Moses Kagan on Real Estate

Archive for the ‘Brokerage’ Category

Seeing the big picture

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One of my agents is working with a client on an interesting deal and running into a problem.

The building itself is great – big, recently built, non-rent control, in an improving area, fair price.

The problem is that the current owners don’t have their act together. Missing leases, conflicting estoppels, deferred maintenance issues.

None of this is unusual; as I have written here many times no one sells you a great building at a fair price. They sell you great buildings at unfair prices or screwed up buildings requiring a bunch of work at fair prices.

This particular deal is an example of the later type, except that, as issues with apartment buildings go, these ones are pretty minor.

So, what’s the problem?

Our clients are detail-oriented people who are successful in their jobs. They run their affairs in an orderly manner and I believe it unnerves them to see this asset so poorly managed. They have therefore been wavering about whether to move forward with the deal.

This is totally understandable. But it’s short-sighted.


In our business, you need to think not about how things are but about how they can be. Then, you need to work backwards from your vision of the future to see whether you can make it happen for an amount of time / hassle / money to make the deal attractive to you.

This deal, with a little effort, looks like this:

  • $230 / sq ft
  • 9.8x GRM
  • 7.25-7.5% cap (unlevered yield)
  • 10-12% cash on cash return (!), depending on how they finance it

All of this on a newer, non-rent control building in an improving area.

Do you know what that is, particularly in this market? A home run.

Written by mjkagan

12/19/2014 at 11:39 am

Describing what we do

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Have been doing some thinking about how, exactly, to explain how Adaptive helps clients deploy capital in the multifamily space.

Regular readers know we do bunch of different things, including:

  • Managing real estate investments (via discretionary funds and one-off projects)
  • Fee-for-service development (where we get paid cash to help investors buy and rehab their own properties)
  • Property management (for our own deals and select 3rd-party owners)
  • Brokerage

On the brokerage front, I’ve recently found myself describing our service in the following way:

“Adaptive applies the tools, methodologies and procedures developed for our own deals to the deals we do for our clients.”

Someone is eventually going to help me turn the above into a catchy tagline… clearly it hasn’t happened yet!

Written by mjkagan

10/28/2014 at 11:34 am

Why I talk myself out of commissions

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Recently, have found myself telling a lot of people not to buy real estate. Weird, right?

It’s not that I don’t think people should own apartment buildings. They absolutely should, for a whole host of reasons.

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.

Written by mjkagan

10/22/2014 at 9:56 am

If I were a broker…

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…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.

Written by mjkagan

10/20/2014 at 10:20 am

Building a reputation

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One of our agents and I just signed a listing agreement on a 4plex we will be bringing to market shortly. (If you want to hear about it before it goes on the MLS, I recommend joining the mailing list right now.)

When we were preparing our pitch to the owner, my colleague pulled all of the relevant comparable sales over the past year.

Guess what?

There are 26 4plexes marked as “sold” by the MLS in the areas in which we are interested (the improving parts of NELA) in the last six months. That means there were 52 “sides” (each transaction has a buy-side broker and a sell-side broker).

Adaptive accounts for six of those sides. No other brokerage accounts for more than two.

And we also sold two others off-market (four more sides because we represented buyer and seller) and another on market deal is closing today (knock on wood!).

I’ve thought for a long time that we were better than any other brokerage at helping clients navigate the complexities of buying smaller income properties in NELA. Now, it seems, the market is catching on.

Written by mjkagan

10/09/2014 at 10:00 am

How we value apartment buildings (part 2)

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In my last post, I talked about how our approach to valuing apartment buildings derives from my experience as an investment banker trying to value media and technology companies.

Simply put: When you’re trying to get a sense for the value of an asset in an illiquid market, you want to use all of the tools available to you.

For apartment buildings, here’s what we do:

1. Consider the property as a straight buy-and-hold / yield deal

This one is pretty simple. We assume the buyer of the property will be a rational investor looking to achieve a reasonable yield on the cash she will use to acquire the property.

We build a model of the property incorporating the rents it commands, reasonable estimates of the expenses, and appropriate financing structure(s). Then, we input a range of potential valuations, which results in the model outputting a range of potential yields an acquirer could expect to achieve.

Since we’re working with loads of buyers at all times (and buying for ourselves as well), we have a good sense for the yields buyers demand in the areas in which we’re active. One good way to think about valuation is to select the price at which a buyer would achieve the minimum yield which we have found buyers willing to accept.

2. If 2-4 units, consider as owner-occupier deal

Ah, but not all deals are acquired by rational investors. For certain properties, usually 2-4 units with at least one unit desirable, 2+ bedroom unit delivered vacant, an owner occupier will sometimes be willing to pay more than a rational investor would.

Why is this? People are irrationally excited to own their own homes. All the proof you need is right there in the sales data for single family homes. In Southern California, you can easily rent a home for $4,000 / month which would sell for $1,000,000. At 20% down and $800k borrowed at 4.5%, the owner’s monthly out of pocket expense is something like $5,500 / month. One way to think about the difference between the $4,000 and $5,500 numbers is that this is the premium people are willing to pay to be an owner rather than a renter.

So, when we are asked to value an income property which might appeal to an owner-user, we try to price in an ownership premium for the owner’s unit… in other words, we can confidently consider valuations for the building which result in the new owner paying more out-of-pocket each month than the unit would rent for.

3. Evaluate as re-positioning opportunity

There is a big category of deals that just don’t make sense as buy-and-hold / yield deals. These are typically properties with tenants paying far under-market rents. At a certain point, the rents are so low that a price derived from applying a standard yield to the expected cashflow would result in a ridiculously low price / sq ft or price / unit.

These are the deals we love to buy. So, we know the economics better than anyone.

By working backwards from the new rents possible in the property and incorporating an estimate of the profit a new owner would want to achieve for doing the hard work of repositioning the building, we can get at the maximum price this kind of buyer would be willing to pay for the property.

4. Evaluate as a development deal

You would be amazed at how few brokers think to check the zoning of properties they are valuing for sale. This is usually not a huge deal, because pretty often the existing structures are built pretty much to the maximum density that the lot allows. But, every so often, there are major, major exceptions.

I’ll give you one from my own career: I bought a 15 unit (with 1 additional, non-conforming unit) in 2009. Without stopping to consider the zoning, I totally rehabbed the building and re-tenanted it. Then, sometime later, I realized that the property was zoned for 26 units. I might have been better-off tearing down the building and building 26 units in its place.

Anyway, whenever we are valuing a property, we consider what a developer would do with the lot. We look at how many units can be built, how much it would cost to build them, what the resulting building would be worth, and how much profit a developer could expect.

Usually, the valuation resulting from this method is lower than from the other methods (after all, it implicitly values the existing structure at zero). But, every once in a while, it turns out that the land is more valuable for development than in its existing configuration.

Pulling it all together

The result of the above valuation methodology is to clarify what prices different kinds of buyers can afford to deliver for a property. This gives us (and the owner) a sense for the highest price likely to be achieved in a sale.

And, very importantly, it lets us know how best to market the property. For example: If what you really have is a land deal, it does no good to spend a bunch of time and money on staging and taking pics for the MLS, since the likely buyer is going to tear the place down, anyway. On the other hand, if you have a property that will work owner-user, then you want to spend some time and money really marketing that owner unit, because that’s how you’re going to get the best price.

Are you considering selling? Want to make sure your sale process is run in an intelligent manner? Get in touch and we’ll come run the numbers for you and discuss the right strategy for extracting maximum value.

Written by mjkagan

09/22/2014 at 10:18 am

Posted in Brokerage, How to

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

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

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