Moses Kagan on Real Estate

Archive for the ‘Development’ Category

Amnesty for illegals (apartments, that is)

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Per the LA Times (and via Curbed): Landlord and tenant groups in LA are uniting around an initiative to allow landlords to legalize non-conforming apartments more easily.

Right now, if the Housing Department catches a landlord with an illegal apartment, here’s what happens:

  • LAHD cites landlord for un-permitted unit, orders her to either get it permitted or vacate it
  • Landlord attempts to permit; discovers that it’s nearly impossible to do (because adding a unit always requires adding parking and adding parking is nearly impossible)
  • Landlord decides to vacate unit
  • Tenant is evicted; receives $8-19k from landlord (ouch), who must also pay to remove the kitchen and bathroom

The net result of the above is that the tenant is out a place to live and the landlord is out a bunch of money and receiving less rent going forward.

You can see why landlords and tenants have an incentive to band together to try to change city policy. And, low and behold, they’re trying: The idea is to get the city to make it easier for the landlord to bring the unit into compliance so that the tenant can stay.

I’ve permitted a non-conforming unit before and it’s no joke. The problems break down into two categories:

  1. Bringing the unit itself up to code. That means appropriate ingress/egress, windows, fire protection, etc. This is almost always possible to do, so long as there is sufficient money… and the value-add from adding a unit would almost always justify the cost;
  2. Adding the parking. In my case, I was able to squeeze in another parking space by moving a giant electrical panel at the cost of $30k. But, generally, this is impossible, because there’s just not enough space on the lot and digging out subterranean parking would be totally financially infeasible.

So here’s the rub: If the city is going to make it easier to permit non-conforming units, it’s going to have to waive the parking requirements.  And the city has generally been very wary of anything that would reduce parking and therefore anger neighbors.

Have rents got so high that politicians are willing to consider allowing alienating homeowners by allowing landlords to reconfigure existing buildings to add more units? I doubt it. But I hope I’m wong… because my business would get much, much better if it did!


Written by mjkagan

08/19/2014 at 10:38 am

Posted in Development, How to

What’s wrong with this picture?

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I usually avoid giving design advice on this blog, mostly because my partner Jon is the design expert at Adaptive. I mostly do the numbers.

That said, I thought I’d draw your attention today to a classic error that landlords make when renovating apartments.

Look at this picture:


Can you see what’s wrong?

The owner decided to use tile or some kind of laminate for the dining / kitchen area.

The effect is to make the room feel considerably smaller than it actually is, because the eye is tricked into thinking it’s divided in two.

If, instead, the owner had continued the wood floor all the way to the far wall, the space would feel huge and open.

Why do people choose to do tile dining / kitchen areas? Well, I guess there’s an argument that they hold-up better when water is spilled on them. But tenants these days tend to cook a whole lot less than before.

That said, as between getting (1) higher rents but having to refinish the floors slightly more often; and (2) getting lower rents, I’ll take 1 every time.

Written by mjkagan

08/15/2014 at 5:45 am

Posted in Development

Off with the security bars

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How can you tell that Silver Lake and Echo Park weren’t always so nice?

The window bars.

Back in the 1980s and 1990s, both neighborhoods had plenty of shootings, burglaries, etc. People naturally responded by “up-armoring” their homes with strong doors, fences and window bars.

Now, both neighborhoods are very safe. It’s not that there’s no crime; it’s just that most of the serious stuff is gangster-on-gangster violence that does not involve civilians.

Meanwhile, those window bars are still up, mostly due to laziness on the part of homeowners and landlords.

But they send absolutely the wrong message about the neighborhoods. And, worse than that, tenant absolutely loathe them. No one likes to spend a lot of money to feel like they’re in jail.

So, do us all a favor and take a look at your Silver Lake / Echo Park property (properties?). If you still have those bars up, it’s time to send the handyman over to take them down.

Written by mjkagan

08/14/2014 at 9:35 am

Posted in Development

Interesting piece on the history of LA zoning

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I recognize that my continued harping on our antiquated zoning code is not the fastest way to build readership (to put it mildly). However, I am not going to stop writing about it, because zoning shapes LA in ways of which most people are not at all aware.

In any case, today I want to draw your attention to an interesting piece about the history of our code which was recently posted on the Recode LA website.

Here’s the money quote:

“[C]onflicts over the maintenance of the early postwar concept of good zoning have led to a great number of discretionary actions built into the Code. These have tended to increase the weight of those disinclined to allow change. This use of discretion has been at the expense of the creation of new housing. It has been at the expense of the environment and efficiency, displacing density from urban areas to exurban locations.”


Written by mjkagan

08/13/2014 at 12:54 pm

Posted in Development

An email filter I’d like

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Can someone please figure out how I can block solicitations from brokers who want to sell me “turn-key” assets?

“Turn-key” is broker-speak for “No value left to add”.

Don’t misunderstand: There is a large group of investors for whom turn-key deals make a ton of sense, including everyone who has bought deals from me over the past five years.

