Mostly, it’s underwriting deals.
Here’s what happens:
- Either I find a deal on the MLS, Loopnet, etc. or else a broker or client sends it to me
- I get my hands on the rent roll (surprisingly hard, sometimes)
- I look at the property on google maps to get a sense for the location and, critically, the style of building
- I look at the property on ZIMAS to get the square footage and unit mix
- Based on our experience renovating about a million deals, I concoct a plan for the property which seeks to maximize the yield post-renovation; everything is on the table, from moving walls to expanding to outdoor space… you name it
- I make a little model that looks at the cost of buying, the cost of rehabbing, the estimated rents, and the estimate expenses to get at an expected yield
- I speak with my partner Jon to confirm / fix my assumptions
- If the deal meets our target yield, we write an offer
Sounds pretty simple, right? The reason is works is that we do so many deals that we (1) know pretty quickly what the optimal plan for the building will be; (2) how much it will cost / how long it will take; and (3) what the rents and expenses will be.
It’s not that we are never wrong; there are surprises in every business, ours included. It’s just that we’re wrong very, very rarely.
In our business, you get surprised all the time in ways both great and terrible.
Take this new project we’re doing in Highland Park…
It turns out there’s a two inch layer of concrete under the floor, meaning we can experiment with doing polished concrete for less than it would cost us to do hardwood.
The bad news is that a few of the previous tenants decided it would be a good idea to use cement to attach awful tiles to the underlying concrete… meaning we somehow need to deal with this:
Someone is going to spend a lot of time in this apartment with a grinder of some sort…
In February of 2012, I wrote a piece confidently predicting that Westlake, the neighborhood roughly south of Silver Lake and Echo Park and west of Downtown, would never gentrify. Here is my piece in all its glory.
To lazy to click the link? Here’s my (flawed) argument in a nutshell:
- The housing stock is incredibly dense, lacks parking and is rent controlled, making it very difficult to renovate buildings and achieve sufficiently high rents to make the investment pay-off
- The crime rate remains quite high and, without wholesale change in the apartment buildings that comprise the neighborhood (which ain’t happening; see above), it’s unlikely that will change any time soon
[Side note: The language in the original piece, including the unfortunate use of the phrase “by force”, is pretty awful. Needless to say, it predates the explosion over Boyle Heights, when I became a bit more sensitive about my choice of words on this site. I left the original post alone because it seems dishonest to change it in retrospect.]
Now, it turns out that Westlake is starting to see the glimmers of improvement, including some new bars and creative office tenants and also some buildings in the early stages of renovation / revitalization.
Why was I so wrong?
It turns out that proximity to the western edge of Downtown, with its rapidly expanding set of amenities (bars, restaurants, clubs, etc.) and high rents ($2000 for a studio?!), is enough to tempt some more adventurous tenants to jump west across the 110.
It’s early enough that the numbers don’t work for my kind of deals. But, depending on what happens over the next few years Downtown, we may all look back on my 2012 Westlake piece as one of the dumber things I’ve ever written on this blog.
Sometimes clients ask me why we’re so focused on Northeast LA (Silver Lake, Echo Park, Highland Park, etc.). After all, LA is a big place and there are plenty of other places to buy apartment buildings. So why the focus on the hipster areas?
Hint: It ain’t because we love asymmetrical haircuts, beards and artisanal pickles.
Regular readers know I would do deals on the moon if the numbers made sense.
The reason we focus on those key areas of NELA is because that’s where the money is!
There are still plenty of owners who have run-down buildings which they stopped maintaining years ago.
When those owners get sick of running slum buildings or pass away and leave them to their children, we have the opportunity to buy them, fix them up (a lot!), and charge rents sufficiently high to make the whole thing worthwhile.
I’m constantly on the lookout for more areas where our model works (using this equation), but for right now, NELA is where it’s at.
In a word, “No”.
Because we’re not interested in buying the properties our brokerage clients want to buy.
Our typical brokerage assignment is to help someone buy:
- 2-4 units
- 20-25% down (so, looking to put out $100-250k in capital)
- 70-75% LTV mortgage
- Minimal renovation required
- Cashflowing (eg priced at 12x GRM or less)
The deal outlined above is perfect for a non-professional investor, who will generate a decent yield with a 30 year fixed mortgage while using a reasonable amount of cash and keeping headaches to a minimum.
But that kind of deal doesn’t work for us, because we can’t use that kind of leverage and we’re willing to go through major hassle in order to generate far above-market returns.
What we want to buy for our funds:
- 4+ units
- $500k up to $2-3MM
- All cash
- Massive renovation required
- $200 / sq ft or less
- Don’t care about the yield (eg willing to pay a functionally unlimited multiple of the rents)
As you can see, the deals we want are complicated and capital-intensive. In short, they are not the kind of deals that our typical clients are equipped to do.