Why people pay high prices

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Had someone yesterday email me asking why I think people are paying insane prices for Los Angeles apartment buildings.

By insane, I mean 15-19x annual rents. At those prices, there’s basically no cashflow; in fact, at the upper end of the range, it’s likely you’ll pay to own the asset each month (instead of the asset paying you!).

As I see it, there are three reasons why someone might be willing to pay such insane prices:

  1. She may intend to do something else with the property. For example, I just paid 18x for a property. But, since I plan to renovate, I don’t care much about the existing rents. Same goes for developers who rip down and replace older buildings;
  2. She may expect appreciation. Prices in LA have risen faster than inflation for decades. Some people might be fine with just breaking even on the cashflow and hoping for appreciation. I don’t like this strategy in a hot market (where prices are already at a cyclical high), but what do I know?; and
  3. She may be misinformed. Inexperienced buyers are easily duped by inexperienced / dishonest brokers who fail to price-in normal expenses, making bad deals appear reasonable.

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