Archive for the ‘Buying’ Category
I spend a lot of time on this blog talking about preventing bad things from happening on deals.
That’s what due diligence is all about: Trying to identify all of the things that could potentially go wrong on a deal and then either ensuring they do not or else planning to mitigate the negative consequences.
But sometimes deals surprise on the upside.
What do I mean by that? Sometimes you inspect and find out the units have more potential than you thought. Sometimes you find that rent controlled units you thought were occupied are, in fact, vacant. Sometimes the electrical was upgraded with permits, saving you from having to do it yourself. And so on.
The thing is, you never get to benefit from these positive surprises if you don’t make offers, get into escrow and see.
Now, I’m not advocating tying up deals that are way off working in hopes that something amazing will come to light that will save you. That’s unrealistic, because the likelihood of a material upside surprise is pretty low.
But, if a deal is on the margin, there is often something to be gained by being aggressive and getting control of the deal.
Sometimes, you find out that what was marginal is actually pretty sweet.
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.
Recently, I’ve been mulling the idea of buying an industrial building and cutting it up into affordable artist studios.
I have observed that these kinds of deals can work pretty well if you get the property very cheaply and keep your renovation costs low. You obviously also have to be in an interesting area… but we obviously know a few of those.
Why do I like the strategy? Artists tend to pioneer interesting areas because they look for very cheap space to work. The kind of people who hang out with artists (often, creative types who work in more traditional jobs) end up being drawn in and pretty soon small design / tech shops start to get interested, too.
The problem with this kind of deal is that the numbers are very unlikely to look good up-front. Yes, you can probably find a good building pretty cheap. But the rents are going to be low to begin, so the yield is not going to be very good.
So, why do this kind of deal? Well, one reason is that I like art because I grew up around it… check out this picture my dad, Larry Kagan, just sent me of his latest piece (yes, that plane is comprised entirely of shadows cast by the wire “clouds” above it… pretty sweet, huh?):
But there’s also the opportunity for increased rents and, therefore, yield if you get the branding and tenant mix right.
I can’t do this kind of deal with the funds we’ve raised; they’re for apartment. But if anyone out there is interested in kicking in some money alongside us on this kind of project, reach out. Maybe we can find a way to do it together.
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.
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:
- Signed cancellation instructions; and
- 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.
This article in the Times is worth reading.
The argument is basically that we’re entering bubble territory in single family home pricing in the main coastal cities.
I think the rent estimates they’re using may not reflect the rents that are actually getting paid.
That said, when I see small houses on small lots in B+/A- areas trading at $1MM, I get nervous for the buyers.
I’m mostly a price per sq foot buyer. Because I always renovate, I’m not very interested in the income of the building prior to acquisition. I am, however, extremely interests in the structure I am buying, since that structure is the raw material we will work with to produce the eventual product we are selling: Wonderfully renovated apartments.
I told the people who attended our seminar recently that I start to get interested around $200 / sq ft. But that brings us to the subject of today’s post: The fact that all square feet aren’t created equal.
Here are some examples of situations where a $200 price / sq ft still isn’t cheap:
1. Where you have wasted space. Picture a standard 1920s center hallway building. The center hallway is often 5′ wide. If the building is 100′ long, you’re wasting 5 x 100′ = 500 sq ft per level on hallways. No one pays rent for hallways, but, as a buyer you’re still paying for the space and, as a renovator, you’re still paying to fix it up. So, center hallway buildings need to be priced at a discount to $200 / sq to be interesting.
2. When you have huge units. The economics of our business are to a large extent determined by the achievable rent per sq ft. What kind of units generate the highest rent per sq ft? Studios. Think about it: A renovated 375 sq ft studio in Silver Lake can get $1300 all day – $3.47 / sq ft. A renovated 600 sq ft 1 bed / 1 bath gets $1700 – or $2.83 / sq ft. A 1300 sq ft 3 bed / 2 bath gets $3000 – $2.31. As you can see, the larger the unit, the lower the price / sq ft achievable.* Therefore, the return to the buyer of a building priced at a given $ / sq ft declines as the unit size increases. A building with lots of studios priced at $200 / sq is likely to be considerably more attractive than a building with lots of 3 beds priced at $200 / sq.
