Moses Kagan on Real Estate

Archive for the ‘Selling’ Category

Here’s a bad selling strategy

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Take a look at this listing on Silver Ridge in Silver Lake:

http://takesunset.com/2013/03/2338-silver-ridge-avenue-in-silver-lake/

Absolutely beautiful example of modernist design in an A+ location.

So, why am I complaining about it?

Take a look at those rents. They’re getting $2595 each, which implies they were rented pretty recently (if they’d been rented more than a year ago, I would expect the number to be less “round”, due to one or more 3% increases). That equates to roughly $62k / year, meaning the property is listed at a whopping 14.5x the rents.

Now, for an investor, that’s an insane price. The returns are going to be terrible going in and for a long time to come.

For a homeowner, that price may not be that crazy. After all, if you want to live in one of the units, you can talk yourself into paying whatever price you feel.

But, here’s the problem: The tenants are rent controlled. So, getting them out in favor of an owner-occupier user is going to cost a minimum of around $7500 (more if the tenants are older, have children, etc.) plus a major pain in the ass with the city.

By filling both units and then putting the property on the market, the owner has made it much more difficult to get the price he wants. A better strategy would have been to rent one of the two units, renovate the other as a really slick owner-occupier unit and sell it with that unit vacant.

Written by mjkagan

03/21/2013 at 4:48 am

Posted in Brokerage, Selling

Deadlines and documents

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When we write offers for apartment buildings, we usually want a 17-21 day loan contingency. The concept is to give us some assurance that we will be able to get the loan we want before we irrevocably commit to doing the deal. Pretty standard.

But lately, I’ve been running into the same problem over and over again: Un-prepared sellers and brokers.

To get some assurances from a bank that you can get the loan you need, the bank is going to want to see a current rent statement (setting out rents, move-in dates, etc.) and at least two years of operating statements (P&Ls).

The bank needs this information to get a sense for the rents that will be coming in, the expenses that will be going out, and, therefore, what will be left over to pay the mortgage. Not unreasonable.

But, lately, I’ve done a bunch of deals where the seller / listing broker aren’t prepared with the above information immediately upon opening escrow. Kind of weird, right? I could get rent rolls for any of the properties I manage in 5 seconds, with P&Ls available 5 seconds after that.

As a buyer, the problem with delays in getting documentation is that each day’s delay means a delay in receiving confirmation from the bank that they can do a loan. And, because the loan contingency has a time limit on it, the buyer can find himself in a position where, technically, the seller can ask him to remove his loan contingency and the buyer don’t have any sense for whether he can get the loan he needs.

The above situation leads to all kinds of unpleasantness with the seller, who believes the buyer is trying to delay closing. But, really, it’s all about the seller and listing broker not being prepared when escrow opens to actually make a deal.

Selling apartment buildings is NOT just about sticking some pictures on the MLS and Loopnet. It’s about preparing the owner and the property to run a clean, efficient process that absolutely maximizes the value the owner gets while minimizing the risk.

Written by mjkagan

02/26/2013 at 11:57 am

Posted in Brokerage, Buying, Selling

How much is my apartment building worth?

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The short answer is, if it’s in Los Angeles, its probably worth more now than it has ever been worth in the past.

Why?

Because everyone with cash and a brain is sick of getting 0.01% interest in his/her checking account and is therefore chasing yield by buying buildings, because even a so-so deal on a building is going to generate 3-4% / year, (hopefully) with room to appreciate.

But what does that mean for you, dear apartment building owner? Well, let’s give you some rough numbers:

First, take the total monthly rent you collect from your building. If you live in one of the units, add to that total rent a fair estimate of what your unit would rent for on the open market if you moved out.

Now multiply that total rent number by 12 to get the total annual rent. With me so far? Now multiply the annual rent by 10 – that’s the lower end estimate of what it’s worth. Now multiply the total annual rent number by 13 – that’s the higher end estimate.

For example: Say you own a fourplex with four identical units and you live in one of the units. Say the other three units each rent for $1500 / month. Your total monthly rent is $1500 x 3 = $4500 + $1500 for your unit = $6000. Now multiply $6000 x 12 = $72,000. Your building is worth between $72k x 10 = $720k and $72k x 13 = $936k.

