Archive for the ‘Uncategorized’ Category
(Not me – don’t get excited.)
Over the past few days, I attended a conference for wealth managers. I won’t lie: My intention was to meet the people tasked with managing assets for affluent investors, with the idea of convincing some of them to steer their clients my way. Turned out to be the wrong decision; these guys can get sued to kingdom-come for putting clients into private deals that go bad, so they’re very reluctant referrers.
But just because the conference wasn’t right for me doesn’t mean it wasn’t interesting. One of the things that kept coming up was the fear that many investors have of outliving their assets in retirement. This got me thinking about how income producing real estate fits into a retirement plan.
The cool thing about income producing real estate purchased with a mortgage is that it is effectively a tax-efficient vehicle for forced retirement savings. What do I mean? Consider the situation of someone who buys a small apartment building in her thirties:
- Say she puts down $200k on an $800k property with rents of $73k and net operating income of $45k (a 5.6% CAP)
- To finance the deal, she takes out a $600k mortgage with a standard 30 year amortization and a fixed interest rate
- Say further than she does a reasonable, but not spectacular job managing the building
- Each month, before she pays out any cashflow to herself, she makes the mortgage payment, reducing what she owes the bank
- The interest on the payment is tax deductible
- And the principal portion of the payment, which is taxable, is more than offset by the depreciation
- In addition to retiring the mortgage little by little, the building spits out some cash each year
Here’s what happens to our investor as she is hitting retirement age in her 60s:
- The building pays off its own mortgage 30 years after the acquisition
- The investor now owns an asset which is worth whatever 2044′s equivalent of $800k is (assuming it increases in value along with inflation; she should do better if the property is well-chosen) – whatever else she did with her money during her life, she has a big asset free and clear
- Assuming rent and expenses grew at the same rate as inflation, once the mortgage is repaid, she’ll have an income of 2044′s equivalent of $45k / year
Whatever else our investor did with her finances during her life, she’s going into retirement with an income of $45k / year and an asset worth $800k. That doesn’t make her rich, by any means, but it does make her self-sufficient, particularly coupled with her government-provided healthcare (Medicare) and income support (Social Security).
Can you rely on just one apartment building to see you through retirement? That’s probably a bad idea. But, if you manage to get 1-2 of these deals done in your thirties plus behave reasonably responsibly over-all, you’re going to end up just fine.
Just sold the second of our Fund 1 deals: 2514 London St., a fourplex just south of the 101 in Westlake / HiFi
This one was pretty good, though not nearly as good as our 1947 Clinton deal.
- In for around $850k
- Took in cash of approx. $20k during ownership
- Sold for $1,150,000
- Net profit of around $240k on $850k
- ROI of 28%, in 14 months
I’m proud to report that the new owner is keeping us on to manage the property*, so nothing will change for the residents or the neighbors. As usual, we’re sad to see the property go, but happy for the new owners and our investors.
*I’m kind of surprised when people don’t keep us on… after all, we know the property better than anyone, we got the rents in the first place, we can easily force vendors to come back and fix any warranty issues, and we want to keep people who buy from us happy!
Went to the Mid-City Neighborhood Council meeting last night at the invitation of my friend Michael Sonntag, the president of the council. Was my first time attending one of these meetings, so didn’t know what to expect.
Two contradictory thoughts on the meeting:
1. The business of local government is small-bore in the extreme. What I mean is that the council was dealing with problems on literally a block-by-block level: The pavement at the corner of La Brea and 20th St., free tree planting, chasing illegal vendors off Rimpau, etc. There was no grand policy being made.
2. Local government is incredibly inspiring. Here was this group of people, many of whom certainly have other things to do, volunteering to spend their time on improving the neighborhood. It was democracy at its absolute finest, with local considerations being heard and resources allocated according to the wishes of the citizens.
Sometimes, I complain about local government. It’s often slow, overly bureaucratic, etc. But, at the end of the day, and unlike more autocratic systems where things get done faster and more easily, our system responds to the will of individual citizens. It’s not perfect, but it’s better than the alternatives.
Sorry, have to vent:
1. “So and so grew the value of the business from $100MM in 1985 to $500MM today”.
That sounds really impressive, but it’s only a roughly 5.9% annual growth rate with compounding. Any time a journalist quotes two numbers divided by a period of time, s/he should automatically give you the compound annual growth rate. This would allow you to very easily distinguish between a truly remarkable result (of the type Warren Buffet created at Berkshire) from someone who was just buying t-bills or something.
