A Tale of Two Cities: What’s Driving Capital to LA vs. New York?
“Los Angeles is just New York lying down,” once wrote Quentin Crisp. Whether that’s true or not is up for debate, but one thing is certain: Both gateway cities are capital magnets.
So, is the City of Angels finally holding its own against Gotham? Historically New York was the darling of foreign investment, but L.A. is attracting more than its fair share of overseas capital and even New York-devoted owners are looking West. Then there’s the steady flow of debt deals on both coasts, the cut-throat competition for which shows no sign of abating.
It makes sense, market experts say, given the similarities between the two markets.
“I think the primary drivers are similar, and capital of all types wants to be in both markets,” Seth Grossman, a senior managing director in Meridian Capital Group’s L.A. office, said. “They are two of the most robust, diverse economies in the U.S. and are better suited to weather cycles than smaller, potentially more affordable markets that look good now and offer higher yields, but in a downturn will likely have far more volatility. Long-sighted investors understand this lower beta and are drawn to it.”
CapitalSource is an active provider of construction and bridge loans in both both cities. “New York is dense with opportunity and undeniably the number one city for attracting overseas capital in the country,” Patrick Crandall, a director in the lender’s L.A. office said. “The investment opportunities are probably a little deeper in New York and certainly larger. L.A. by its very nature is so much more spread out and I feel there are so many opportunities for all stripes of investor in L.A. Plus, it can be a little less prohibitive price-wise than New York.”
Interestingly, some of those entering the L.A. market today are historically New York-focused owners.
“Related [Companies] has made a really big play [in L.A.], as has Steve Witkoff [of Witkoff Group] and the LeFraks, so there are plenty of New York owners here,” Crandall said. “I don’t know that the same is true of L.A. developers moving to New York.”
While Related is keeping busy with its Hudson Yards development in New York, the jewel in the developer’s L.A. crown is The Grand, its $1 billion Frank Gehry-designed master planned mixed-use development in the Bunker Hill area of Downtown L.A. The owner closed on a $630 million construction loan (from Deutsche Bank) for the behemoth project in November 2018.
“As a company, we’re pretty active all over L.A., but I would say we’re most excited about what’s happening Downtown right now, with the renaissance the area is going through,” Rick Vogel, a senior vice president at Related, told CO last month.
“The whole idea behind [The Grand] is to try to recreate the cultural epicenter that this area has always been touted to be,” Vogel added. “It probably has the largest collection of performing arts and visual arts facilities anywhere in the country and yet, there’s no real neighborhood here. There’s no meaningful residential development, very little retail and restaurants, and it really needs something that can turn it into a 24-hour, seven-day-a-week kind of neighborhood. The Grand, which will bring in a luxurious hotel, luxurious residences and a large retail base could really turn it into a wonderful, 24/7 neighborhood.” Construction is scheduled for completion in 2021.
Then, there’s New York-based Waterbridge Capital and Continental Equities, who in May 2018 were in the market for a $500 million loan for the for their redevelopment of The Museum Building—a 1.1-million-square-foot mixed-use project at 801 South Broadway in Downtown L.A.
“We’ve seen an increased percentage of inbound inquiries from clients who have traditionally been New York-centric or have portfolios that are New York-heavy,” said Warren de Haan, a co-founder of ACORE Capital. “They’re looking to L.A. and San Francisco and Silicon Valley and the West Coast more broadly— Seattle and Portland—as places to make sizable and definitive investments.”
The trend has accelerated over the past 24 months, de Haan said: “The interest in L.A. from opportunity funds, private equity shops and high net-worth individuals is pronounced.”
As we (maybe, possibly, perhaps, who knows) approach the end of the cycle, an onset of caution may mean that the outlay on New York trophy assets is harder to digest for some owners and L.A. has more bite-sized offerings.
“New York is a city with a number of enormous stand-alone opportunities,” explained Bill Fishel, the co-head of HFF’s L.A. office. “If you think about an office property in the middle of Manhattan you’re talking hundreds of millions of dollars per asset. Where we are in the cycle nobody knows for sure, but we’re seeing this conversation start to shift away from making a really big bet on individual assets. Owners are starting to think more about diversity across markets and diversity across portfolios.”
In L.A. the individual asset sizing is smaller but it also has the benefit of being a gateway market with an endless amount of liquidity and sustained investor interest. “We’re now having discussions in real time with people who are saying, ‘I’d rather come to L.A. now and buy five $40 million buildings as opposed to one $200 million asset,’ ” Fishel said.
