Moses Kagan on Real Estate

How Adaptive thinks about valuing apartment buildings

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The first time someone asked me to come in to talk to them about listing their property for sale, I was pretty unsure about how to handle the meeting.

Of course, I had my own ideas about the value of the property. But I was also concerned about the possibility of losing the assignment by being too conservative about the proposed listing price. After all, there a lot of brokers, some of them very successful, who “buy” listings by telling sellers what they want to hear, instead of what reality is.

In the end, I decided to fall back on my training as an i-banker. In that job, a few times a month, we’d be invited in to pitch for the sale of $20-250MM media / technology companies. Of course, the most important question from the potential client would be: “What’s my company worth?”.

This was a difficult question to answer, because companies are so different from each other.

The best approach was to use a combination of methods. We would do a discounted cashflow valuation of the company’s free cashflow. We would do an analysis of comparable sale transactions to get at a reasonable multiple of revenue and earnings (usually EBITDA, for the accounting nerds out there… which is an insane profit measure to use, but that’s another rant). Then, we would look at how the public markets valued similar, publicly traded companies (again, extracting revenue and EBITDA multiples).

Individually, these methods were unreliable. But, if you did the work and then put the value estimates together and took a range, you could get a pretty accurate sense for the market value of the company in an auction situation.

It turns out this is a very good way to think about valuing apartment buildings, too. So, in the next day or two, I will set out the way we here at Adaptive go about valuing apartment buildings here in Los Angeles for the purposes of selling them.

Written by mjkagan

09/16/2014 at 10:41 am

Sorry, Westlake, I was wrong

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In February of 2012, I wrote a piece confidently predicting that Westlake, the neighborhood roughly south of Silver Lake and Echo Park and west of Downtown, would never gentrify. Here is my piece in all its glory.

To lazy to click the link? Here’s my (flawed) argument in a nutshell:

  • The housing stock is incredibly dense, lacks parking and is rent controlled, making it very difficult to renovate buildings and achieve sufficiently high rents to make the investment pay-off
  • The crime rate remains quite high and, without wholesale change in the apartment buildings that comprise the neighborhood (which ain’t happening; see above), it’s unlikely that will change any time soon

[Side note: The language in the original piece, including the unfortunate use of the phrase "by force", is pretty awful. Needless to say, it predates the explosion over Boyle Heights, when I became a bit more sensitive about my choice of words on this site. I left the original post alone because it seems dishonest to change it in retrospect.]

Now, it turns out that Westlake is starting to see the glimmers of improvement, including some new bars and creative office tenants and also some buildings in the early stages of renovation / revitalization.

Why was I so wrong?

It turns out that proximity to the western edge of Downtown, with its rapidly expanding set of amenities (bars, restaurants, clubs, etc.) and high rents ($2000 for a studio?!), is enough to tempt some more adventurous tenants to jump west across the 110.

It’s early enough that the numbers don’t work for my kind of deals. But, depending on what happens over the next few years Downtown, we may all look back on my 2012 Westlake piece as one of the dumber things I’ve ever written on this blog.

Written by mjkagan

09/15/2014 at 10:11 am

Posted in Development

When might you sell?

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On the one hand, the answer is absolutely “never”. I’ve sold approx. 15 buildings I’ve renovated since 2012 and I regret selling nearly all of them.

Why? Because when you own a renovated apartment building with high quality tenants in an improving area, you can expect continued rent, and therefore value, increases over time. Add to that the transaction costs associated with selling and you’re very often better-off just buying and holding onto the buildings.

But there are some good reasons to sell income producing real estate, some related to the real estate itself and some to extrinsic factors:

1. Your depreciation runs out. This only affects long-term owners. After 27.5 years of ownership, the property is fully depreciated. That means you lose a very important tax shield (because you can no longer deduct 1/27.5 of the value of the structure at the time of purchase from your pre-tax income). At that time, you might want to consider selling the property via a 1031 exchange and rolling the proceeds into a new project where you will benefit from depreciation.

2. Your property requires major capital investment. Over time, all building deteriorate, even if they are well-cared for. If your building is due for major systems upgrades (plumbing, electric, etc.), then selling might be the right thing to do. Why? You need to value your time… and managing a re-piping of a building is a pain in the ass. You may be better off allowing a new owner to come in and do the work, while you take your money (again, via a 1031 exchange) and buy something in better condition.

