Moses Kagan on Real Estate

Archive for the ‘Buying’ Category

The economics of buying a home in an improving neighborhood

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You can now get regular financing on a house under $419,000 for up to 95% of the purchase price.

These aren’t FHA loans with high mortgage insurance payments; they’re relatively standard bank loans.

Thought I’d run the numbers on a standard, $350k house in an up-and-coming neighborhood to determine if it makes sense for renters to dive in.

Obviously, this post comes with my standard caveat about using lots of leverage: Leverage magnifies outcomes, both good and bad. So, if you’re going to use 95% LTV leverage you better be damn sure that either the value of the house is going to increase or that you will be easily able to cover housing payment even in a down economy.

That said, let’s get to the numbers on a hypothetical $350,000 house with 2 beds, 1 bath and a bit of land:

  • Put down $17,500
  • Borrow $332,500 at 4.125% fixed for 30 years
  • Monthly mortgage payment of $1,611
  • Monthly property taxes of ($350,000 x 1.25%)/12 = $364
  • Monthly insurance of $1500 / 12 = $125
  • Reserve $100 / month for repairs
  • Total monthly payment of $2,200

Now, for most of the neighborhoods in question, $2,200 is a bit more than it would cost to rent the same property.

But owning is a bit more tax efficient than renting. Of your $1611 x 12 = $19,332 in mortgage payments in the first year, ~$13,620 is mortgage interest, which is tax deductible. Assuming your marginal tax rate is 30%, that $13,620 in mortgage interest saves you $4,086 in taxes, or $341 / month.

So, after taxes, you’re actually paying out $1859 / month to live in a 2 bed / 1 bath house in an improving neighborhood.

In my opinion, that is a deal worth doing. If you’re interested in doing something like this and you have good credit and around $25k-30k in cash, get in touch.

Written by mjkagan

12/18/2014 at 12:56 pm

Posted in Buying, Debt

The gestation of an idea

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I spend a lot of my time kind of aimlessly drifting.

It’s pretty weird that I do this; I think most business people are much more focused than I am on a day-to-day basis.

What I do is read a whole bunch of stuff and talk to people.

I’m not necessarily specifically looking for an investment thesis or idea. I’m just trying to think about what the world will look like years from now and how one might allocate capital now in order to be positioned to take advantage of these trends before they come fully to fruition.

And then, every once in a while, an idea comes to me.

Mostly, these ideas are too small to be interesting. But, sometimes, they’re big.

What do I mean by big? Well, the ideas need to be big enough to put $5-10MM in capital to work. Otherwise, it’s not really worth the headache to figure out of how to implement them.

Just in the last few days, I’ve had another one of those ideas.

Now, lots of people have big ideas.

What separates me from other dreamers is that, when I get a big idea, I know how to make it happen.

And that’s what I’m going to do with this one.

Stay tuned.

Written by mjkagan

12/05/2014 at 10:57 am

A pretty amazing success story

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Yesterday, I got a call from one of the first people for whom I ever brokered a deal.

He is in the process of refinancing the mortgage on the small apartment building I helped him buy. He was calling to see if I had any tips for his upcoming appraisal.

As I always do before an appraisal, I pulled the comps to see where the value was likely to come out (and maybe provide the appraiser with some PARTICULARLY relevant comparable transactions).

Before I tell you where value came out, let me set the stage. He bought his ~3,000 sq ft building in Echo Park for ~$730k. He put down ~$36k (was an FHA loan) and spent maybe $75k on renovations.

The comps are showing a valuation range of $400 / sq ft. That implies a value of around $1.2MM. (Though, of course, who knows where an appraiser will come in!?)

So, ignoring transaction costs and not accounting for loan amortization since the transaction (because I’m being lazy), his $111k investment is now worth ~$506k.

How did this happen? Pretty simple, really: Lots of leverage and spectacular timing.

Written by mjkagan

12/03/2014 at 10:29 am

Where are interest rates going?

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I have no idea and anyone who says they know for certain is either:

  1. A liar; or
  2. Should be trading interest rate futures on Wall Street

That said, having a view on interest rates is pretty important in our business.

