoiding auctions is pretty valuable because we've found that when a property actually goes to auction and closes, it tends to trade 10% to 20% above what our price would have been. So having that pricing advantage by avoiding auctions, that builds an extra margin for error in our investments that frankly, we want to try to get into every investment to avoid overpaying. So bottom line, this lack of institutional competition and the resulting abundance of value-added opportunities because of the breadth of "mom and pop" ownership here, and the competitive advantage that that provides to an institutional player like Paladin, that's one of the reasons we're primarily focused on buying Class B/Class C apartments here in Southern California, and why we think it's a pretty compelling opportunity over the foreseeable future.