2. “Target’s profits dropped 46% as a result of the hacking scandal over the holidays”
Obviously, a 46% percent decline in profits is a bad result. But retailers have very high fixed costs (they pay lots of rent and salary) and work at very low margins. So, relatively small declines in revenue have major impacts on their bottom lines.
For example: Say you’re a retailer with $100MM in revenue and $90MM in costs, implying $10MM in net profits at a 10% margin (that’s actually high for retail). Of your costs, assume $50MM fixed (rent, salaries, etc.), and $40MM variable (cost of goods sold), implying a gross profit of $60MM on $100MM of revenue, or 60% (again, not that unusual). Now, assume your sales drops by 5%. Revenue is now $95MM, gross profit is $57MM, and net profit is $7MM.
Your net profit just declined from $10MM to $7MM, a decline of 30%! But that was off a decline in sales of just 5%, which is pretty small and easily explained by changes in the weather, economy, etc. So, business journalists ought to be required to put in some kind of a disclaimer about how high-fixed cost, low net margin businesses can experience large swings in profitability on relatively small changes in sales.
For the slow posting.
We’re enmeshed in several deals right now and I can’t really share any of the details on the blog.
More next week; for now, enjoy the weekend!
In lieu of writing here today, I’ve written a sponsored post on the Eastsider, a blog covering goings-on in most of the neighborhoods in which we are interested.
Here’s the link. (Note: If you read Kagansblog regularly, the Eastsider post may be a bit repetitive.)
Today’s NY Times has an interesting piece about the effects certain types of affordable housing has on the lives of the people lucky enough to benefit from it.
Of course, the main benefit is that the tenant is able to live in a neighborhood which would ordinarily be totally out of reach.
But there is something else going on as well, a kind of limiting of life options. When the most important thing you have in the world is a cheap place to live, you are wedded to that one place as if your feet were nailed down. You can’t move to chase a job, a better climate, a creative project, or a love interest.
Yes, you have somewhere to live. But that place constrains your choices, which ultimately warps your life.
You’d be amazed at how many tenants I see moving out of places they’ve lived for a long time who end up doing something radically different with their lives, like moving out of state, or buying a house, or renting a totally different kind of apartment (usually larger!).
Just a quick note to welcome readers who stumbled across my most recent post on the Eastsider.
This blog is all about my experiences buying, renovating, managing and selling apartment buildings in Los Angeles. Because I tend to write about issues that arise in my business every day, the topics can range from taxation to rent control to permitting to valuation analysis.
If you’re just discovering the blog, I recommend:
- Checking out the “Essential reading” posts over there on the right of the page –>
- Signing up for the mailing list, which I use to send out interesting deals probably once every 1-2 months. You can sign up by clicking here and then entering your details at the bottom of the page.
Our new mayor has an interesting proposal: Phase out LA’s notorious gross receipts business tax. This would be a wonderful development for real estate investors in the city and an even better one for small business owners generally.
What is the “gross receipts tax”? It’s a tax the City of LA charges all businesses on gross revenue. Depending on the business, this ranges between something like $1.27 / $1,000 of gross revenue (for rental real estate) all the way up to $5.07 / $1,000 (for professionals like lawyers and architects).
Why is this tax stupid? Many of the businesses that generate the largest numbers of jobs are low margin. For example: A car dealership probably makes a gross profit (revenue less the direct cost of the goods sold) of something like $250 for each new car it sells. On a $20,000 new car, that’s a margin of 1.25% (dealerships make most of their money on used cars and service). But the gross receipts tax for “selling businesses” is $1.27 / $1,000, or $25.40.
The City of LA is basically making itself a first dollar partner and taking 10% of the dealer’s margin!
For low margin businesses, losing that amount of profit to the city makes locating here stupid, which is why there are tons of car dealerships in, for example, Glendale.
In general, you want to tax the things you want less of and avoid taxing the things you want more of. Car dealerships, for example, employ hundreds of people in relatively high-wage jobs (mechanics, salespeople, etc.). We want those jobs in LA, so we ought to work on improving the business climate for those types of employers.
If you need to make up for the lost revenue, how about raising taxes on liquor, cigarettes, gasoline, fast-food, soda, etc.?
Sorry for the lack of posts here in the last two days. We moved out of our rental and into the new fourplex on Wednesday and have been dealing with the aftermath since.
Last time we moved, we had no children and it was still fairly painful.
Now, with two kids and two dogs, it’s a lot worse, even with the help of Lucy’s amazing parents Jo and Richard.
I have been juggling the move and my work responsibilities, making it hard to find time to write. But I promise to be back on the horse on Monday.
Have a great weekend.