Why? Because the price of income producing real estate is highly dependent upon the cost of borrowing money.

If interest rates move up, cap rates (the “unlevered return”) move up, and the price of income producing real estate falls. If interest rates drop, cap rates drop, and the price of income producing real estate rises. (For more on this subject, check out this post.)

Given that the future prices of the assets I invest in are heavily dependent on interest rates, I have to have a view, so:

  • Believe we’re in for a period of sustained low rates
  • This is due to a huge glut of savings (worldwide, but also among baby-boomers who are all at peak net worth right now) chasing returns… eg competing to loan money
  • Also do to sustained weakness in almost all of the major developed economies, with the exception of the US
  • Persistently low inflation in the US, causing the Fed to fear deflation (as happened in Japan)

I have no idea if the above is correct. And, even if it is, it doesn’t mean rates will stay as low as they are now… just that it will be a long time before mortgages are 6-7% again.

Written by mjkagan

11/25/2014 at 2:58 pm

Posted in Buying, Debt

Ballpark returns

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Had an interesting conversation today with a guy looking at building condos / small lot.

One of the questions he had was what kind of returns a developer can expect.

I’m far from an expert on ground up, but I’ve run the numbers on a lot of projects.

Right now, here’s where I think you end up for smaller projects (say, 5-20 units):

  • As a rental: If you know what you’re doing, think you can build into a 6.5-7.5% unlevered yield. That means you buy the land all cash and build all cash and, when it’s done, you get roughly 6.5-7.5% on your money annually. You can improve this number by using a construction loan to build and/or refinancing post stabilization.
  • For sale: I have seen several 20% ROI deals. Again, this assumes building all cash. Remember, too, that building for sale projects is more of a 24 month project (since the entitlements take longer to secure than those for rental housing)

Just to clarify, it’s not like deals like this are falling off trees. You have to hunt them, know what you’re looking for, and know how to execute. And, of course, there are all kinds of risks with ground-up construction… the scariest of which is the market moving against you during the project.

Still, if I had a ton of my own money, I think I’d be buying pretty high quality land, building rentals on it, and holding them. Long term, owning high quality, non-rent controlled assets in good parts of LA is probably a winner, even with the relatively high cost of land at the moment.

(Note: This post is not a solicitation for investment nor a guarantee of any kind of performance on any particular deal.)

Written by mjkagan

11/24/2014 at 3:24 pm

We missed…

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Just missed on a deal I really wanted and I’m upset because I didn’t follow my own advice.

When I’m brokering deals and people ask me what to bid, here is what I always tell them:

  • It’s impossible to know what others will bid
  • Instead, play with the numbers to figure out the highest price you can pay while still getting an acceptable return
  • Bid that price knowing that, if someone bids more, you don’t mind losing the deal

So, what did I do?

I bid a price where the returns were very tasty.

I could have bid more and had the deal end up at an acceptable number.

But I didn’t and I lost the deal.

Now, I’m filled with regret.

Written by mjkagan

11/20/2014 at 9:58 am

Posted in Buying

Concentration vs. diversification

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One of the interesting issues with managing other people’s money is having to decide how exactly to allocate that money among projects.

At any given fund size, you need to decide whether you should do a small number of big deals or a large number of small deals.

All the theory points toward diversifying. After all, assuming that all projects have similar return characteristics, if you spread the money among many projects, 1-2 going badly won’t destroy your results. And, indeed, the docs governing many investment funds require that they refrain from allocating more than a certain percentage of their equity to any given deal for exactly this reason.