I recognize that’s a pretty broad range of values. The reason it’s so broad is that all buildings are different. A renovated building in Silver Lake with rents which are a bit below market easily hits that 13x number (and probably goes past it). A disaster in Boyle Heights probably goes for 10x or maybe even less.

If you’re really serious about finding out exactly what your property is worth, whether out of curiosity or because you’re thinking of selling or re-financing, get in touch. If you give me the address and the rent roll for any building in Los Angeles and answer a few other questions, I can give you a rough sense for the value in five minutes or less. It’s like a party trick, but for really, really boring parties.

Written by mjkagan

01/21/2013 at 6:56 am

Posted in Brokerage, Selling, Success

Micheltorena is sold

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A few days ago we closed the sale of 1516 Micheltorena, an 8 unit building in Silver Lake.

Here are the relevant numbers:

  • Bought for $954k in September 2010
  • Renovated for $645k
  • Total capital outlay of $1.6MM
  • Stabilized rent roll of $215k / year
  • Took roughly $200k in cash out of the building while we owned it
  • Sold for $2.1MM gross, a hair under 10x
  • Total pre-tax profit of roughly $640k
  • Return on investment (ROI) of $640k / $1.6MM = 41%

I was sad to see this one go. The location, just north of Sunset on Micheltorena, is prime. I have zero doubt that I will look back and wish I had not sold the building. However, the tyranny of IRR meant that it was better to sell and take the profit than to re-finance and hold.

One other interesting note: We bought this one off-market and sold it off-market, which is kind of unusual. I feel good about having sufficiently strong broker relationships that I can do deals like this now. It certainly wasn’t always the case!

Best of luck to the new owners!

Written by mjkagan

12/18/2012 at 7:41 am

Why a quiet marketing period makes sense

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When it comes down to it, most brokers who sell residential properties don’t know a lot about marketing income property. (One easy way you can tell is that most of them don’t include information that is absolutely critical to an income property investor – like the rents! – in their MLS listings.)

But why does it matter if a broker doesn’t know a lot about income properties? After all, don’t all brokers just post a listing on the MLS and wait for offers to roll in? After all, isn’t marketing a property as widely as possible the best thing you can do to maximize price?

I don’t believe so, and here’s why:

  • As a buyer, when you offer on a property on the MLS and have your offer accepted, you know you’re the winning bidder in an auction;
  • This means, by definition, that your bid was higher than everyone else’s;
  • This means that, once you’re in escrow, you might be able to chip the price (by raising all kinds of issues about the physical condition of the property, etc.), because there’s probably some room between your (highest) bid and the next one down.

So, if you’re listing your property on the MLS, you are almost definitely going to see the buyer try to chip you in escrow. Contrast this with an offer that comes through a “quiet”, off-market marketing period.

With a “quiet” marketing period, the listing broker puts out the word that the property may be available if a buyer is willing to pay the full price. He puts it out to his own buyer list and also to select agents he knows have serious buyers ready to make a deal.

Assuming the broker does his job well, several strong offers should come in. Then, the broker can run a quick “best and final” counter process to clean up the contract terms and maximize price before finally accepting an offer and opening escrow.

Consider the situation this buyer is in: He has a deal that has not been widely exposed. If he tries to chip price, he knows the seller can always cancel and take the property to market, where someone else will certainly buy it. Because the threat of cancelation is credible, he’s much, much less likely to try to chip price. Mission accomplished.

And, the best part is, if, for whatever reason, an acceptable offer does not emerge during the “quiet” marketing period, the seller can always just go ahead and put the property on the MLS, anyway.

So, if the above is clearly the best strategy for marketing properties, why don’t all brokers do it? The ones who don’t just don’t have sufficient contacts among the relevant market participants (buyers and brokers) to effectively get the word out. And those are the brokers you don’t want selling your property in the first place.

Written by mjkagan

11/19/2012 at 4:01 am

Posted in Brokerage, How to, Selling

More on the state of the apartment market

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This is a verbatim quote from an email from an agent listing an apartment building in a nice part of the Valley:

“Yes, it is available, but seller is now asking $50k over listing price. Need an offer all cash at listing price or above no contingencies. That is the only way.”