Busy, wealthy people who want to place capital in multifamily can do a LOT worse than paying the market price for a very-close-to-perfect asset with high quality tenants.

And syndicators who can raise cheaply and don’t mind thin margins can do well with these deals, too, because they don’t require much in the way of management time and expertise.

But I’m not personally wealthy (yet!) and I’m not the best fund-raiser in the world (I’m temperamentally unsuited to bullshitting people). So the money we raise is expensive.

And that means we’re looking for screwed-up buildings, where there is plenty of value to add and excess returns to be generated.

So, please, no more calling / emailing me about “turn-key” deals… I’m totally uninterested.

Written by mjkagan

08/12/2014 at 11:10 am

Seeing the matrix

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Do you remember The Matrix, the amazing 1990s sci-fi flick with Keanu Reeves? In it, Keanu’s character learns to see the numbers behind the invented reality he inhabits.

Why am I talking about this on a real estate blog? Because it occurred to me this morning as I was taking out the trash from our office that I see the matrix, too (or, at least, a part of it). Stop laughing.

Take a look around you. Do you see buildings? If you do, what you’re really seeing are the physical manifestations of capital and the cashflows that capital commands.

What’s capital? Capital is stored, excess value. You work, generate income, and consume less than you generate. The remainder, which you save, is capital, which can be put to work productively, either by you or by others to whom you give it (via equity investment or loans) in exchange for a cashflow of some kind.

And capital and its attendant cashflows are physically manifested all around us, all the time.

Do you see a house? That’s capital provided by a bank which commands a cashflow from the borrower who “owns” the house (I put “owns” in quotes because, of course, the bank has first call on the value of the house until the lien is satisfied). There’s also an implicit stream of cash flowing to the owner in exchange for his equity which he enjoys in the form of the right to use the house and benefit from the appreciation.

Do you see an apartment or office building? That’s a stream of rent, less expenses, flowing to the owners and to whichever bank financed them.

Do you see an owner-user commercial building (like a factor owned by the company that produces things there)? The company doesn’t pay rent to itself. However, the company’s profits are higher because it’s not paying rent and the difference between what the company’s profits are and what they would be if the company had to pay rent for the space represents an implicit cashflow owing to the company because it owns the asset.

Depending on, inter alia, interest rates, the rate of decay or improvement of the physical structures themselves, and long-term changes in the desirability of different neighborhoods, the values placed by the market on the cashflows constantly change. Understanding those values and being able to anticipate how they can and will change is at the heart of what we do.

Remember this as you walk around looking at buildings.

Written by mjkagan

08/11/2014 at 5:08 am

Posted in Development

History repeating?

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Back in the 1980s, Japanese companies flush with cash acquired a ton of office buildings (and maybe hotels, too?) in LA at very high prices.

In the recession of the early-to-mid-1990s, they got their asses handed to them.

Now, there is a wave of Chinese developers flush with cash buying up office buildings, hotels, and development projects in LA.

But there is a ton of apartment / condo / hotel product getting built right now, especially downtown, where many of the target properties are located.

The question these developers need to ask themselves is pretty simple: Will the current cycle persist long enough for the market to absorb all this new product?

I’m not ready to say that the Chinese money is going to get crushed the way the Japanese money did.

But I’m not sure I’d be making the bets they’re making.

Written by mjkagan

08/08/2014 at 4:17 am

Posted in Buying, Development

The math behind discovering a new neighborhood

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As prices continue to rise for the kind of beat-up, badly managed assets that are our bread-and-butter, we are spending more time looking at new neighborhoods.

Am I going to tell you which ones I’m focusing on? No, because a bunch of people who compete with me read this blog.

But I will share with you the way that I think about these things.

There is an equation that underpins our whole business: (rent – operating expenses) / (acquisition price + rehab) = yield

1. The cost of renovating a building doesn’t change much, no matter where you do it. No one charges you less for washer / dryers because you’re putting them in Compton, or more for ACs because you’re putting them in Beverly Hills.

2. The operating expenses don’t change much, no matter where in the city you are. You pay roughly the same amount for property taxes, water, management, repairs, etc. wherever your building is.

Given that your rehab and operating expense stay proportionately the same, what does move around?

1. The acquisition price of the building. Obviously, in the equation above, the lower the acquisition price, the smaller the denominator, and the higher the yield (all things being equal).

2. The rents. The higher the rents, the larger the numerator, and therefore the higher the yield (again, all things being equal).

What does all of this mean? Because all the stuff in the middle (the capex and the opex) doesn’t change much, you need to look for neighborhoods where you can buy cheap and rent expensive. Those are the areas where you ought to be able to generate excess yields.

The trick, of course, is to distinguish a truly improving neighborhood (one where you can buy cheap but rent dear) from a dumpy one (where you can buy cheap but can’t get the rents to work).

