Why it all comes back to judgement

One of the under-appreciated qualities that go into doing what we do is judgement.

Almost every project brings with it unanticipated problems, from the trivial to the potentially severe.

At this point, I think it’s fair to see that we’ve seen the majority of these problems before and know the solutions.

But, even now, after having renovated 40+ buildings (I know… crazy, right?), new things crop up.

If they’re easy, someone else deals with them before they get to me.

If they’re complicated, they land on my desk.

And it’s my job to figure out the least bad way to resolve them.

But I’m rarely an expert at whatever the problem is. So, what I do is call on the relevant expert(s) and then make a decision based on my experience and the values of our company; in other words, I make a judgement call.

I know, with 100% certainty that I don’t make the right decision all the time.

But the goal is to be be right most of the time and, to make the decisions quickly so that things keep moving forward, and to avoid doing anything that compromises our integrity or puts our investors’ money at risk.

You can’t juke the operating expenses

There’s another broker with whom I’m acquainted who always seems to have amazing deals to show her clients.

Every week or so, I see her pitching deals with 8-10% cash on cash returns.

Eventually, I started to get curious. After all, this is a tough market. I have every advantage in the world, and it’s not easy for me to produce 10% cash-on-cash. How was this woman doing it for capital-constrained clients?

Do you know how she finds these deals?

She takes the same listings we use and runs a financial model that does not include operating expenses besides property tax and insurance. So, for example, there is no estimate of the water / sewer bill, pest control, repairs and maintenance, etc.

Of course this makes the numbers look great.

But she is going to have some very surprised owners in the months and years to come!

From whom should I borrow?

(Sorry for the obnoxious headline… my inner grammarian wouldn’t allow me to end a headline with a preposition.)

Had a friend call me today asking that simple question. Turns out a broker has been pushing her to use a particular loan broker and my friend wanted to know if that was good advice or not.

So, without any further pre-amble, here’s my advice re borrowing:

1. If you are buying a single family home in relatively good condition and have good credit, go directly to a bank, preferably Wells Fargo or Bank of America, rather than a loan broker. Why? The big banks get their capital incredibly cheaply (something like 70% of the money deposited at Wells Fargo is in non-interest-bearing checking accounts). So, those banks can offer loans at rates which are materially cheaper than those offered through the small banks that work through loan brokers (and which have to pay high interest rates to attract deposits).

2. If you are buying an apartment building in LA, go with a loan broker. It’s really hard to find good deals on LA apartment buildings. When you do find one, it almost always has something wrong with it (mold, foundation settling, etc.). Big banks have zero interest in making problematic loans, so, when a problem crops up, they run for the hills. Loan brokers, on the other hand, only make money from slamming loans through smaller banks. So, when you’re buying something with issues and you absolutely, positively need someone to get the deal done, go with the guy / gal with skin in the game… eg the loan broker.

3. If you are buying something which is uninhabitable or you have terrible credit, then your only option is to work with a private money lender (eg a loan shark). These guys are willing to take on all kinds of risk, but they get paid exorbitant interest rates to do so (usually 8-10% once all the fees are factored in).


What I’m a sucker for…

I have a deep, embarrassing, long term addiction to low price per sq ft deals.

There, I admitted it.

Do you know why I’m addicted?

It’s pretty simple:

1. On the tenant side, buying for a really low per sq means that you can offer large apartments at relatively low, per sq ft rents and still make money. Most tenants don’t think about things in these exact terms, but the effect is obvious when they walk in the door: They can’t believe they’re getting this much space for that little rent.

2. On the sale side: When you buy at a very low price per sq ft, the eventual exit is much, much easier. The reason is that, once you improve the building and raise the rents, you’re still not going to touch the established $ / sq ft comps on exit. For example, we sold 1947 Clinton St for around 11.3x the rent and 3210 Bellevue for around 11/4x the rent. But Clinton was a huge building, so the price ended up at $306 / sq and Bellevue was tiny, so the the price ended up around $440  sq ft (from memory). If you were an appraiser, which deal would you find easier to underwrite?

echo park, multifamily, apartment building

But there’s a downside to my addiction: I often get very excited about deals in areas where the rents simply won’t justify renovations, even if you acquire at a very low price per sq. These deals kill me, because I know in my bones they’re worth buying, but, because the value-add piece isn’t justified by present rents, I can’t use my value-add funds to buy them.

Some day, I’m going to have enough capital sitting around to snatch up these deals when I see them with the idea of just waiting around until the rents justify renovations. Until then, I mostly have to watch them go by…

A well-run sale process

We’re currently participating in an interesting sale process, so thought I’d share the details.

The seller and listing broker have chosen to run their process differently than most and will, I think, achieve better than average results.

To understand what they’re doing differently, you first need to understand how a normal process works. In a normal process, the broker puts the property on the MLS, Loopnet, etc. at the highest price he thinks a buyer might possibly pay. Offers trickle in, the seller counters, eventually a deal is struck and then the buyer begins his diligence (inspections, etc.).

The downside to a normal process is this: If the buyer decides, for whatever reason, to walk away after inspections, the listing broker is left having to go back to the other potential buyers (if any) and try to rekindle their interest in the property.

The process in which we are participating is very different. Here’s how it’s being run:

  1. Property was marketed at a very reasonable price
  2. All serious buyers who submitted offers were invited to inspect the building thoroughly on the same day
  3. After inspections, buyers still interested are required to remove the physical inspection contingencies from their offers
  4. Those buyers receive access to a data-room with all of the relevant documentation, including leases, estoppels, etc.
  5. Buyers who remain interested are then required to submit their best and final offer on a totally non-contingent basis (eg with no way to back out)

Obviously, the downside of this new process is that buyers are required to invest considerable time and energy in the deal prior to learning whether they will actually get it, meaning that some buyers will be less likely to participate at all.

On the other hand, the seller is able to maintain competitive tension all the way through the inspections and documentation review. And, the seller knows that the winning bid is firm (eg that the buyer can’t easily want away).

Of course, there’s no way to know whether this process will result in a better outcome for the seller than a normal process would have (because we don’t get to run experiments in real life). But my guess is that it will, and I think more sellers ought to consider running processes like this one.