Moses Kagan on Real Estate

Wasted a ton of time this weekend due to broker error.

This genius, who will remain nameless, listed his property for sale on the relevant listing databases. The property is odd, but it has a ton of potential if you change its use.

We spent a bunch of time running numbers and dreaming up a strategy for how to get the change of use.

When I called the broker this morning to confirm it’s still available, he casually asked if I knew the property was a ground lease.*

No, I did not… because it’s not on any of the marketing materials!

Obviously, there’s a huge difference between (1) investing a ton of time and money in a property you own; and (2) investing a ton of time and money in someone else’s property.

#1 is fine; #2 is likely to end badly. Glad I spent the time on this, rather than hanging out with my kids…

*What’s a ground lease? It’s when an owner wants to keep a property for the very long term, have nothing to do with improving it, but also collect rent from it. He will sometimes allow someone else to develop it under a very long lease, usually 99 years or something. The developer builds and operates the structure while paying the (usually quite low) ground lease payment to the owner. At the end of the 99 year period, if the lease hasn’t been extended, ownership of the structure reverts to the owner of the land, and the developer is out of luck. 

Regular readers know I’m not exactly a big fan of the suburbs.

My chief complaint is that the lack of density pretty much guarantees that municipalities will not be able to fund upkeep of the infrastructure, because there are too few people / businesses per mile of road / sewer pipe / water pipe / etc.

(Because of our insane zoning in LA, where it’s incredibly hard to build densely and you need to provide unbelievable amounts of parking, we experience similar problems – just check out the potholes in the roads you drive on every day.)

Today, I stumbled across strongtowns.org, an interesting website that’s trying to help suburban towns make smarter choices about development.

Thought you might appreciate watching a TED talk from the founder of the site:

The NY Times has an interesting piece today on cities trying to help long-time homeowners whose property taxes are going up as a result of gentrification.

Here’s the money quote:

“The initiatives, planned or underway in Boston, Philadelphia, Washington, Pittsburgh and other cities, are centered on reducing or freezing property taxes for such homeowners in an effort to promote neighborhood stability, preserve character and provide a dividend of sorts to those who have stayed through years of high crime, population loss and declining property values, officials say.”

Here’s what the cities are trying to prevent: Area gets better, new people move in, prices go up, property taxes get re-assessed upwards, existing residents can’t afford to pay, existing residents sell and move-on, community suffers.

In California, Prop 13 protects homeowners in this situation, because property taxes are pegged at roughly 1.25% of the purchase price and can only be increased by a maximum of 2% annually thereafter. So, price increases of more than 2% annually have no effect on CA property taxes. (For more on Prop 13 and its implications for property owners, read this and this.)

But our experience with property tax limitations in CA does point to one interesting problem with the policies contemplated by the above-referenced cities: If you limit property tax increases, you dramatically slow the rate at which neighborhoods improve.

To illustrate why, consider two examples:

1. The case of the vacant lots on La Brea, just south of Wilshire. (If you’re too lazy to click the link: There are vacant lots on La Brea, an incredibly important and valuable street, because the prop taxes are low so the owner has no incentive to sell or develop himself); and

2. All over the city, but particularly in Silver Lake and Echo Park, there are people who bought their homes in the 1980s for peanuts. Many of these homes have now fallen into disrepair because the owners are insufficiently well-capitalized to maintain them. These owners almost never sell, because they are living for very, very little. So, their properties will remain eye-sores in perpetuity.

So, if cities are going to opt to help the original owners stay, they ought to put in place some standards for property upkeep and, possibly, a program to help pay for upkeep if the owners can’t afford it.

Word comes today from the Eastsider that the Silver Lake Neighborhood Council has just approved the Sunset Gateway project on the eastern edge of Echo Park.

Regular readers know that I’m a big fan of dense, in-fill development. And the part of Sunset on which this project is sited is particularly grim and in need of investment.

So, why am I worried about the project? Well, I’ve seen the insides of several of the mega projects that have gone up recently in Hollywood, and I’m concerned that Aragon Properties is going to screw up the interiors the same way those other developers did.

Here’s the deal: Rents in Silver Lake and Echo Park are high and rising. That’s why Aragon targeted this site in the first place. However, the type of tenants who are paying those high rents are doing so because they are attracted to a very specific kind of lifestyle which they believe is reflected in the neighborhoods and which they like to have reflected in their apartments. I know this because we cater to them in every development we do.

The interior design choices made in those projects (fake wood floors, yellow shag carpet in bedrooms, shiny black quartz counters with cheap stainless sinks, showers out of a 1990s hotel in Vegas, bad light fixtures, etc.) are not going to fly with the type of tenants who are paying up to live in Echo Park.

If Aragon does the same bad interior design job those other guys did, they may never know it, because rents and absorption may live up to their pro forma. So they may never know that they left a whole bunch of money on the table by doing a sub-optimal job on the design. But we’ll know.

We’re getting closer and closer to finishing the 4plex at 3210 Bellevue that we bought last July.

It’s an interesting deal, in that we got smaller units than we did at, for example, 1012 N. Virgil, (825 sq ft instead of 950), but a lot of land (10k+ sq ft).

