Moses Kagan on Real Estate

One of the issues I deal with periodically is “buyer conflict”.

By buyer conflict, I mean the situation where multiple buyers with whom we are working decide to offer on the same piece of property.

As you might imagine, this presents a problem: We always want to help our clients get what they want, and this is one of the few cases where we will definitely fail at least one client (since, by definition, only one can buy the property).

So, how do we handle these infrequent, but annoying, conflicts? About how you would expect – gingerly, and with focus on behaving ethically.

In general, we:

1. Give priority to the first client who decides to offer on the property.
2. Cooperate. Once an agent has offered for one client, if another of his/her clients wants to offer, I personally write the offer for the second client;
3. Never disclose proprietary information from one client to another or one agent to another. So one client will never hear what the other client is bidding. And his agent won’t hear what the other client is bidding, either; and,
4. Disclose, disclose, disclose. With the exception of proprietary information relating to competitive bids, we favor total transparency. So, if we’ve written for one client and another ends up wanting to write, we make sure both of them know we’re representing multiple clients.

Buying good deals is, almost by definition, a ruthlessly competitive business. We do our best to help our clients get what they want. And, in the rare cases when our clients want the same thing, we do our best to give them the best possible help/advice, so that the client who wants the property most ends up getting it.

One of the weird things about our business is that I am both a broker and a principal investor. That means I look at deals for other people and for myself.

Who cares? Other brokers.

Brokers make money as middlemen. Their goal is to know who’s selling and who’s buying and match the two together. Simple, right?

The problem I sometimes have with brokers is that they are worried about sharing information with me. On the one had, they know that I buy all cash, close quickly, etc., so, in some ways, I am an ideal client.

On the other hand, they are aware that I also help other people buy stuff and they are concerned that they will share some information with me about who is selling and that I will then sell the deal to one of my clients, thereby cheating them out of a commission.

This is a totally reasonable and valid concern.

Here’s how I handle it: I never, ever share information about deals which brokers bring to me as a principal without getting their permission first.

The reason is simple: Sure, I could use the information to make a quick commission. But I’m in this business for the long haul. It does me no good at all to get a reputation for screwing brokers out of commissions… they’ll just stop bringing me good deals!

Here is how to begin the process of buying your first apartment building:

1. Determine whether you are the kind of person who should own an apartment building. Some people just aren’t cut out to own apartment buildings. Before plunging in, read this to find out whether you’re one of these people. Believe me… better to find out before you buy one!

2. Figure out how much capital you have. To buy a building, you’re going to need a downpayment of between 3.5% and 25% of the cost of the building (depending on whether you can use FHA or not). You’re also going to need to have some additional cash to cover closing costs, any repairs you’ll need to make, and some reserves in case things go wrong. To figure out whether you are ready to buy a building, you need to start by figuring out how much cash you can scrape together. If it’s less than $25k, my advice is to keep saving. If you’ve got more, you’re ready to move forward.

3. Find out if you can get a loan. No brokers or sellers will take you seriously until you show them you can get a loan to buy a building. This is done by working with either a direct lender (your bank) or a loan broker. I recommend going with a loan broker, and I specifically recommend using Justin Brown at Nu Home Financial (for smaller deals). Get in touch with a loan broker, tell them you want to buy a building, and ask them if you can get a loan. They will ask you for a bunch of personal financial information (including a credit check). Don’t be shy; they need this information to give you an honest opinion. Once they have the info, they’ll tell you whether you qualify and how large a loan you can get.

4. Choose a few areas that seem to be improving. For a beginning investor, the easiest way to make money in the apartment business is to pay a fair price for a sound building in an improving area without using too much debt. As the area improves, the rents you can charge will go up. This will have the effect of increasing your profits without you having to do too much. I generally focus on Northeast Los Angeles and Mid-City, because I know those areas are improving, but there are others. Pro tip: Ask your coolest, artsy-est, broke-est friends where they rent – that’s probably a good place to start looking.

5. Figure out who the most active, knowledgeable brokers are in those areas. Pay close attention to the following sentence: It is INSANE to work with a broker who is not an expert in apartment deals and/or does not do a lot of business in your preferred areas. You don’t pay your broker; he gets paid by the seller’s broker. There is no cost to you, whether you work with the best broker in town or a total moron. So choose someone who knows what he/she is doing, because there are plenty of ways to get hurt very badly if your broker is incompetent. Do some google searches, figure out who buys and sells a lot of apartment complexes in your chosen areas and get in touch with them.