Just as in New York the competition for acquisitions is heating up in L.A. where the buyers are especially diverse—from foreign buyers to institutional owners to family offices to syndicators to mom-and-pop shops. “So many products for sale in L.A. face so much competition from each of these potential buyer groups,” Grossman said.
One notable L.A. market evolution over the last few years however has been the “upscaling” of buyers,” Grossman said. “It seems that every buyer I work with has been executing on assets at least a tier or two higher quality or larger than what they had been chasing a few years ago, which creates more competition in each category. A large driver for this is the tremendous access to capital—debt and equity looking to be placed in L.A.”
When it comes to competition for financing deals, lending sources said the two cities are neck and neck with an abundance of attention from the capital markets.
From Bank of China’s $600 million refinance of L&L Holding Company’s 200 Fifth Avenue and Morgan Stanley’s $900 million refi of the Starrett-Lehigh building, both in New York, to Square Mile Capital Management and Deutsche Bank’s $232 million refinance of Culver City’s (W)rapper Tower and CapitalSource’s $117 million construction financing of The Residences at Wilshire Curson, the latter two in L.A., lenders are pulling no punches. While the deal sizes are generally smaller in L.A., the market still sees whoppers like Deutsche Bank’s $630 million construction loan for The Grand.
“Interestingly there is maybe a little bit of East Coast versus West Coast competition,” said Dennis Schuh, the chief originations officer at Starwood Property Trust. “A lot of firms house their businesses out of New York and from a real estate lending perspective I think people like to be covered by people that are more local so generally a lot of firms have beachheads on both coasts.”
Meridian Capital Group recently closed an adaptive-use financing in Downtown L.A. that will convert a 1920s Desmond’s Department Store which sat vacant for decades into a Class-A mixed-use project with ground-floor retail, coworking office space, and a restaurant and bar on the top floors. “That submarket has experienced tremendous growth this cycle, and the deal would not have been feasible five years ago from a tenant-demand and/or cost perspective. Due to rent growth and major market improvement and transformation, it drew very competitive lender bids,” Grossman said. “We’ve also closed numerous multifamily projects ranging from construction to bridge to permanent financing.”
Multifamily is one of the hottest asset classes from a lending perspective right now in L.A. Grossman said, so financing competition for any multifamily transaction, large or small, is in no shortage. “We are seeing domestic lenders fighting for every project and foreign lenders bidding very aggressively for what are typically the larger loan sizes or higher-profile transactions,” he said.
The uptick in relocation of households, both from other parts of L.A. as well as outside of La La Land, is supporting much of Downtown’s multifamily development.
As such, “There are a number of developments on the multifamily side that are underwriting to top-of-the-market numbers that we have not achieved in L.A. previously, especially in Downtown,” Fishel said.
But while multifamily is vigorously pursued on the capital side, “If I had to pick one I’d say that industrial is unleashing the most aggression from the capital markets,” he added.
In New York industrial lending opportunities are scarce, and the office sector continues to be the most desirable from a dollar standpoint.
“[Office] has been perceived as something of a safe-haven investment given its long-term price appreciation, steady and competitive yields when compared with other global gateway markets,” said Craig Leibowitz, the director of JLL’s research group in New York.
“It’s pretty common to have $500 million office transactions with tremendous frequency,” Leibowitz continued. “We have some anomalies—Chelsea Market was a $2.4 billion office transaction [sold to Google in 2018]— but conversely there are very few industrial opportunities in New York City so there is unrepentant demand for it, from both a debt and equity perspective.”
Throughout North America there are elevated levels of capital chasing value-add and opportunistic opportunities as well as debt. Comparatively there is limited capital focused on core and core-plus opportunities, which New York has to offer. So, when a value-add opportunity pops up, the capital is sure to chase it.
“We are seeing some buildings being repositioned and Terminal Stores is a great example of that,” Leibowitz said of L&L Holding Company and Normandy Real Estate Partners’ $880 million acquisition of the former warehouse, financed with a $650 million loan from Blackstone in November. “It’s in a white-hot real estate market in terms of occupier fundamentals but also necessitates a pretty extensive renovation program and that is where much of the capital is focused on. But those type of opportunities are limited.”
Midtown South continues to be the most supply-constrained and highest-priced market in the country but in terms of desirous areas the West Side is seemingly the best side.
Google announced its $1 billion Hudson Square Campus last month and The Walt Disney Company ponied up $650 million for a development site at 4 Hudson Square in July 2018. Those two giants, together with numerous other creative firms have driven up rents in the market.
And then, of course, there’s a little area called Hudson Yards.
“This market is starved for new office construction; the average age of a new office building in Manhattan is 1956,” Leibowitz said. “Which explains why the Hudson Yards/ Manhattan West district has really outperformed and similar new construction projects have outperformed.”