But real life, of course, can be more complicated than theory, because:

  1. Sometimes (not often, but sometimes) the larger project(s) promise better returns than the smaller ones that are available at a given time; and
  2. In our business, which is extremely hands-on, managerial attention is at a premium, so spreading it among many, smaller deals may mean worse performance than if the attention were concentrated on fewer, larger deals

So, what do we do? We:

  1. Keep in mind that, all things being equal, diversification is better;
  2. Are willing to concentrate, because we:
    1. Limit ourselves to deals where we believe there is a considerable margin of safety (eg deals that are sufficiently profitable to absorb bad news)
    2. Limit leverage, which is the factor most likely to lead to disaster in our business
    3. Refrain from doing deals on brick- and un-reinforced soft-story buildings (because these can both collapse in earthquakes, the other major risk)

Will the above prevent us from losing money for our investors? No. There is always the chance we screw up. But we believe the above gives us a reasonable degree of safety while allowing us to chase attractive returns (which, after all, is the whole point of doing this).

Written by mjkagan

11/19/2014 at 2:10 pm

Apologies for the lack of posts

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Didn’t write Friday or Monday because I’ve been slammed.

We were finishing up diligence on the first deal for Adaptive Realty Fund 3, our latest investment vehicle.

Late last night, we removed contingencies, with closing to come early next week.

On top of that, my very capable assistant has been out sick, so I’m doing more of the grunt work than I usually do on one of these deals.

Anyway, we’re super-excited about this latest building and will provide details when its prudent to do so (eg not for a while).

Written by mjkagan

11/18/2014 at 12:45 pm

Posted in Buying, Development

Some stats on our business

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Jon and I are hiring a photographer to go back and document all of the buildings we’ve renovated.

She asked for a list, so I went back through my records to produce one.

Thought you would be interested in the results of my research:

  • Completed gut-renovations on 25 buildings totaling 156 units
  • Renovations in progress on 10 buildings totaling 103 units
  • Six buildings totaling 40 units awaiting renovation
  • In escrow on two buildings totaling 16 units

Assuming all goes well, by this time next year, we will have completed 43 buildings comprising 315 units in seven years.

I’ve excluded from the list another 10 properties totaling 61 units which we bought renovated or intend to renovate at some point in the indefinite future.

Not bad for starting in this business in early 2008, huh?


Written by mjkagan

11/11/2014 at 11:03 am

Taking apart a deal: An East Hollywood Duplex

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Today, I’m going to try something new: Taking a look at a deal in one of our neighborhoods so that we can get a sense for what the numbers look like for the new owner.

So, let’s take a look at an East Hollywood duplex that sold yesterday. I should start out by saying I didn’t offer on the property and do not know the agents, the buyer or the seller. So I have no special information about anyones’ motives here. My intention is just to take a look at the deal from several different perspectives to see if I can figure out why the buyer chose to buy this particular property at this particular price.

Here is the headline information from the MLS and ZIMAS:

  • List price: $549,000
  • Sale price: $563,000 (so, above list)
  • Two 2 bed / 1 bath bungalows totaling 1,443 sq ft
  • 6,200 sq ft lot zoned RD1.5
  • Rents of $851 and $557 (so, $16,896 / year)

And here are some ballpark estimates for the actual annual costs of ownership:

  • Property tax: $563,000 x 1.25% = $7,037.50
  • Insurance: $1,800
  • Water/sewer: $1,200
  • Gardener: $1,200
  • Pest control: $550
  • Repairs and maintenance: $1,800

So, my guess is that the total annual costs of owning the property are approx. $13,600.

Let’s take a look at this deal through a few different lenses in order to see if we can understand what the buyer was thinking.

Buy and hold investment deal

The first, and simplest way to think about this deal is as a buy and hold where the new owner is just hoping to sit there, collect the rent, pay the expenses and keep whatever is left over as a return on his money. For simplicity, let’s start by assuming the buyer pays all cash. Assuming the above numbers are correct, the owner pays $563,000 in cash and gets, in exchange, $16,900 (rents) – $13,600 (expenses) = $3,300 in net operating income.

Then, divide the $3,300 NOI by the purchase price of $563,000 to get your cap rate… or, on second thought, don’t because you’ll plotz (that’s Yiddish for “drop dead”). All I’ll say is that, if you know anyone who’s interested in investing $563,000 of their hard-earned money in exchange for a return of 0.5% annual, please send them my way.