6. Meet the brokers and choose one to work with. Remember: You don’t pay your broker. Since price isn’t the issue, you can and should choose who to work with based on who knows the most, who is the most active, and who gives you the best feeling. Sit down with the brokers you identified in Step 5 and figure out who you would like to work with. Remember, the process takes three-to-six months, so you might as well like the person you’re going to be spending so much time with.

7. Listen to the broker and be responsive. Working with buyers is a tough business for any broker, because you have to invest a lot of time without knowing if the buyer is serious about actually buying something. If you want your broker to take you seriously and do his/her best for you, you need to listen carefully to what he/she tells you. And, most importantly, be responsive. When your broker sends you a potential property to buy and explains why it’s a good deal, pay attention! Good deals only come around every so often. If you’re not responsive, your broker will just end up sending the best ones to the clients who are.

Look… this is a serious thing you’re considering doing. You’re thinking about putting down a large chunk of your cash and/or assuming a ton of debt to buy what is effectively a small business. It can easily be the best financial decision you ever make or the worst. Be serious. Think carefully. And be ready to move quickly when opportunity knocks.

If, after reading the above, you still think think buying an apartment building is the right thing for you and your family, get in touch. I’m always happy to chat, and hopefully I can help steer you in the right direction.

Since I’ve decided to make my career in one little corner of Los Angeles, I spend a lot of time thinking about how best to preserve and enhance my reputation among the brokers, owners, and tenants who participate in my market.

The most important thing I do to get and keep a good reputation is to do what I say I’m going to do.

For example: I don’t re-trade. Re-trading is offering high, tying the property up, and then trying to chip the seller in escrow. That’s definitely the right way to go if you don’t care about how people perceive you.

But, I can’t do that, because I intend to do a lot of deals and I want people to be able to trust my offers when I make them.

If I say I’m going to pay a certain price for a building, I pay it, unless there is some major issue that crops up during diligence of which I was not informed prior to going into contract.

Believe me, it’s extremely frustrating to lose deals to people who don’t care about their reputations. But, I’ve also been able to get deals others would never, ever be able to get because the brokers knew me and trusted that I would close.

I’m hoping, in the long run, that behaving like a mensch wins me more deals than it loses me. But the jury is definitely still out.

Literally every day, I ponder the following questions:

1. When will the Fed stop buying bonds and allow interest rates to rise?, and
2. When rates rise, how much will they rise by?

If you believe that the Fed is going to keep stimulating the economy for several years and/or that, when it stops, rates won’t rise by much, then you’re bullish on 5+ unit deals.

If you believe the Fed will stop imminently and / or that rates will jump sharply when it does, then you’re not touching 5+ unit deals with a ten-foot pole unless you have a strong value-add strategy.

Where do you come down?

1. You don’t like confrontation. Inevitably, you are going to have tenants who screw things up and need to leave your building. No one is going to care about it as much as you do, so you’re the one with whom the buck is going to stop. If you can’t stick up for yourself / your family, don’t buy a building.

2. You can’t tolerate risk. Apartment buildings are little businesses. No matter how much you plan / prepare / etc., there is still risk to owning them. Earthquakes happen. Fires happen. Market prices and rents swing. Working with a good agent and being smart about what you buy and how you buy it can mitigate risk to a large extent, but it can’t remove risk entirely. This is a big boy / big girl game.

3. You hate negotiating. In business, I’ve found, everything is a negotiation, whether you realize it or not. When you own a building / business, you’re going to be employing all kinds of people and companies. Many of them will try to take advantage of you. You don’t have to “win” every negotiation (often, you’re willing to happily pay a price the other side is happy to accept), but you need to be aware that you are, indeed, negotiating. And you have to not despise the process.

4. You’re disorganized. There is an unbelievable amount of paperwork that accompanies owning buildings. There are a million different regulatory agencies, tax authorities, insurance companies, banks, managers, etc., all of whom want documentation, bills paid on time and in full, etc. If you’re the kind of person who avoids opening mail, either make sure you hire someone to do it (that’s what I do) or stay out of the business.

5. You don’t like numbers. This isn’t a video game. There isn’t a big “You Win” or “You Lose” screen that pops up. The business is about patiently husbanding your capital, placing it, watching it grow, limiting your expenses, mitigating your risk, etc. All of this involves thinking about numbers. If you don’t like numbers, do something else.

6. You don’t like to learn. I’m still learning a lot, every single day, roughly five years into doing this for a living. If you want to do a good job with buying and owning apartment buildings, you have to keep your ears open for new ideas, your eyes open for new neighborhoods or changes to existing neighborhoods, and your mind open to thinking about existing assets / threats / opportunities in new ways. If you’re closed off and hate new ideas, don’t start buying buildings.

Rookie mistake today.

