Archive for the ‘Buying’ Category
I’m looking at a deal right now that doesn’t work for my funds because there’s not enough margin in it to flip or to earn the kind of yields that our investors expect.
But it’s a reasonable deal for an individual willing to roll his/her sleeves up and do some work. How can this be?
The answer is in the leverage available to individuals vs. the leverage available to LLCs.
As an individual investor, you can fix a 30 year loan for $800k at around 4.75% on a 2-4 unit deal. If you can use that kind of leverage on a deal where, fully renovated, you’re in for 11x the rent in an improving area, you’re going to be happy with the result.
Those loans are not available to LLCs. The best we can do on a 2-4 unit deal is something like 65% LTV, fixed for 10 years, interest-only. The cashflow on this will be pretty decent, but there’s not really an exit play. So, we pass.
Wish I had the cash for the deal right now!
A contact just sent me this link to an excerpt from Warren Buffett’s most recent Berkshire Hathaway shareholder letter.
Buffett’s approach is pretty much exactly how I think about multifamily real estate in improving parts of LA:
- Pay a reasonable price, such that the yield in year 1 is acceptable
- Don’t put yourself in a position where you might be a forced seller (so, don’t over-lever)
- Manage for yield
- Ignore swings in market prices, except to buy more when prices get low
- Never sell
If you just do this, my guess is that you’ll end up very happy about your investment(s).
Oh, and if you are interested in investing, you should 100%, absolutely, no question read Buffett’s collected shareholder letters, which are available as a collection on Kindle.
(Hat tip to EZ for the link!)
Right now, our agents have three deals in escrow for various clients. Generally speaking, these are deals in emerging neighborhoods where the in-place cashflow is reasonable and there are good reasons to think that rents can be increased dramatically over the coming years.
It is not easy to find these kinds of deals, but they are out there. All it takes is some expertise and a bunch of elbow grease on our part and some confidence on yours.
Interested in finding a good place to park some of your savings? Get in touch. It’s definitely not fish in a barrel (like 2009-10), but it’s not exactly needle in a haystack, either (yet!).
We get this a lot: We help a client write on a building. Someone else wins the auction and goes into escrow. The winner cancels during his contingency period. The listing agent comes back to us, offering to go into escrow on the terms we offered previously.
Very often, our client gets cold feet at that moment. The thought process is something like this: “Why did the first buyer back out? What’s wrong with the property? What if I buy the property and then find out I missed something and got a bad deal?”
While these feeling are natural, they’re totally unhelpful.
If you want to act like a professional investor, which is basically why our clients hire us, then you have to trust the process. The process is:
- Find a deal that looks like the numbers might work
- Offer a price such that the numbers do work
- If you get the property, conduct an extremely thorough diligence process
- Assuming everything checks out, close
Notice that nowhere in the above list do I mention what anyone else is doing. Why? Who cares?!!
Other people do stupid deals all day long. They also fail to do good deals for equally stupid reasons. If you’re going to make investment decisions based on what other people do, then you’re setting yourself up to achieve the same results other people achieve.
Being good at this game is about being cautious, calculating, unsentimental, and, most importantly, confident enough in your own preparation and judgment to ignore other people and pull the trigger when a deal looks right.
A friend of mine from college called me late last week with an interesting problem: He wanted to know how to value a vacant building he was considering buying.
There are two good ways to think about this problem:
The first might be thought of as “price per pound“, where we are looking at the physical land and structure, rather than at the income that land and structure generate. For this kind of analysis, we calculate a reasonable price per square foot for both the land and the structure based on recent, comparable transactions. We also keep in mind the cost of buying a comparable piece of land and building a comparable structure… you rarely want to pay more to buy something than it would cost to build.
The second, more problematic, manner of valuing a vacant building is to use an “estimated income” approach. With occupied buildings, it’s easy to evaluate a property based on it’s income; you just calculate the net operating income (“NOI”) the building is generating, divide it by the price you’re being asked to pay, and compare the quotient, called the CAP rate, to other, comparable deals to see if it’s fair. Obviously, the problem with the vacant building is that there is no NOI.
But you can estimate an NOI. First, you need to estimate the income the building can generate. It’s important you make this guess based on the present condition of the building. (If you estimate income assuming a renovation, then you will end up paying the seller a price for his un-renovated building which reflects the renovations you are going to pay to do!) So, look at the present condition of the building and compare it to other recently rented buildings and those on the market and figure out what kind of rent the building can generate.
Next, you need to estimate the expenses for the building. There are two key mistakes to avoid here: (1) Don’t blindly take the seller’s current expenses… vacant buildings use less heat, power, water, etc. than occupied ones!, and (2) Don’t assume any renovations to reduce costs (more efficient fixtures, heater, etc.)… otherwise, you’ll end up paying the seller for work you’re going to pay to do.
Once you have reasonable estimates for rent and expenses, you can subtract the latter from the former to get the estimated NOI. Then, you divide the NOI by the asking price to determine the estimated CAP rate, which you can compare to other, similar properties recently transacted or on the market.