Probably someone reading is thinking “Ah, but what if you borrowed the money, rather than paying cash”? Well, that’s even worse. Say the buyer borrowed 75% of the purchase price ($422,250) at 4.25% fixed for 30 years. His mortgage payment is 2,077 / month, or $24,924 / year. Of course, he’s getting $3,300 in NOI, so his actual annual cashflow is only $-21,624. Another way of saying that is: For the pleasure of investing $140,750 of his cash, he gets the right to lose $21,624 in the first year. Again, not something I’d recommend!


Ok, but some of you are thinking, what about if the owner intends to move into one of the units? Does that make this a reasonable deal? Let’s see…

Owner-occupier needs to live in the property, so will have to relocate one of the two tenants. Because both tenants live in similarly sized 2/1 bed units, the city will force the owner to bump the tenant who moved in more recently, which is presumably the one paying $851. The cost of doing so will be around $15k, plus whatever the new owner wants to spend fixing up the unit for him/her to live in.

Let’s assume the new owner buys with a mortgage, because no owner-occupiers buy beat-up duplexes all cash… people that rich don’t live in beat-up duplexes!

What do the numbers look like? Well, the annual expenses are still $13,600. The rent from the remaining occupied unit is $557 x 12 = $6,684. That means the new owner will have to cover $13,600-6,684 = $6,916 / year in expenses out of pocket, or $576 / month. But there’s also the mortgage to consider… which is going to be $2,077 / month.

So, our new owner-occupier would be putting down $140,750 plus $14k for the tenant relocation plus, say $15k for renovations to the unit, for a total of $169,750 for the privilege of paying $2653 / month to live in an apartment which he could probably just rent for $2200. That, friends, is a terrible deal.


Maybe our buyer is a developer. Maybe he doesn’t care about the existing rents or structures and is instead going to build something new on the lot.

Here’s what he’s thinking:

  • 6200 sq ft lot
  • RD1.5, meaning 1,500 sq ft / dwelling
  • So, 6200 / 1500 = 4 dwelling units (you always round down with zoning calcs like this)
  • That’s [$563,000 + ($18,600 x 2)] / 4 = $150,000 per unit of developable land (the $18,600 is what you’d have to pay to reloc each tenant under the Ellis Act)

The simplest way to go would be to try to build four 800 sq ft apartments. At, say, $200 / sq ft to build, that’s 800 x $200 = $160k / unit in construction costs.

$160k construction plus $150k in land costs = $310k / unit. Assuming rent of $2500 (brand new construction) x 12 months = $30,000 annual rent for each unit, that’s a GRM of $310k / $30k = 10x… decent, but really not anywhere near good enough to justify the hassle.


Hopefully, it’s clear from the above that the buyer is not a buy and hold investor, an owner-occupier, or a developer. He must have more creative plans for the property… perhaps he plans to steal a page from Moses’ book and reposition the property.

Maybe he’s thinking:

  • Buy for $563k
  • Relocate the tenants for, say, $40k total (unlikely, but possible)
  • Renovate for $100k ($50k / unit is cheap for separate structures)
  • All in for $703k (this assumes it’s his money and that he doesn’t need to pay interest on it)

So, what’s the thing worth? Well, maybe he gets $2400 / month in rent / unit. That’s possible if he does a good job. $2400 x 2 units x 12 months = $57,600 / year in rent. Do we have a home-run on our hands? Well, the yield is now $57,600 (rent) – $15k in expenses (up a bit, because prop tax and insurance will be higher in this scenario) = $42,600 / year in NOI. That’s an unlevered return of $42,600 / $703,000 = 6%. Not bad, but, again, not really worth the work

And, unfortunately, the deal’s not flippable. With $57,600 in rent, even at 12x (a stretch with the rents maxed), you’re exiting at a price of $691,000, less than you put into the property (and that’s before paying brokers, transfer taxes, etc.)


Again, I don’t know the people who did this deal. It’s totally possible that they know something about this property that I don’t. But unless it’s sitting on an oil field or something, I can’t, for the life of me, figure out what the buyer was thinking. Any ideas?

Written by mjkagan

10/17/2014 at 2:48 pm