3. You want to consolidate the equity from several smaller properties. Managing a bunch of little buildings can be a real drag. One good move can be to sell several of them at the same time via 1031 exchange and then roll the equity together into one larger property, which you can then hire a management company to run. These are complex transactions, but they are feasible if you know what you’re doing (or hire someone who does).

4. Moving equity from low-growth to high-growth neighborhoods. Rents (and therefore values) don’t rise at the same rate across the entire city. If you currently own somewhere that is stable or growing only very slowly, it can be advantageous to sell and then move the equity to a faster-growing neighborhood. This is a tricky one, because you need to have real conviction about both your existing neighborhood and the new one.

5. Life events / age. This one is not really a choice… it’s just an acknowledgement that life sometimes intrudes on real estate investments. Example from my own life: My folks have owned and managed small apartment buildings in Troy, NY for 30 years or so. Recently, they have begun to sell, since the market is strong and they’d rather sell out now, while they’re young enough that they’re not forced sellers. The alternative would be to hold until they’re too old to manage themselves and then potentially have to sell into a down market.

If you own property and any of the above apply to you, you might consider getting in touch. As you can probably guess, I’m going to lean on you not to sell. But, if, after we discuss, it seems like selling would make sense for you in your situation, then perhaps we can help.

Written by mjkagan

09/12/2014 at 10:49 am

Posted in Brokerage


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Sometimes clients ask me why we’re so focused on Northeast LA (Silver Lake, Echo Park, Highland Park, etc.). After all, LA is a big place and there are plenty of other places to buy apartment buildings. So why the focus on the hipster areas?

Hint: It ain’t because we love asymmetrical haircuts, beards and artisanal pickles.

Regular readers know I would do deals on the moon if the numbers made sense.

The reason we focus on those key areas of NELA is because that’s where the money is!

There are still plenty of owners who have run-down buildings which they stopped maintaining years ago.

When those owners get sick of running slum buildings or pass away and leave them to their children, we have the opportunity to buy them, fix them up (a lot!), and charge rents sufficiently high to make the whole thing worthwhile.

I’m constantly on the lookout for more areas where our model works (using this equation), but for right now, NELA is where it’s at.

Written by mjkagan

09/10/2014 at 10:15 am

Posted in Buying, Development

Do we compete with our brokerage clients?

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In a word, “No”.


Because we’re not interested in buying the properties our brokerage clients want to buy.

Our typical brokerage assignment is to help someone buy:

  • 2-4 units
  • $500k-1MM
  • 20-25% down (so, looking to put out $100-250k in capital)
  • 70-75% LTV mortgage
  • Minimal renovation required
  • Cashflowing (eg priced at 12x GRM or less)

The deal outlined above is perfect for a non-professional investor, who will generate a decent yield with a 30 year fixed mortgage while using a reasonable amount of cash and keeping headaches to a minimum.

But that kind of deal doesn’t work for us, because we can’t use that kind of leverage and we’re willing to go through major hassle in order to generate far above-market returns.

What we want to buy for our funds:

  • 4+ units
  • $500k up to $2-3MM
  • All cash
  • Massive renovation required
  • $200 / sq ft or less
  • Don’t care about the yield (eg willing to pay a functionally unlimited multiple of the rents)

As you can see, the deals we want are complicated and capital-intensive. In short, they are not the kind of deals that our typical clients are equipped to do.

Written by mjkagan

09/09/2014 at 10:35 am

How the Adaptive brokerage works

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Regular readers know that Adaptive has a small but very active brokerage business. Figured I’d take the time today to explain where it came from and how it works.

Back when I was buying and renovating buildings through Better Dwellings, my first real estate vehicle, I started to get frustrated with the way the deals were being done. I would scour the market for a deal and then have to call a friendly broker up to get him / her to write on it for me.

After a while, it started to feel ridiculous to be handing brokers tens of thousands of dollars in buy-side commissions when I was doing all of the work. So, I went and got my license.

I did a ton of deals through BD and made all kinds of mistakes, many of which are documented in this blog. But I got very, very good at brokerage, particularly on the buy-side.

As BD was winding down in 2011-12, some friends came to me to ask if I would help them buy a home (not an apartment building). I wasn’t exactly flush with cash at that point, so I said yes. I did that deal and then several more. Those were the first deals I ever did for other people (in other words, my first as a real broker).

