There are some deals right now that:
- Aren’t right for our current fund (because the near-term returns aren’t high enough), but
- I want to buy (because I think they have a lot of potential down the road)
One obvious solution to this problem would be to buy the deals with non-fund money, either my own or from a JV-partner.
The problem is that doing so might come pretty close to the line from a fiduciary perspective, because I’ve committed to my fund investors that I will give the fund my best ideas.
If I go buy these deals with separate money, the investors in my fund might get the idea that I haven’t lived up to my moral and legal obligations. And that’s not something I’m willing to let happen.
So, I’m going to let these pitches go by. How annoying.
Am looking at an interesting deal, but it’s in an HPOZ (Historic Preservation Overlay Zone).
Because the structure was built during the time-period the HPOZ is intended to protect, it is categorized as a “contributing structure”.
It is extremely hard to do anything to a contributing structure.We would need prior approval for any work on the exterior and that approval will not be granted for anything that changes the original design.
That means we can’t, among other things, move or enlarge the windows, insert sliding glass doors, build our standard fencing, etc.
Because we can’t use most of our normal tricks, we need to project lower rents for the completed units than we would if we were not constrained.
Because we are projecting lower rents, the deal goes from being a marginal “yes” at the list price to a strong “no”.
On my numbers, the reduction in building value due solely to the HPOZ designation is something like $100,000, or 10-15%.
It’s not unfair to wonder what, exactly, the city is getting in exchange for that diminution of the property value.
Recently, have found myself telling a lot of people not to buy real estate. Weird, right?
But the market is pretty hot right now and it’s easy to make a bad deal.
I don’t worry about this with the sophisticated investors with whom we work. They trust us not to do anything stupid and we take that trust incredibly seriously. Plus, being sophisticated investors, they are accustomed to deals sometimes not working out. So, in the unlikely event that we were to lose money (it hasn’t happened yet, but it probably will!), it would not be the end of the world.
I do, however, worry about less sophisticated / less wealthy clients of our brokerage. These people tend to have $50-500k to play with and that money is very, very important to them.
So, we find ourselves advising many of these people not to buy things that they themselves want to buy.
Why would a brokerage talk itself out of commission income?
The answer is pretty simple: The brokerage is tiny compared to the rest of our business. We have big ambitions for it, but those ambitions will only be realized over the course of years. And the way that we will realize them is to make sure that our clients are happy with the deals we help them buy. Happy clients refer their friends / family / etc. and that is, by far, the best kind of marketing.
So, we’re perfectly happy to tell people not to buy marginal deals. We figure, over the long run, earning trust is considerably more valuable than money.
Saw that someone arrived on the blog yesterday using the following search term “convert duplex into single family home”.
Here’s my advice: Don’t do it. Or, at least, don’t do it with permits.
Regular readers know I’m strongly in favor of using permits for every single construction project. It’s a bit more expensive, but you want to be able to sleep at night knowing that the work was done properly and is in compliance with relevant city codes.
So, why am I advocating doing any conversion of a duplex into a single family without permits?
This is one piece of work that can cause severe, permanent value destruction.
Why? Many older buildings have grandfathered units. For example: You might have a 4plex on a lot which is now zoned only for duplexes.
If you go to the city and ask for a permit to remove a unit in the aforementioned building and turn it into a triplex, they will happily give it to you. But later, when you want to re-convert the triplex into a 4plex, you will not be able to.
Why does this matter? After all, it’s not like, in converting from a 4plex to a triplex, you’re losing square footage.
But, as we’ve discussed previously, generally the smaller the unit, the higher the rent per square foot. Given the choice, you’d always rather have more units rather than fewer in any given square footage.
So, it’s insane to remove a unit, because you will impair the achievable rents and, therefore, the value. And the change is likely to be irreversible.
…who didn’t also renovate tons of apartment buildings, I would:
- Run rent surveys across all relevant neighborhoods, all the time
- Constantly poll my clients about construction costs for different finish levels and unit sizes
- Constantly poll my clients about eviction / tenant relocation costs
Why would I do all these things?
Because, without the above information, I would:
- Ignore some deals which I absolutely should push my clients to buy; and
- Push my clients to buy some deals they absolutely should not buy.
Both of the above mistakes would cost my clients money (either in bad deals or missed opportunities) and therefore cost me credibility.
Fortunately for me and for our clients, Adaptive does so many renovation projects in the relevant neighborhoods that we know better than anyone what the above numbers actually look like. That doesn’t mean we don’t make mistakes, but it does mean those mistakes are rarer and less costly than they would otherwise be.
In case you’ve been under a rock: The stock market has been in free-fall since the beginning of October. Here’s a handy chart:
The thinking among investors is that the world economy is slowing due to weakness in Europe and China.
Usually, when investors get spooked by stocks, they sell stocks and buy relatively safer government bonds. And, indeed, you can see the result in US Treasury bond yields:
Yields were around 2.50% and then fell very rapidly down to 2.15% (as of noon today).
What does all of this mean for real estate? Well, mortgage rates tend to be pegged to the yield on t-bills. So, as investors get spooked and flee equities in favor of government debt, they are driving down the rate at which you can borrow on homes / apartment buildings / etc. Here’s the relevant graph:
It’s a bit hard to see, but rates, which were as high as 4.4% in January, are down to 4% as of today.
In real estate, all else being equal, prices rise and fall in an inverse relationship with interest rates (the cheaper the debt, the higher the price someone can pay for the asset and get an acceptable yield, and vice versa). So, if we’re entering another period of low interest rate loans, you can expect prices to stay the same or rise, all else being equal.
For a long time, as young professionals aged into their late 20s / early 30s, they would move out of LA to suburbs in search of a big single family home with a yard, etc.
Demand for apartments in LA, particularly in the areas east / north of Hollywood, was therefore mostly constrained to professionals in their 20s and working people who did not have the income or assets to move out to the suburbs. (That’s not to say there weren’t / aren’t exceptions… we’re speaking in broad strokes here.)
It’s not clear what caused professionals to stop moving to the ‘burbs. The trend really began in earnest around the beginning of the Great Recession in 2007-8. So it may have been that professionals didn’t have the money to move or couldn’t get the loans.
Another explanation was that 2007 was when the first of the Millennials (the massive generation born roughly 1979-2000) hit the age when previous generations would have started to consider moving to the suburbs… but the Millennials basically said “nope” to the high consumption, high debt suburban lifestyle.
Whatever the reason, LA finds itself with a major problem / opportunity: The Millennials are staying in the city and competing with more traditional renters (the young and the working class) for housing, driving rents through the roof. So either the city is going to find some way to allow developers to massively increase supply, or we’re looking at rapid rent increases for the foreseeable future.
Have been thinking about holding another seminar / property tour.
Think this one would focus on one property we’re currently renovating.
We’d examine the initial listing, our thinking in pursuing the deal, how we got it, what the issues were in diligence, and our pro forma.
Then, we’d go walk the property to take a look at the construction underway.
I’m not sure we’re going to do this… It feels like we’d be giving away a lot of information. But I also think it might be great for the right kind of person: someone with considerable resources to invest and am interest in how this stuff works.
If that sounds like you, please email me at Moses (at) adaptiverealty (dot) com and let me know the following: whether you own properties already, your experience with renovation projects, how actively you are pursuing deals, and anything else that might be helpful for me in getting to know about your suitability for this kind of intense seminar.