3. If there’s no land. Price per sq ft looks at the structure, but that’s not the only component of building value. For example: Look at our deal at 3212 Bellevue. We’re going to sell that thing at a price which will equate to $425 / sq ft or something. Sounds really high, right? But you have to consider that Bellevue is on 10,000 sq ft of land. That much land allows us to give all the units parking, storage, private outdoor spaces, decks, etc. The result: Very high rents / sq ft. And very high rent / sq ft imply a very high price / sq ft on exit. The opposite is also true: If you have a $200 / sq ft building with no space available for parking / outdoor space, then your rents are going to suffer, which means that $200 / sq ft may not work.
If you start to consider the above rules in reference to lots and lots of deals, you will find that there are all kinds of interesting interactions that take place when you combine buildings of varying configurations with units of varying sizes with lots of varying sizes. Deals which don’t look great reveal themselves as almost certain winners. And deals which superficially look like winners end up looking very risky indeed.
*Incidentally, this is one of the reasons zoning limits the number of units on a given lot… otherwise, developers would build huge buildings full of lots of very small studios.
That’s basically what we do all day.
What do I mean?
Well, we’re looking for mismanaged, run-down, incorrectly-priced assets for ourselves or our clients to buy.
Very often, the processes we have to navigate to secure these screw-up assets are, to put it mildly, “non-standard”.
This ain’t the kind of brokering they teach down at your friendly neighborhood real estate office (you know the one I mean… where they mostly do single family homes and the success of the agents mostly depends on how white their teeth are).
We see all manner of greed, incompetence, fraud, unlawful behavior towards tenants, double-dealing, etc.
Our job is to navigate through all of the above to secure the assets in question without exposing ourselves and / or our clients to undue risk and without doing anything unlawful / unethical ourselves.
Basically, we wade through shit. Why? Because, in a market like this one, you gotta wade through shit to get the gold.
I get this question a ton, usually from brokers who are interested in figuring out a way to take both sides of the commission (by representing both the buyer and the seller).
For the record, here’s my answer:
1. If you bring me a deal which is “off-market”, in the sense that it has not been widely marketed on the MLS, Loopnet, etc., then I will happily have you write for me. Nice work in bringing it to me: For a certain type of deal, I’m almost always the best buyer.
2. If you bring me some valuable piece of information regarding a deal which is on the market which causes me to view the deal differently, then I will happily have you write for me. Examples of information like this: The deal will actually be delivered vacant, the seller is willing to take dramatically less than asking, the property is actually non-rent control due to some obscure agreement with the city, etc.
3. If your deal has been widely marketed and I approach you, then I am almost certainly writing my own offer. The only exception would be in a scenario where the deal is ridiculously, blindingly, spectacularly good… and those deals tend to get bid up as soon as they are widely marketed.
The concept is pretty simple: I want to incentivize brokers to bring me good deals, disincentivize them from calling me about stuff I already see online, and allow myself to take the buy-side commissions when I’ve done the work of identifying the deal.
In a word: “Yes”.
I wrote two offers yesterday and have been writing on a pace of roughly five / week for months.
We’re helping a client close one deal on Friday and another the following Friday.
We’re in escrow with a client trying to determine whether to move forward on a deal now.
I’ve personally been dilly-dallying about offering on yet another deal for myself because I don’t have the money together yet.
And there’s a fourplex I like very much in an emerging area that I can’t BELIEVE no one has bought yet… It’s making me want to tear my hair out.
While prices are definitely high(er) now, I strongly believe that this economic cycle has not even really got started yet. Why do I think that? Because there really has not been much hiring nor wage growth. As employers begin to hire, unemployment goes down and wages begin to move up, there will be more household formation. And more household formation means more people looking for apartments to rent. Which means higher rents.
Does this mean I’m running around buying everything? No. There are millions of stupid deals floating around. But, if you can make the numbers work on something decent now, I think you will end up happy with the result, even when the inevitable downturn comes 2-3 years from now.