Eventually, so many people started asking me for help buying buildings that I could not service them all, particularly since I was by that point investing Adaptive Realty Fund 1 and also starting to work on fee-for-service projects.

At around this time, Marcus McInerney contacted me via the blog. Marcus had done a bunch of his own rehab deals in the Echo Park area and was clearly bright, honest and ambitious. We agreed that he would be the perfect person to help some of the people who were contacting me looking for help.

Marcus joined Adaptive as our first agent and he and I worked very closely those first six months or so to teach him our methods. He did so well that we brought on more agents, all of whom I have personally trained and whom I continue to supervise closely.

So, now, when someone contacts me looking for help buying an apartment building, here’s what happens:

  • First, we spend a bunch of time discussing the prospective client’s resources, goals, expectations, etc.
  • Then, I go away and consider which of the agents would be the best fit for that specific clients;
  • If the client agrees with my suggestion, I make the introduction and then ensure that the agents gets off to a smooth start with the client
  • As the client makes offers and, eventually, gets into contract on a deal, I am in daily contact with the agent (and, sometimes, the client) coaching, giving advice, and making introductions to relevant service providers
  • Finally, if / when the deal closes, Adaptive takes 30% of the commission earned by the agent (obviously, the agent keeps the rest)

Right now, the brokerage represents a tiny fraction of Adaptive’s revenue. But, I love the work. And, over time, as we find really special people and bring them into the fold, I expect the business will grow into something more substantial.

But the only way from here to there is to keep helping smart clients do smart apartment deals. So that’s what we’re doing.

Written by mjkagan

09/08/2014 at 12:08 pm

How a fund manager gets paid

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Do you ever wonder how, exactly, Adaptive makes money? Figured I’d break it down for you.

Today, let’s talk about our investment funds. These are discretionary investment vehicles. That means a group of people with capital to deploy commit a certain amount of money (say, $100-250k) to the entity. Then, we, as managers of the entity, take the money committed by all of the investors (typically in the $2-5MM range) and use it to buy, renovate, lease-up and (eventually) sell apartment buildings.

So, how exactly do we, Adaptive, make money from these investment funds? Here’s how:

  • Asset management – Like most money managers, we generally take 1% of the capital committed to the fund as an annual fee. The purpose of this fee is to help offset the cost of running our operation (bookkeeping / accounting / investor relations / acquisitions staff / etc.);
  • Brokerage – If we find the deal, generally Adaptive Realty, Inc. acts as the broker on behalf of the buying entity and therefore collects a 2-3% buy-side commission. Of course, if it’s an off-market deal that comes to us via another broker, that broker takes the commission;
  • Acquisition fee – Whether we broker the deal or not, we typically take a 1.5% acquisition fee to compensate us for the work that goes into finding the deal, negotiating the terms, and undertaking the due diligence necessary to ensure it’s a good fit for the fund;
  • Construction oversight – There is an unbelievable amount of design, purchasing, and construction project management that goes into one of our projects. We therefore charge the fund a construction oversight fee, of 10-15% of the construction budget to off-set the cost to our organization of providing these services; and
  • Property management – For better or worse, we do almost all of our own property management, for which we are paid 5-6% of the annual rents on completed buildings. I almost forgot to add this fee in, because property management is a terrible, loss-making business and neither Jon nor I see a dime of this money.
  • Exit brokerage – When it comes time to sell a deal, we typically act as listing broker under standard industry terms (5-6%), earning ourselves a brokerage commission which we split with the broker representing the buyer.
  • Promote – This is our share of the profits. This comes only after investors have received all their money back and also (usually) a pre-negotiated “preferred” return on their money. The split varies depending on the deal and how high the pref is.

Does the above sound complicated? It is. But we’re providing an incredibly valuable service to investors, one which requires an awful lot of effort and experience, and we obviously need to get paid for it.

Tomorrow, we’ll talk about the brokerage and property management business.

Note: This blog post is not a solicitation for investment or an offer to sell any securities.

Written by mjkagan

09/04/2014 at 4:18 am

Why our infrastructure is falling apart

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The NY Times had an interesting piece over the weekend about LA’s failing infrastructure. It focused, as all these pieces do, on the age of our pipes, sidewalks, etc., plus on CA’s general tax-aversion.

