Moses Kagan on Real Estate

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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

How I assign agents

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When someone comes to me for help buying an apartment building, the first thing that happens is we have a phone conversation.

During the talk, I give an overview of our process, then spend a bunch of time asking questions of the potential client, including: how much capital she has to deploy, what size deal she wants to do, what her return requirements are, which areas she likes, etc.

Based on the above information, I need to decide:

1. Whether it makes sense for us to work together at all. All we brokers have to sell is our time. On the buy-side, which is mostly where we work, there is absolutely no guarantee that any particular client is going to do a deal where we get paid. So, to make sure we have a functional business, we need to screen potential clients to ensure they are serious, have the necessary financial resources, and have reasonable return requirements. If yes, great; if no, we’ll very politely decline the work.

2. Which agent she should work with. This one is tricky. Obviously, target deal size and area play a very big part. But, ultimately, getting a deal done is about the agent and client working together as a team. Therefore, I try to balance the more objective factors with a big subjective one, too: Would these people get along?

I wish I had a great system to going back and checking on the decisions I have made about whether to work with clients and to whom to refer them. But I don’t.

With respect to the question of whether the prospective clients are worth the time the agents need to invest, all I can say is that the agents are making a living and continue to happily service the clients.

With respect to the question of whether I’m doing a good job matching agents with clients: We’ve had tons of repeat business. So I can’t be screwing it up too too badly.

Written by mjkagan

08/26/2014 at 10:51 am

Posted in Brokerage

How to get the best out of your buy-side agent

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Be responsive.

What do I mean? Well, at any time, my agents are working with a handful of active buyers, plus some more “passive” types who have expressed interest in doing something but aren’t motivated.

So, how do the agents decide whom to focus on?

Simple: The more responsive and engaged buyers get the lion’s share of the attention, because the agent naturally expects those buyers to be more likely to actually write offers and close deals.

So, if you want our best, here’s what you have to do:

  • Have reasonable expectations (so, no, you can’t buy a 9% cap in LA… that was impossible in 2009, let alone now)
  • Clearly define for us what you’re looking for
  • Respond promptly when we send you deals that we think make sense based on the criteria you have expressed
  • Forward along other deals that you see that we may have missed (we’re good, but sometimes stuff does slip through the cracks)
  • Trust us, at least as far as writing an offer (later you can come up with all of the reasons not to buy the building)

On the other hand, here is how to ensure you don’t get our best:

  • Expect miracles in terms of returns
  • Waffle about what type of property you want (today it’s buy and hold, tomorrow it’s a renovation project, then you want to build small lot, whatever…)
  • Take more than 24 hours to respond to ideas we send (in fact, if you wait 12 hours, that’s a bad sign… when something good comes along, you want to MOVE)
  • Get involved in long philosophical conversations when it’s time to write the offer, rather than just writing (there’s little-to-no risk in writing; you can back out before sending your EMD if that’s what you decide you want to do)

Just remember: All the agents have to sell is their time. They’re going to be pretty ruthless about allocating it to the buyers who demonstrate real willingness to act when a good opportunity presents itself.

Written by mjkagan

07/23/2014 at 3:26 pm

Posted in Brokerage

The brokerage is beginning to hit its stride

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One of the things I wrestle with is how much time to devote to our brokerage operation.

As many of you know, I supervise six agents who help investors buy and sell investment property in gentrifying parts of LA.

Compared to our fund management business and our fee-for-service development business, the brokerage is tiny. To give you a sense for how tiny: We generate more revenue from one decent fee-for-service deal than we will from the entire brokerage this year.

That’s not to say that the agents aren’t active; they are. It’s just that the economics of the business are such that the agents (appropriately!) receive the vast majority of the commission income from their deals. And since the deals they are doing are generally not huge (mostly in the $500-1.5MM range), the amount of revenue we collect on a given deal is pretty small. Even with pretty active agents, the numbers don’t really get that interesting.

So, why do I bother with the brokerage?

1. We derive a lot of market intelligence from the agents, who are all smart, diligent people constantly looking for interesting deals to sell to their clients. They’ve often brokered deals for us (in other words, represented our fund entities in acquisitions).

2. At scale, the brokerage economics improve. Six agents, particularly agents towards the beginning of their careers, don’t generate a ton of revenue. But, depending on productivity, 20 agents absolutely would. We’re not actively recruiting, because we wouldn’t accept most applicants, anyway. But, over time, I continue to run across talented people who I think we do well in real estate and I bring those people in and train them. Over time, we’ll probably get to the point where the brokerage is an interesting business.

3. It’s gratifying to teach people how to make real estate deals. There’s a big part of me that would have been pretty satisfied with being a highschool teacher (except I’m greedier than that!). So it’s nice to get to spend part of each week teaching something I love, even if it may not be strictly economically rational for me to do so.