I like these little bungalow deals with big lots because they’re pleasant to live in… there’s usually a lot of parking plus space for decks, yards, etc. I expect we’re going to blow the doors off on a  rent $ / sq ft basis, because the units will feel like little homes.

Anyway, here are some pics of the progress…

If you’re interested in city land use politics, you’re probably aware of the huge fight over the re-zoning of Hollywood that’s been going on since the new Hollywood Community Plan was enacted in 2012. (If this is the first you’re hearing of it, check this out.)

In a nutshell, the Hollywood Community Plan is intended to allow for denser development of Hollywood, which as the center of the second largest city in America, certainly ought to have dense, transit oriented development.

Recently, a group of NIMBY (not-in-my-back-yard) jokers managed to get a judge to issue an injunction blocking the city from issuing any permits which rely on the Plan.

Why should I care? After all, Adaptive doesn’t (yet) build ground-up.  We’re not making the Hollywood any denser. So we ought not to be affected by the injunction, right?

Wrong. The city, in its brilliance, has suspended the issuance of ANY non-expedited permits for all projects in the Hollywood Specific Plan area until DBS and Planning can create a system to figure out which permits do not rely upon the blocked Community Plan and can therefore be issued.

So, my renovation projects in East Hollywood which have literally nothing to do with the scuffle over building heights in Hollywood, are delayed. And, if you’re doing anything more substantial than a kitchen / bathroom remodeling anywhere in Hollywood, you’re going to be delayed, too.

Total. Epic. Fail.

Anyone who spends any time looking at development projects in LA knows that parking is the key to everything.

Because of LA’s roots/identity as a series of connected suburbs, we have a zoning code which requires a ton of parking for all uses. For example, if you build a two bedroom apartment, you need to provide two parking spaces. If you want to build a retail use, the code can sometimes require 10 spaces per 1,000 sq ft.

The net result of all of this required parking is that you can’t really build to a high degree of density. You end up with parking taking up all of the ground floor of your apartment projects. And, if you want to build retail, you need huge parking lots around your store.

What’s wrong with devoting a whole bunch of space on the ground floor to parking? It makes things awful for pedestrians.

So, a modest proposal: LA should identify 10 parking challenged areas, use eminent domain to acquire suitable land in each, then build big, modern (ideally robotic) parking garages with retail on the first floor. The spots should be available on an hourly, daily or monthly basis and the cost should reflect (most of) the cost of building the garages.

By charging market rates, (obviously) not charging itself property tax, and collecting rent on the retail, it should be possible to build these garages using nearly 100% debt, meaning the entire project would be close to costless.

The final touch: In the immediately areas around each garage, the city ought to offer to relax parking requirements for new development, possibly in exchange for one-off or continuing payments from the developers.

The net result would be to dramatically increase density in each of the targeted areas without causing parking problems and without costing the city anything.

1. Perpetuate outdated notions about the desirability of single family homes;

2. Impose incredibly restrictive zoning in areas close to jobs, ensuring that homes there will remain very expensive;

3. Provide large, implicit subsidies to drivers, specifically by failing to price-in the societal cost of greenhouse gas emissions;

4. Under-invest in mass transit;

5. Allow exurban developers to build large, cheap single family homes on large lots in sprawling developments.

The result: A bunch of people sitting in their cars for 60-120 minutes a day, eating fast food, getting fat, not spending enough time with their kids, polluting the earth, and generally being unhappy.

Yahoo Finance had a somewhat interesting article yesterday regarding the mass ownership of homes as rentals by big investment funds.

In case you haven’t been following this issue: Tons of homeowners lost their homes during the Great Recession. Because there were so many vacant homes, prices dropped really far, particularly in certain western and southern states. Prices dropped so low that it became possible to buy homes, clean them up, rent them out, and get a rental yield of 7-10% / yr.

Because there were so many homes, and the price of homes is so high, this represented a massive opportunity to deploy capital. Big Wall Street investment companies raised huge funds and bought literally thousands of homes with the intention of renting them out, collecting a yield, and then selling as the market improves.

Not a bad plan, right? Well, the “expert” Yahoo quotes makes the reasonable point that these investment companies were probably underestimating the difficulty of managing huge portfolios of individual homes, which are spread out and have idiosyncratic designs / problems. Bottom line: It’s considerably harder to manage one hundred individual homes than it is to manage a 100 unit apartment complex (leaving aside local issues like rent control).

So, will the private equity players end up screwed? My guess is that they will not generate the kinds of rent yields they forecast, due to the difficulty of economically maintaining large numbers of homes. I expect that the PE guys who bought in relatively close-in areas, where jobs are available, will be bailed out by homes price appreciation. But I expect that the PE guys who bought in farther out areas, where jobs are likely to remain scarce and commuting costs are high, will end up owning homes that no one wants to buy.

Agent: “I want to pitch this property to the Mid-City clients. 2 out of the 3 units will be delivered vacant at COE and there is some upside in the rents. The only problem is that the 3rd unit is unpermitted. How hard is it to legalize a rental unit retroactively?”

Moses:

“Depends on three factors:

1. Does the zoning permit three units?

2. Is there enough parking for three units?

3. Was the construction work to make the third unit done to code or is it janky?