Saw a deal on the MLS priced at $299,000. Looked pretty good, so, without waiting to talk to the listing broker, I threw together an all-cash offer for $260,000 and sent it over, figuring we’d settle at $280,000 or something.

Got the following email back from the broker:

“Sold for 340k just a little bit ago”

Ouch.

P.S.: It’s fine-worthy for a broker not to change the status of a listing on the MLS. So, for example, this deal should have gone “pending” when it went under contract and then “sold” when it sold. Imagine if I had run around getting a buyer all excited about the deal, only to find out I wasted everyone’s time: Not cool.

Regular readers know I deal mainly in apartment buildings between 2-20 units. In doing so, I run across all kinds of issues, including missing financial records, bad leases, lack of estoppels, un-permitted construction, city violations, etc.

Many of these problems just don’t exist when you deal with larger assets. That’s because larger assets tend to attract more sophisticated owners, brokers, managers, lenders, etc.

So, why do I persist in working on smaller deals? After all, I’m good enough at my job now to buy, renovate and sell 50 unit complexes more or less as easily as I do 12 unit complexes.

The reason has to do with returns. There is a limited number of large assets in Los Angeles. All the relevant players know about every sale. And all the relevant players bring more or less the same ideas / financing / etc. to bear on every opportunity. So, the buyer of big assets is typically the guy who was willing to accept the lowest return.

In contrast, there is an almost infinite number of smaller deals. The people who buy and sell them are generally less sophisticated. The properties themselves are typically managed in a sub-optimal fashion (to put it mildly), with low rents, deferred maintenance, bad design, etc.

Guess what that means? The opportunity to earn out-sized returns if you are willing / able to wade through all the crap and sort these smaller buildings out.

When we write offers for apartment buildings, we usually want a 17-21 day loan contingency. The concept is to give us some assurance that we will be able to get the loan we want before we irrevocably commit to doing the deal. Pretty standard.

But lately, I’ve been running into the same problem over and over again: Un-prepared sellers and brokers.

To get some assurances from a bank that you can get the loan you need, the bank is going to want to see a current rent statement (setting out rents, move-in dates, etc.) and at least two years of operating statements (P&Ls).

The bank needs this information to get a sense for the rents that will be coming in, the expenses that will be going out, and, therefore, what will be left over to pay the mortgage. Not unreasonable.

But, lately, I’ve done a bunch of deals where the seller / listing broker aren’t prepared with the above information immediately upon opening escrow. Kind of weird, right? I could get rent rolls for any of the properties I manage in 5 seconds, with P&Ls available 5 seconds after that.

As a buyer, the problem with delays in getting documentation is that each day’s delay means a delay in receiving confirmation from the bank that they can do a loan. And, because the loan contingency has a time limit on it, the buyer can find himself in a position where, technically, the seller can ask him to remove his loan contingency and the buyer don’t have any sense for whether he can get the loan he needs.

The above situation leads to all kinds of unpleasantness with the seller, who believes the buyer is trying to delay closing. But, really, it’s all about the seller and listing broker not being prepared when escrow opens to actually make a deal.

Selling apartment buildings is NOT just about sticking some pictures on the MLS and Loopnet. It’s about preparing the owner and the property to run a clean, efficient process that absolutely maximizes the value the owner gets while minimizing the risk.

We’ve talked a bit about 1031 exchanges before, but here’s a re-cap:

• 1031 is a tax loophole designed to allow a seller to avoid paying capital gains tax on a property when he sells
• To do so, seller sells his property and has escrow transfer his equity to a so-called 1031 facilitator
• Then, seller has a set time period to identify several properties he might buy with the equity
• He makes an agreement to buy one
• At closing, the equity comes in from the facilitator
• The original seller avoids paying capital gains tax on any profits in the deal; instead, he transfers his old tax basis to the new property

There are a bunch of rules and regulations I’ve left out of the above description for the sake of simplicity.

But, if you’re sharp, you can already spot the problem with being a 1031 exchanger. Can you spot it?

The problem is with the “set time period”. Any time you are up against a hard deadline in a negotiation, you’re at the mercy of the other party.

In this case, the problem is that the owner of the property you’re trying to exchange into knows that you are on a deadline. If he wants to play hardball, he can delay until you are up against the clock and then push you for concessions, knowing that you have to accept them or risk having to pay capital gains tax on your sale.

The net result of the above is that a 1031 exchanger is at a significant disadvantage. Sure, there are plenty of times when the tax savings are large enough that it doesn’t really matter if you aren’t getting a great deal. But, if the savings are marginal, my advice is to forget the exchange, pay the tax, and focus on getting yourself a good deal.