I keep the brokerage going / growing for all of the reasons above. So it’s quite gratifying for me personally to stretches like the one we’re in now, where one of my agents just closed a deal yesterday and has another (big one) closing next week and where another agent just closed a very difficult deal today and has another one closing early next week.

The brokerage appears to be hitting its stride!

Written by mjkagan

07/18/2014 at 10:46 am

Why I (almost) always ask for retrofit

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In Los Angeles, the law requires that every building that changes hands needs to have low-flow toilets and shower-heads installed in the bathrooms (to preserve water). The law is enforced by means of a single form that is required to be completed prior to close wherein a contractor, licensed plumber or real estate agent attests that the relevant fixtures have been installed.

For newer or newly renovated buildings, any toilets or shower-heads that passed plumbing inspections comply with the code. For older buildings, it is pretty likely that the owner will not have made the necessary changes.

So, the question that crops up on sales of older buildings is: How will installation of the required fixtures be handled?

Many buy-side brokers opt not to request that the seller handle the retrofit prior to close, in hopes of making their offers marginally more appealing to sellers (who will therefore not have to spend the money).

But this causes the following problem: Either (a) the buyer is going to have to pay for the retrofit prior to closing (in other words, pay for work to be done on a building she doesn’t own) OR (b) a contractor, plumber or agent is going to have to lie on a government document.

Would it surprise you to hear that “b” is chosen pretty often?

We’re in this business for the long haul, so we’re not going to risk our reputation or those of the subs with whom we work closely by lying on forms. That means we will almost always insist on the seller doing the work prior to close. If it means we have to offer slightly better terms in our offer to compensate, that’s ok.

Written by mjkagan

06/24/2014 at 4:11 am

Posted in Brokerage, Buying

The difference between a loan broker and a direct lender

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In our business, we frequently have clients come to us with pre-approvals from direct lenders like Bank of America, Wells, etc.

The clients love the banks because they promise high loan amounts and low interest rates.

And, on simple deals where there are no real issues with the borrower or the property, the direct lenders do fine.

So, why do we strongly recommend to our clients that they use a loan broker instead of a direct lender?

Because, when problems come up in a deal, which they almost inevitably do when you’re wading through shit, the direct lenders just decline the loan and head for the hills.

Why do they do this? Bank of America does not care about closing your loan. They’re going to close a million loans. All the bank cares about is not doing anything non-standard so as to avoid upsetting regulators. So, when a problem pops up, it’s much better for the bank to run away. There’s always another loan to do.

Contrast this with a loan broker who gets paid to close deals. All he cares about is closing the loan. If the lender raises an issue with the property or the borrower, the loan broker is there to figure out a creative way to jam the loan through. Because, if she doesn’t, she doesn’t get paid. And, if she does jam a questionable loan through, it’s the bank’s problem, not the loan broker’s.

Now, it should be noted that you’re going to pay for a loan broker’s services. The loan may be a hair more expensive.

But you’re paying for a greater certainty of closing. And, in our business, where the problem is the lack of reasonable deals, the last thing you want to happen as you near the finish line is to have some drone at a big bank tell you they can’t close.


Written by mjkagan

06/04/2014 at 1:14 pm

Posted in Brokerage, Buying, Debt

How to negotiate a price reduction

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I really, really hate chipping price during escrow. Do you know what I mean by “chipping price”? It’s when the buyer, after doing his diligence, comes back and requests a price reduction from the seller in exchange for removing contingencies and moving forward with the deal.

Why do I hate it? I do an enormous number of deals in a relatively small area. I see the same brokers again and again. Sure, I might be able to chip someone once, but what happens the next time I want to do a deal with that broker? Likely, he’s going to tell his client that they can’t trust my offer, because I’ll just come back and lower it. So, in order to make sure that I and my clients get the absolute best shot at every attractive deal that comes on the market, I make it a point not to to screw around.

That being said, there are occasionally situations where asking for price reduction is unavoidable. For example, we sometimes come across buildings where the square footage as measured during inspections is materially different (by more than 1,000 sq ft) from the public records. In those situations, you can’t not ask for a reduction.

So, what do you do?

Here’s what I do: I present the seller with two signed documents:

  1. Signed cancellation instructions; and
  2. An amendment removing all contingencies conditional upon a price reduction to $X (whatever price I need to make the deal work)

Why do I do it like this? Pretty simple, really. The point is to show the seller that we’re not just screwing around and trying to chip price for no reason. We’re saying the property is really not what we thought it was and the deal absolutely does not work at the price, so we’re willing to walk away, and all the seller needs to do to make that happen is to counter-sign the cancellation instructions and we’re done.

If, on the other hand, the seller is amenable to the price reduction, he can simply sign the amendment and be confident that the deal is now non-contingent and no further price reductions will be requested / required.



Written by mjkagan

06/03/2014 at 3:38 pm

Posted in Brokerage, Buying