Think this stuff is too boring / difficult to consider? Vacant buildings are very often where the opportunity is, because sellers and brokers screw up their estimates of income and/or expenses and therefore mis-price their assets. My current house and the Silver Lake fourplex I recently helped my parents buy were both vacant when we acquired them.
We’re checking out a 4plex we’re in escrow on today.
It’s my kind of deal:
- Cheap on a $/sq ft basis
- Outdoor space
- Up-and-coming area
Just like everything else we buy, it’s going to be a hard slog to turn it into the kind of place that people will pay a lot of rent for. But that’s what we do, over and over and over again.
Here they are, in no particular order:
1. Misunderstanding rent control – You’d be amazed at how many inquiries I get from people whose big idea is to buy a building with cheap rents, fix it up and raise the rents. Good idea, right? Not if you don’t have a plan for relocating the tenants. Tenants in all pre-1978 buildings are protected by rent control. You need to understand your rights and theirs BEFORE you buy the building.
2. Failing to scope the sewer line – If you buy an older building in LA, particularly one in a hilly area, and you don’t scope the sewer line, you deserve whatever you get. Most of the old ones were made of clay. Roots grow into them and stop the sewage from draining. So you get clogs or worse in your building. It costs $300 or so to scope a line… which is a small price to pay to avoid a $10,000-15,000 problem.
3. Failing to get estoppels – You’d be amazed at how few brokers demand estoppels. Here’s the deal: If you don’t confirm the rents via signed estoppels, you’re relying on the seller being honest with you about the rents. Are most sellers honest? Yes. Are some not? Yes. So trust, but verify.
4. Over-leveraging – Almost everyone in real estate gives in to the temptation to use as much debt as the bank will lend them. When the market is down, that’s not a bad play, because leverage magnifies outcomes. But, if you buy with a lot of leverage when prices and rents are high – watch out! Depending on how much you paid and how much debt you used, a 10-15% drop in rents can wipe out your cashflow and make it hard to service the mortgage.
5. Over-paying – No matter how much you push and prod the numbers, it doesn’t make sense to pay 15x the rents unless you have a great plan for how you’re going to raise them (quickly). And yet I watch people do this every single day. When you over-pay like that, you end up having to pay to own the building… which is exactly the opposite of how these deals should work.
This blog usually covered apartment buildings. Today, however, I want to say something about single family homes.
Generally speaking, I’m not a fan of single family homes as investments. Buying one is really a consumption decision and you really ought to do it only when you’re very confident that you will be able to generate the income necessary to carry the mortgage.
All of that said, if you are going to buy a single family home and you like Northeast LA, you really ought to be thinking about Mt. Washington.
This won’t be news to those of you who spend a lot of time on the Eastside. But, for those of you who don’t, here’s what Mt. Washington offers:
- Relatively large homes suitable for families
- Big lots (most on slopes, some flat)
- Views (it’s a mountain, after all)
- A very strong elementary school with amazing parent involvement
- Proximity to all of the interesting retail along York Blvd. in Highland Park
About the only downsides I can see are the fact that it’s not walkable at all and you need to be careful that your small pets aren’t eaten by coyotes.
Most importantly, from my perspective, is the pricing. You can buy a big, nice house in Mt. Washington with all of the advantages I set out about for around $800k. For that price, you basically get a shack in Silver Lake these days.
So, while I continue to strongly discourage buying a SFR as a first home, if you’re going to ignore me anyway and you like Northeast LA, check out Mt. Washington.
I need a POCKET LISTING for an apartment building.
I have a CASH BUYER with $x,xxx,xxx to spend.
Need a high cap rate in a good area.
Let me know if you have anything.
So, let me get this straight: You’re looking for an off-market opportunity to buy something in a good area with a high cap rate (eg a low price relative to the income it generates)?
What a surprise… it turns out that I, along with every single other broker and investor in the entire city of LA, am looking for a similar property!
One of the saddest things about my business is watching people do deals which are undeniably stupid.
Want an example: How about paying 13x rent for a 5+ unit deal with a bunch of leverage and no plan for removing the tenants / raising the rents?
If you do a deal like that, here’s what happens:
- Your cashflow going in is very low or, if there are any maintenance issues, zero;
- You can raise rents by 3% / year, but it’s going to be a while before those increases begin to add up;
- You loan is locked for, say, 5 years, after which your interest rate will likely float up;
- When your monthly payments float up, any cashflow you had started to generate off the rent increases is gone, and you’re likely back to breaking even or having to pay to own the building;
- When you try to refinance to lock in a rate, you probably find that, with the new, higher interest rates, you don’t have enough equity to get a new bank to loan as much as the old bank did, leaving you a choice between living with the floating rate and putting more money into the deal to make a new loan work
We talk to a lot of owners who are in precisely this situation. They’re usually trying to sell their property for just enough more than they paid for it to cover transfer taxes, escrow and title, and brokers. And, often, they’re out of luck, because the property is basically worth what they bought it for (or less).
In light of the above, it continues to astonish me that people do these insane deals. I guess there are plenty of people in LA with sufficient money not to care about having to pay to own buildings that are supposed to be paying them. I’m not one of those people, and my clients aren’t either!