Apartment Rents Are Not High Enough to Justify Building New Construction in Coachella Valley

This title asserts two issues:

1. Rents are low, and not likely to increase significantly, and...
2. ...Construction is expensive.

1. Rents are low in this area, and not likely to go up considerably.

Rents in Coachella Valley range about 80¢ per square foot  (big units in Indio) to about $1.50 PSF (small units in Palm Springs). 

This compares to $2 PSF in up-scale areas of Los Angeles. New construction in LA is projecting $4 PSF for luxury apartments, with amenities and concierge service. 

As I posited in my last blog entry, rents are probably not going to shoot up in this area, because the average working household won't be able to afford it. Without wages going up, the cost of living is the barrier.

2. Construction is expensive, and shooting up. 

Construction companies contracted during the last Recession, and the survivors are now very busy. They're not likely to cut their prices. In addition, the cost of materials is very high, historically (supply and demand pushed up prices).  

Plus, cities have made it increasingly expensive, and risky, to propose development. Architectural design, consultant studies, attorneys, and insurance pre-load any development ideas with hundreds of thousands of dollars of costs -- before even being approved by the city. I know developers that are bitter after their experience with various Coachella Valley city planners. I see their point. 

So what are the economics?

Rewards have to attract the developer. By investing in T-bills, money can earn two percent. By making real estate loans, it can earn about seven percent. So developing, with its risks, must earn more. 

Most developers I know won't consider a project that will earn less than fifteen percent, considering the hours of effort, and riskiness of creating a project.  And that's a bare minimum. Let's use twenty percent "internal rate of return".

Every IRR calculation starts with the initial investment. Let's say that a twenty unit apartment building in a working class neighborhood will be our goal. Let's use Palm Desert, a nice upper middle class area in Coachella Valley.

Rents are about $1.20 PSF in Palm Desert, according to CoStar Data. 

Let's build our twenty units as two bedrooms, about 800 SF.

Vacancy in Palm Desert is about three percent (CoStar), but most underwriters use a minimum of five percent vacancy.

Expenses for an apartment building run between 35% and 40% of rent revenues.  I'll use an average of those numbers, or 37.5%.

So, it looks like we would have an asset worth about $2.5 million after building it and filling it with paying tenants. (And this is figuring we just had the money sitting around, and didn't need to borrow any. More on this later.)

What would it take to create this $2.5 million asset?

Forgive the generality, but this calculation is a personal decision for each developer. If their time is worth anything, and they see risk as a cost, there's just nothing left over for buying land in a desirable area and going through the process.

Okay, I'm not wringing my hands and complaining about life. Investors can use this information to make decisions. See next chapter...