Moses Kagan on Real Estate

You might think that, somewhere, the City of Los Angeles has plans for every structure erected in the city, at least since modern building permits came into use in the 1910s. You might think that, if you’re planning to renovate an old building, you can go down to some records room, pull the plans, and then begin work on designing your renovation.

You would be wrong on both counts. Here’s why:

1. The city has very spotty records for plans going back before the early 1990s. Want to see plans for a 1920s building? Forget it.
2. Even in the rare instances that the city has the plans, the rules require that you get written permission from the architect before the city will release them. Which is fine, except that, for a building built in 1960 by an architect aged 50, you’re trying to get written permission from someone who is 103 years old.

So, the first step of every single renovation project we do is to get “as-builts” drawn.

What are “as-builts”? They are detailed drawings done by an architect who measures every dimension of the building as it is in real life and puts it on paper.

Only then can you start messing around with putting together new layouts for your units.

Thought you might like to see what 1920s buildings look like when you rip them open.

When I say we gut our projects, I mean 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!

Lately, it feels like we’re spending a lot more time speaking with potential partners about fee-for-services deals, rather than straight brokerage.

What do I mean by “fee for services”? Jon and I have relationships with certain investors where we help them buy and renovate apartment buildings in exchange for brokerage fees and cash payments from the partner.

These aren’t our favorite deals to do, because the tax rate on the cash we receive is so high. However, in the right circumstances, with the right partner, they make sense to us.

So, why are we seeing an uptick in requests for this kind of deal? The reason seems to be the increase in prices across the market.

Basically, if you’re an investor looking to buy a building, you have two options:

1. Buy some blah building at something like 11-12x the rents and accept the terrible return that implies; or
2. Buy something really beat up at 14-20x the rents** and spend money to fix it up, with the intention of getting to something more reasonable like 9-10.5x the rents (on a newly renovated building).

Clearly, the second option is more appealing than the first (since the returns are better and the asset will be in much better shape post-renovations). But many investors don’t have the time / experience to carry out this strategy. That’s why they’re paying us to do it.

**Two readers emailed in to ask why a beat up property would have a high GRM. The reasoning is: When you have a building with really low rents, getting a market GRM would drive the price ridiculously low.

For example: Say you have a fouplex is Silver Lake that’s 4,000 sq ft and which is getting $600 / month each from four tenants, or $28,800 / year. If you apply a “fair” GRM of 11-12x, you get a price of $316-345k. But the owner isn’t stupid. He looks around and sees other 4plexes selling for $800-900k. His broker might argue that the rents in the subject building are low, but the owner doesn’t care – he’s focused on what he gets for his building, not what market is. Maybe he’s willing to let the thing go for $650k. That’s $162/sq ft, which is still very cheap on a price / sq ft basis. But it’s a 22.5x GRM.

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.

Just finished leasing up a 5 unit Echo Park project we did with some partners.

Leased all units between Wednesday and Sunday night of last week at rents ranging from $100-250 above forecasts. Read that again.

On this deal, after paying us our fee, our partners own a brand-new, renovated apartment building for under 9x the rents. That blows away what anyone can get just by buying a building on the market.

Here’s an exterior pic:

And an interior:

On to the next one…

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.

If you ever think what we do is sit behind the desk and jockey spreadsheets, you’re wrong. Recently, we’ve been dealing with a rash of thefts by low-lifes.

Heres a partial list of things that have been stolen from our projects over the past month or so:

• New copper plumbing and new electrical wires from one project. No idea who did it, but we had to pay the plumber and electrician to buy new materials and re-do the work. 
• New copper plumbing from a different project. This one was someone from the plumber’s team, so he paid to fix this.
• A paint-sprayer (this was owned by one of our contractors).
• A microwave and some drawer handles from a vacant building that’s up and running.
• Two un-cut quartz countertops from a project under construction

As a result of the above, we’ve had to hire security for almost all of the projects we have in progress.

My question is this: What the hell is wrong with people?

David Walentas of Two Trees Management.

Who’s that?

Walentas was in the business as small-time owner / developer in NY in the 1970s. Then, in the early 1980s, he made a deal to buy a bunch of warehouses in a then-ignored  part of Brooklyn called DUMBO (“Down Under the Manhattan Bridge Overpass”) for something like $6 / sq ft.

He spent 15 years fighting with the city to get approval to start turning the warehouses into apartments. His partners gave up and he bought them out. Then, finally, the city relented and let him start re-developing the buildings.

He gave away retail space on the ground floor to cool shops and restuarants to improve the neighborhood. Then he developed condos upstairs which are now selling for $1,000 / sq ft.

Now, he’s a billionaire. Read more about him here.