What it left out was any discussion of the role our zoning code plays.

Here’s the deal: If, as a city, you make it difficult to build dense multifamily, you do two things, both of which are awful:

  1. You force people to spread out. This means that you need to maintain more road miles per person, more sewer pipe miles, more water pipe miles, etc. So your costs are higher; and
  2. You limit the value of your land and therefore artificially reduce your tax base. There’s a reason developers want to build more units on every given plot of land… the land is worth more if you can fit more people on it (either via rent or condo sale proceeds). Property taxes (imperfectly, due to Prop 13) reflect the value of the land, so less density equals less tax revenue.

So that’s why we’re in the position we’re in: An expensive to maintain infrastructure with limited revenue to pay for it.

Unfortunately, we can’t go back and change the way LA developed. We’re stuck with, for example, maintaining absurd one lane roads up in the hills, the utilities that service the homes up there, and the fire department required to prevent them from burning down.

But we can change the zoning code, right now, to prevent further sprawl and begin to densify core neighborhoods of the city. Changing the zoning code to allow for much denser development wouldn’t cost anything and would dramatically increase property values in the affected neighborhoods, leading to happy owners and a city with sufficient resources to re-invest in a world-class infrastructure.

Written by mjkagan

09/03/2014 at 10:23 am

Posted in Development

Lyft, Uber and America

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Regular readers know I’m a major fan of ride-sharing companies. They’ve totally changed the way that I, and many other Angelos, get around our city. And, as I’ve written before, I think the changes are sufficiently profound to eventually reshape the built environment here, too.

But today I want to focus on what I regard as a side benefit of using these services: The opportunity to speak with the drivers.

I speak with every driver, because I’m naturally curious. And, so far, particularly on Uber, the drivers tend to be immigrants. They are all studying, learning English, working multiple jobs, and looking out for opportunities to start businesses.

Every time I have one of those conversations, I’m reminded what an amazing country we have. Because we’ve set up a free economy where people can get ahead by working hard, we attract the hustlers from everywhere, the ones who are willing to forsake the places they were born to follow a dream.

Not all of them will succeed; indeed, many will probably end up going back where they came from. But, from among that group of hungry, energetic risk-takers, you know that businesses are getting created, jobs are getting created, and capital is being formed.

I find it almost impossible to be discouraged about the future of our country, no matter our problems. As long as the hustlers choose us, we’re going to be just fine.

Written by mjkagan

09/02/2014 at 10:19 am

Posted in Development

Highland Park gentrification response

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Hat-tip to Curbed for linking to this really fascinating piece on Highland Park gentrification.

Before I get into my problem with the article, I want to congratulate the author on what I think is a fair, reasonable account of the changes taking place in Highland Park.

Now, to the problem. Here’s the money quote:

These [renter] residents have reason to be anxious about what gentrification may bring to Highland Park…[w]hile rising property values allow homeowners to cash out, there’s no economic upside to gentrification for renters, many of whom are likely already stretched financially…”

Can you tell what’s wrong with the above paragraph? Read it again.

Give up? Here’s the problem: It’s like the author has never heard of rent control.

It’s true that Highland Park has a large number of non-rent control apartment buildings plus plenty of single family rentals (which are non-rent control by definition). So there are definitely residents who are getting pushed out by the more affluent tenants moving into the area.

But there are also tons of pre-1978 apartment buildings which are covered by rent control, which limits rent increases for existing tenants to 3% per year. And, because much of HP is covered by a huge Historic Preservation Overlay Zone, most of those buildings can never be torn down, so matter how high market rents get.

What does it mean to be a rent-control tenant in a gentrifying area?

The market rent is the price put by the market on consuming a particular unit in a particular building. The price is determined in part by characteristics intrinsic to the unit (number of bedrooms, baths, condition, etc.). But it is also determined by extrinsic factors, principally how desirable the neighborhood is.

Rents in Highland Park are running up way faster than 3% / year, in large part because the neighborhood is gentrifying (better food, booze, retail, etc.). And legacy tenants get to patronize those new restaurants and coffee shops alongside the newbies.

So, one way (not the only way) to interpret the above facts is this: As a rent control tenant in Highland Park, you’re getting a better and better deal with each passing year (as your rent falls further and further below the market price for your unit).

Written by mjkagan

08/29/2014 at 11:22 am

Posted in Development