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We do a ton of work for PMI, a company with deep roots in the creative office business which made a successful pivot to multifamily.
Jeff Palmer, one of the principals, has taken up blogging and has a great post on the project we did at 653-659 Silver Lake.
Unlike me, Jeff’s great about taking before and after pictures of projects, so you can really get a sense for what we start out with and how thorough the transformation is.
I’m sure Jeff will have tons more posts in the future and it’s definitely worth following his posts.
Today we’re going to correct a damaging misperception about development.
Many people out there apparently believe that the price of single family homes in desirable neighborhoods like Silver Lake and Echo Park is being driven up by competition from developers. Check out this comment thread on the Eastsider for an example of this line of argumentation.
Developers are limited in what they can build by the zoning. The majority of lots in Silver Lake, Echo Park, etc. are zoned R-1 or R-2. No developer is interested in those lots, because you can’t really develop anything on them.
So, to the extent that “middle income” folks are being outbid, it is not by developers. So, who’s to blame?
Target #1 is “Flippers”, who buy run down old homes, upgrade them, and re-sell at a profit. But it’s important to understand that these guys need to make a profit… so, they’re generally buying the cheap, broken-down old homes that are too screwed up to live in. Your average middle income home buyer has neither the capital, the expertise, nor the desire to fix these homes. While flippers compete for homes at the lower end of the spectrum, they’re not really competition for most conventional home buyers, because there isn’t any profit available by flipping a move-in ready house.
Do you know who the real competition is? Other home buyers! That’s who’s pricing middle income buyers out of the market.
And do you know why the prices keep going up in desirable neighborhoods? Because anti-development zealots, many of them middle income folks themselves, try to block any project which adds supply to the market. Increasing demand plus stagnant supply equals higher prices, every single time.
Have spent the last week or so in Troy, NY, where I grew up.
To give you a sense for how Troy was when I lived here:
- When NY de-institutionalized most of its mentally-ill population in the 1970s as a result of Geraldo Rivera’s investigations into the Willow Brook facility, a disproportionate share of the inmates ended up in Troy
- An industrial powerhouse in the first half of the 1800s, Troy has been in decline ever since
- You can still get a vacant building here by paying the city $1 and paying the back property taxes
- In the 1950s or 1960s, some idiots severed the city from the Hudson River by running a freeway along the banks (this idiocy was repeated in a lot of cities, including LA)
- Unemployment is high and education levels are low; the public schools have always been terrible
- People like me who grew up here were known as “Troilets” as a result of our distinct lack of class
But check out this picture I snapped on Sunday:
It’s a bit tough to tell from my amateurish pic, but the city is absolutely jammed with people enjoying a high-end farmer’s market ($5 lemonade?!).
Here’s what happened, as far as I can tell:
- Troy has always had an amazing stock of brownstone townhomes left over from around the turn of the 20th century
- As creative types have been priced out of NY, many of them have migrated north looking for affordable, urban living
- Meanwhile, the local university, RPI, has grown larger and more selective, attracting a lot of talented new faculty members and grad students
- If you squint, you can see the beginnings of the kind of small design / tech firms that are attracted to cool environments with educated workforces
So, you’ve got a bunch of creative-class urbanites plus a huge stock of amazing, cheap brownstones buzzing around a downtrodden city with walkable downtown neighborhoods. That’s the kindling and fuel.
Then someone organized this amazing farmers’ market, which was the spark. Boom.
Over the past 12 hours, I have been thinking about whether I have anything to add to the discussion / controversy kicked off by our now-infamous bike -tour flyer.
This blog, which is usually read by a few thousand people interested in investing in LA real estate, is suddenly getting a lot of attention from people who are not investors but are, instead, citizens concerned about the impact of gentrification on their neighborhood.
I’m no philosopher, so I don’t have much to add to the ethical debate. Nor am I a social-scientist who can reduce this issue to a spreadsheet problem to be analyzed and solved.
What I am is someone who knows an awful lot about real estate in improving areas. So, I thought I might offer my new readers something a bit more practical: Some tips for surviving the gentrification of your neighborhood.
Keep in mind when you’re reading these that I make no claim to understand exactly how you feel. I can’t know the forces and obstacles you and your family face in your lives, because I don’t come from where you come from. All I can do is share with you some basic knowledge in hopes of either setting your mind at ease about your situation or else giving you a roadmap for how to try.
1. If you rent, you need to rent in a Rent Stabilized Building
The City of Los Angeles Rent Stabilization Ordinance (“RSO”) gives tenants and their children the right to remain in their apartments permanently with limited annual rent increases, so long as they pay rent and don’t destroy the apartment. If you live in an apartment covered by the RSO, congratulations. It is very difficult for anyone to force you to move out and, if they try, you will very likely be able to extract a significant amount of money from them (if you decide you do want to move), money which can change your life (see below).
However, many people don’t understand which buildings are covered by the RSO and which are not. Here’s how it works:
- RSO covers all multi-unit dwellings (that means two or more dwelling units on one piece of land) where the structure was constructed prior to the October of 1978;
- The RSO does not cover apartment buildings built after October 1978;
- The RSO does not cover single family home rentals
If you or your family live in Boyle Heights and you would like to stay in the neighborhood, you need to make absolutely certain that the building in which you live is covered by the RSO. If you don’t know, ask the Housing Department.
If it turns out that your building is not covered, you need to move to one that is, even if moving is scary and even if the new place is more expensive. If you’re not protected by the RSO, you are always 60 days from being thrown out of your home (that’s the length of the notice a landlord has to give you to move out). I know that’s terrifying and possibly morally wrong, but it’s how the law works and you need to protect yourself and your family.
2. Consider trying to buy
For many people, the idea of buying a home seems totally unattainable, particularly after what happened in 2008-2011, when so many people got burned. But the federal government is strongly committed to helping people buy homes. The government mainly helps by running the FHA program, through which buyers with credit scores as low as the mid 500s can buy a home or small apartment building with as little as 3.5% down.
In Boyle Heights, where you can buy a home for $300,000, that would mean you could do it with as little as $10,500. I recognize that seems like a huge amount of money for someone working an hourly job. But it’s also the case that the FHA allows people to get help with the downpayment from family and (sometimes) from the seller.
If you live in Boyle Heights, have decent credit, and can scrape together a downpayment, you should strongly consider buying a home. That way, you and your family benefit from continued improvement in the neighborhood, instead of being threatened by it.
3. Participate in your neighborhood council
Plenty of people got angry enough about our flyer to write mean things about me on Facebook, but will those people attend the neighborhood council meetings where decisions about development get made? If you don’t think your community has power, you’re wrong. Anyone who wants to build anything complicated in Boyle Heights is eventually going to need to come down to those meetings and make the case for why she should be allowed to do so.
If you really care, you should consider going, learning and speaking your mind. Our democracy is imperfect, but people do have a voice if they care enough to use it.
If you are worried about your family getting pushed out of Boyle Heights and want some practical advice, I would be happy to discuss.
For example, if you let me know your address, I can let you know if your home is protected by the RSO or not. Or, if you think your family might be able to pull together the money to buy a home but you have no idea how to get started, I can point you towards some relevant resources / people.
Want help or advice? Just email me. It’s kind of the least I can do, after causing so much distress.
(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.)