I’m keeping the name of the broker confidential, because he’s a very nice guy and he doesn’t control his clients any more than I do. But let’s unpack the wording above, to see what he means:

  1. “Seller asking $50k over listing price” – Pretty self-explanatory; seller has seen a lot of action on his property, senses the direction of the market, and is now greedy.
  2. “Need an offer all cash at listing price or above” – The reason the offer needs to be all cash is because no bank is going to finance more than 50-60% of the acquisition price because otherwise there’s not enough NOI to service the debt (see this article on debt service coverage).
  3. “No contingencies” – I’m asking you to come in and either (1) do your inspections without having the building in contract, meaning you risk your time and money with no assurances that you’ll actually be able to buy the property, or (2) Be totally insane and offer to buy without doing any due diligence.

I don’t claim that this one email is any sort of scientific sample of the state of the market. But, boy, do the sellers seem to have the leverage these days!

Written by mjkagan

08/09/2012 at 4:20 am

Posted in Brokerage, Buying, Selling

How not to price your building

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[Note: I wrote this piece a long time ago but couldn't post it until now, because I didn't want to screw up a potential deal in progress.]

Am helping a couple who are looking to buy an apartment building for roughly $1MM, all cash. Surprisingly, there’s not a lot out there.

I did manage to find one property that looked like it might work, but only if the seller was willing to take an extreme low-ball offer. I explained to my client that there was no harm in trying, sent them the paperwork, and, once they signed, sent in the offer.

The seller came back within a day or so with a counter at a price that was extremely close to our offer. Good news, right?

Not from the seller’s perspective, and here’s why:

  1. My buyers aren’t stupid. When they low-ball and seller comes back immediately basically willing to take the low-ball price, they start thinking about how to get the price even lower.  (Incidentally: This is almost as much of a problem for the brokers as it is for the seller, because once my clients perceive there to be blood in the water, they’re going to want the price lower. If we’re wrong and the seller isn’t desperate, it gets harder to do a deal, because the buyers’ expectations have changed.); and,
  2. Most buyers don’t low-ball; they just pass on the property all together. So it’s pretty unlikely that we’re competing with any other buyers, making it more likely the sellers will be compelled to accept a further price reduction.

So the seller is now in the position of only having one buyer, a buyer who thinks (accurately or not) that the seller is desperate to sell. Ouch.

What should they have done differently? Well, for starters, they should have priced the property closer to where they’re actually willing to sell. This would likely have had the effect of eliciting more buyer interest. Maybe they could have generated a little competitive tension and used it to drive the price up and/or keep the buyers honest.

Even now, they’re doing the wrong thing. Once they decide they’re willing to take the much lower price, but before going into contract with us, they should immediately communicate the new price to the market. Maybe they get lucky, someone else jumps in, and now things get better for them going forward, instead of worse.

Written by mjkagan

07/31/2012 at 4:09 am

Posted in Brokerage, Buying, Selling

Why you get the rents buttoned-up BEFORE listing a property

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Recently, I closed on a deal where the seller inflated the rents in the marketing materials. It was an unpleasant experience for everyone involved, including the buyer, seller, agents and tenants. Here’s what happened:

One of the tenants had applied to the landlord for permission to move a new occupant into his unit. Per LA rent control, the landlord can increase the rent by 10% for each new occupant who is not a minor dependent of the existing tenant. One important caveat is that the landlord must issue the tenant a notice of increased rent within 60 days of “actually or constructively” learning about the new occupant. Obviously, this creates some wiggle room for the tenant, who can claim that the landlord knew but didn’t issue the notice in time.

The seller did not accept the tenant’s application officially, but he did market the property with the rent for that unit increased by 10% (which worked out to roughly $200 per month). The listing agent didn’t know the rules; otherwise, he would have insisted that this problem be buttoned up BEFORE putting the property on the market.

Not knowing anything about this, we offered roughly 10x annual rents to buy the property and we agreed to a deal at 11x. Then we began our due diligence process, which included looking at all the leases and estoppels for each of the tenants. (This is where I beat the dead horse: ALWAYS REVIEW THE ESTOPPELS!!)