The totality of the Hudson Yards/ Manhattan West district is roughly 26.5 million square feet of brand new office space, which for most markets would be a tremendous increase in supply but in New York it only represents 5.5 percent of the in-place or existing inventory. “New York can absorb this new construction,” Leibowitz said.
On the other coast, The Westside of L.A. is also coveted.
“The Westside—West L.A., Beverly Hills, West Hollywood, Santa Monica and Silicon Beach—is always a prominent investment target,” Crandall said. “The closer to the ocean you get the most desirable it is, generally speaking.”
“Anything on the Westside of L.A. is gold, extremely well bid and highly desirable,” de Haan concurred. “It is incredibly supply constrained; there just isn’t much supply of office as an example. But we’ve seen a good amount of development of creative office in Hollywood and Playa Vista has expanded at a very rapid rate. El Segundo, a traditionally aeronautical market, has converted many buildings into creative office buildings that are now very well positioned to accommodate tech company needs.”
Another creative office hub is L.A.’s Arts District in the Downtown area. Atlas Capital and Square Mile Capital Management’s The Row project—which features 1.3 million square feet of creative office space and 35 retail and restaurant locations—is a leading indicator of L.A.’s growth, Fishel said. (HFF worked on behalf of the sponsors to secure a $475 million, three-year loan from Blackstone Real Estate Debt Strategies and also sell a minority interest in the property to the Healthcare of Ontario Pension Plan in June 2017.)
“The Arts District is an area that we’ve been talking about for six years and for a project of this magnitude to be recapitalized in a way that is built for a very long time captures a lot of trends,” he said. “There’s the relocation to L.A. from other markets, new urbanism in a really cogent mixed-use template and format. You’re seeing revitalization in an area that historically had not been a beneficiary of that investment. So you look at the size and scale of that project and there’s really proof of concept.”
In terms of foreign capital investment, both markets continue to be attractive targets.
China-based investors were the leading source of foreign capital in New York from 2015 through the second half of 2017. That has effectively dropped off to zero.
“Following HNA Group’s acquisition of 245 Park Avenue for $2.2 billion in May 2017 there has been almost no activity from China-based institutions, but we continue to see elevated demand from a subset of overseas entities—namely Canada, Germany, Norway and Japan,” Leibowitz said.
That capital is focused on the office sector but we have seen more interest in Class-A multifamily, “which is a relatively new phenomenon in New York, although it’s pretty commonplace elsewhere in the country,” he said.
L.A., on the other hand has seen sustained interest from Singapore, Japan, Korea and Canada.
“Big asset managers like Brookfield and smaller groups like Onni Group have been major players within this market,” Fishel said. “Oxford Properties is also very active—their capital is directly tied to Canadian pension plans that are looking at diversifying their holdings, not only across their country but across all of North America.”
“Downtown L.A. has been an interesting place and a focus of investment particularly from Asian investors,” de Haan said. “It has phenomenal long-term prospects but in the short term the market has to absorb new supply of hotels and apartment buildings. It will probably go through some bumps in the short term.”
While New York has seen some softening and experienced its own bumps in the luxury condominium market, in L.A. the market is barrelling ahead, although with discounted price points.
“New York has preceded some trends that we’re catching up to in L.A.,” Fishel said. “So, you do have a significant number of new condo developments going up. But if you think of the asking prices for brand new condo developments in Midtown Manhattan we’re at a huge discount, so it feels like less binary of an outcome.”
But should a correction come our way some time soon, is one market better insulated than the other?
“I don’t think so,” Schuh said. “New York is more financial services-centric, which it has been historically. If the bank market or Wall Street contracted maybe New York is hit a little harder, but if the technology sector is hit, California is more tech-centric. So it really depends, but both economies are pretty diverse.”
Leibowitz concurred. “Over the past 10 years the New York metropolitan statistical area has experienced the greatest economic diversification of any MSA in the past decade,” he said. “It is now less exposed to secular risk than it ever has been in the past.”
And L.A. is in pretty good shape too.
“I think there are infrastructural elements to L.A. and diversifying components to our microeconomy that give you some comfort,” Fishel said. “I don’t think any of us are insulated from macroeconomic factors, and I also don’t think any of us have our head in the sand. I think that what we have seen is sustained discipline on the part of institutional investors; I don’t have the sense that people are pushing leverage as far as they did in the last cycle and I think a big part of that credit does go to lenders for reigning in maximum loan-to-values. What I do think that is different is, because you have lower leverage you have the risk being held by equity investors—and they are going to win or lose.”