Written by mjkagan

08/07/2014 at 5:24 am

Posted in Buying, Development, How to

City growth, affordability and the decline of the middle class

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The NY Times has an interesting piece today on middle class people leaving increasing expensive coastal cities (SF, NY, etc.) and going to more affordable cities in the interior of the country.

The underlying dynamic is pretty straight-forward: Without the liar’s loans that were available in 2005-6, there’s no way for middle class people with stagnant wages to afford homes / apartments in the coastal areas where prices / rents continue to increase. Rather than live marginal existences on the coasts, lots of people are choosing to move to Oklahoma City, parts of Texas, etc.

If you carry this dynamic to its logical conclusion, you end up with coastal cities that are bifurcated between very well-off people who can afford property and immigrants who are willing to tolerate difficult economic circumstances in order to fill jobs servicing the wealthy people.

To me, that sounds like a pretty awful future. I would prefer to live in a city where the population is diverse in terms of ethnicity / race and also in terms of income.

How do we ensure that middle income people can remain in coastal cities like LA? There are three broad options:

1. Impose restrictions on prices and or rents. Policies like rent control do make it easier for low and middle income people to remain in expensive areas. However, the costs of these policies are disproportionately born by two groups: Owners of the effected real estate (who are unable to get market rates for their property) and people who do not qualify for the assistance (because the rent / price restrictions act in practice as supply reductions, increasing the prices of whatever remains in the market).

2. Have government intervene to create more supply. An example would be government providing tax credits to developers to build affordable housing units. This kind of intervention works (new units are created) but it is impossible to scale. Why? Because it would be ruinously expensive for the government to create enough affordable units to make any kind of dent in market prices. (By the way, one main reason for this is that government often requires developers of affordable projects to use union labor, dramatically increasing the costs of construction.)

3. Change the zoning.

As many of you already know, I am a major proponent of #3. Why?

  • It’s costless upfront. At the stroke of a pen, city government can re-zone land from sparse, single-family to dense multi-family. Developers will immediately jump in, buy up the newly re-zoned land, and start building units. The more permissive the re-zoning, the more units you’ll get.
  • Increasing infrastructure costs can easily be offset. Yes, new apartments require more roads, water pipes, subway stations, etc. But it’s trivial to price this in to the cost of the project by extracting development fees from developers (we already do this).
  • The costs are canceled out. Yes, some people who currently live in the single family areas will bear the cost of much of the new development (they will end up with big apartment buildings on their streets). But the value of their properties will increase materially, giving them the opportunity to sell out at a huge profit, then decamp for areas more in-line with their personal preferences

Bottom line: We have a solution for the lack of affordability of our coastal cities. We just need government to be willing to do what needs to be done.

Written by mjkagan

08/04/2014 at 1:00 pm

Posted in Development

Airbnb and the Ellis Act

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There’s a big fight brewing up in SF over landlord’s use of the Ellis Act to get into the short-term rental business.

What’s the Ellis Act? Well, in CA, the law is that no one can force a landlord to remain in the rental property business. So, the Ellis Act creates a procedure whereby a landlord can declare his intention to take his apartment building out of the rental market and then force out rent control tenants by paying them approx. $19,000.

The Ellis Act is most often used by condo-converters who buy a rent controlled apartment building, force out the tenants, get a condo map approved, and then sell of the units individually. This is, itself, a controversial business, because it removes apartments from the rental market, and LA, among other cities, has created some pretty tough rules intended to make conversion much harder.

Now landlords have identified a new opportunity to use the Ellis Act: Airbnb.

If you have a fixed up apartment in SF or in a desirable part of LA, you can get $200+ / night by renting your unit out on Airbnb. That’s $6,000 / month, or, say, $3,600 assuming 60% occupancy. Even if you spend $1,000 / month on expenses ($12,000 / year, much more than you would spend to operate a standard apartment), you’re still netting $2,600 x 12 months = $31,200 net per year.

Compare that to a rent controlled tenant at $1500 / month. That’s $18,000 gross, less, say $6,500 in annual expenses, or $11,500 net.

Assuming that, in our present low interest-rate environment, landlords are happy with a 7.5% return, they would be willing to spend $266k to get that additional $20k / year in net operating come.

So, you can see that spending the $19k on the Ellis Act, plus, say, $50k fixing up the apartment, is a very good deal from the landlord’s perspective.

The question, though, is whether it is fair to use the Ellis Act in this manner. I don’t see much of a distinction between renting a unit out on a standard lease and renting one out short-term. That, to me, doesn’t rise to the level of “exiting the rental business”, which is supposed to be the standard for Ellis Act evictions.

As regular readers know, I’m not a fan of rent control. But, so long as we have rent control and other laws governing the relationship between landlords and tenants, we ought to enforce them. To me, this case is pretty cut-and-dried… renting your units out on Airbnb is not exiting the rental property business and is therefore an improper use of the Ellis Act.

Written by mjkagan

07/31/2014 at 10:54 am

Posted in Development