Can you see what the problem was? At 11x annual rents (the contract price), that $200 / month accounted for $26,400 worth of the value! If we bought based on the higher number and then the tenant turned around and claimed that the 60 days had elapsed and that the rent increase was void, there would be a good chance that LAHD would side with the tenant and the $26,400 would evaporate.

So, not wanting to take that chance, I requested that the seller get a signed document from the tenant agreeing to the rent increase. Obviously, the tenant didn’t want to sign it.

We were willing to walk from the deal over this, so we told the seller to get the doc signed, reduce the price by $26,400, or sell the property to someone else.

The tenant therefore had the seller over a barrel. And he used the opportunity to extort the seller for a check equal to two years worth of increased rent, or $4,800 ($200 x 24 months). The seller paid the tenant because it was better to do that than to reduce the price by $26,400 or have the deal fall apart. In my opinion, the tenant let the seller off lightly; he had a lot more leverage than he realized and could have exploited it more ruthlessly.

In the end, it all worked out. But this was another reminder of the importance of diligence and experience when it comes to apartment building transactions.

Written by mjkagan

06/20/2012 at 6:04 am

Westmoreland = sold

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Remember 1239 N. Westmoreland? We put up for sale on the MLS on April 17 for $949,000. On May 19, just over a month later, we closed for $950,000. After selling costs, we netted $920,000 or so.

We bought the property and renovated it in 2009 for a total investment of $680,000. During the time we owned it, we took approximately $100,000 in cash out from the rents.

So the profit was ($920,000 + $100,000) – $680,000 = $340,000. That’s a return on investment of 50% in roughly three years with no leverage.

And, to be clear, this wasn’t just a great deal for us (and our investors). It was also a great deal for the buyers, who are going to be cashflowing out the wazzoo. And the city and county of Los Angeles, which are now collecting nearly triple the property taxes they were when we bought it. And the contractor who did the work (thanks Patrick Jr.!). And the materials suppliers. And the broker who represented the buyers. And, perhaps most importantly, for the street, which went from hosting an ugly, vacant disaster to hosting a beautiful modern apartment building.

Am so proud of our whole team for making this one a big success. Kudos.

Written by mjkagan

05/23/2012 at 5:15 am

Posted in Selling, Success

Why choosing a good listing broker matters

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Some people have the impression that who your listing (selling) broker is doesn’t matter that much. After all, whoever it is is going to put the property up on the MLS, maybe have an open house or two, and then collect offers. Who cares how knowledgeable that person is? Why not just hire your cousin and be done with it?

Unsurprisingly, I think this is a big mistake. Here’s an example of what happens when you have a listing broker who doesn’t know what he’s doing:

I just had a client go into and then cancel escrow on a flipped triplex in Silver Lake.

The owner had bought the property at a trustee sale, done a VERY light rehab, and then put it back on the market for a lot more than he bought it for. When we went in to inspect the property, we found some minor things wrong with it, including construction odds-and-ends undone and missing appliances.

If we were all cash buyers getting a deal, we would have gone through with the purchase. But we were using an FHA loan and paying top dollar. This raised two distinct problems for us:

  1. FHA is very wary of flipped properties. If the agree purchase price exceeds what the seller himself paid for the property by a certain percentage, FHA will require two separate appraisal inspections, only one of which the buyer can pay for. Then FHA will use the lower of the two appraisals to set the value of the property, and therefore of the loan they will provide. This increases the risk of the deal falling through.
  2.  FHA requires that properties be in very good shape. In particular, they require that the heater work and that there be a stove and (I believe) other appliances. In this case, because the property wouldn’t have passed the inspection, we were inevitably going to get into a debate with the seller about who should pay to get the property up to snuff, who would stand behind the quality of the work, etc.

What does this have to do with the listing broker? Well, the seller presumably got a whole bunch of offers on the property. On the advice of his listing broker, he chose ours. But this was horrible advice, because it was never particularly likely that this property was going to close with an FHA buyer in the state it was in.

So the seller ended up rejecting a bunch of offers that were likely to close in favor of one that wasn’t likely to close. Not good business: Those buyers have probably all moved on in the five days since we got the property under contract.

Bottom line: Who your broker is matters on the sell-side, too.

Written by mjkagan

05/14/2012 at 9:05 am