Silver Lake Income Properties In High Demand

We’ve just completed a review of the data for sales of 2-4 unit income properties in Silver Lake over the past six months. For more on the methodology, please see below. Meanwhile, here are the headline numbers:

  • Median estimated gross rent multiple: 12.7x annual rents
  • Median estimated CAP rate: 5.5%
  • Median sale price as % of list price: 98%
  • Median days on market: 51
  • Median price per sq ft: $318
  • Median price per unit: $226,500

More color on the data:

What does it mean that properties are selling at 98% of list?
Buyers need to know that the days of low-balling sellers in Silver Lake are pretty much over. To get a property, they need to come in with a strong offer at around the list price.

What does a 12.7x gross rent multiple mean?
This means that properties are selling at around 12.7x the total annual rent that they generate. Here’s some more info on gross rent multiples.

What does a 5.5% cap mean?
An estimated median cap rate of 5.5% means that, if you bought these properties using all cash (instead of a mortgage), you would be earning 5.5% on your money in year one. Here’s some more info on cap rates.

What does it mean that the days on market number is 51?
Days on market includes the time from when the property was first listed until the date of closing. It generally takes 30-45 days to go through the escrow process. This means that properties are getting accepted offers within roughly one to two weeks of being on the market. So buyers need to be confident enough about what they’re doing to move aggressively on properties they like.

Why are buyers paying prices that equate to 5.5% cap rates?

  1. Interest rates are around 4%, so borrowing money to buy these properties actually boosts your annual return into the 8-10% range.
  2. With money market rates around 0.5%, even a 5.5% return looks pretty good.
  3. Buyers are betting that rents will continue to increase over time, thereby increasing the returns.

Fine print: 

We looked at properties listed as sold by the MLS between 9/1/11 and 2/28/12 in the area defined as Silver Lake by the LA Times Neighborhood Mapping Project. There were 20 properties in the initial sample. We removed four properties which, for various reasons, would not have qualified for a mortgage, meaning that only a professional flipper could buy them. For the remaining properties, we estimated the rents for units which were delivered vacant at time of sale. We also estimated the cap rates based on an expense margin of 30% of rents.

Based on information from the Association of REALTORS®/Multiple Listing as of 2/28/12 and /or other sources.  Display of MLS data is deemed reliable but is not guaranteed accurate by the MLS.   The Broker/Agent providing the information contained herein may or may not have been the Listing and/or Selling Agent.

Oh, and yes, we know we left out leap day. Sue us!

The data: Silver Lake Income Property Survey February 2012 – final

How do apartment buildings increase in value? And how can you benefit?

When you put a bunch of money and time into an asset, you want it to increase in value. Obviously.

So you might ask: How does an apartment building increase in value?

Remember: An apartment building investment made correctly should cashflow to you every month, so you make money as you go along. But an increase in value is the icing. Here’s how it can work:

  1. Rents go up as your building or the neighborhood improves. All things being equal, higher rents equal higher profits. So if you pay $1.43MM for $100,000 in profit (a 7 cap) and the profit goes to $120,000, even without any change to the prevailing cap rates, your property should now be worth $120,000 / .07 = $1.71MM.
  2. More people want to own in the neighborhood, driving prices up and (therefore) cap rates down. Say you buy the 7 cap for $1.43MM. Say the rents and, therefore, the profits don’t change. If the prices are bid up such that the prevailing neighborhood cap rate falls from 7 to 6, your property went from being worth $1.43MM to $100,000 / .06 = $1.67MM.
  3. The combo platter. The best outcome is, of course, the rents go up and the cap rates come down. If your profit goes to $120,000 and cap rates fall to 6, the property you bought for $1.43MM is now worth $2.0MM.

There are two ways to take advantage of increases in value:

  1. Sell. Maybe you sell, do a 1031 exchange, take your profits tax free, and invest them in another building in a part of town that’s cheaper but improving. But I don’t recommend it, since you can…
  2. Re-finance. The amount of debt you have on a building is fixed or trending downward, depending upon the type of loan. So any increase in the building’s value accrues to you, the owner, in the form of equity. More equity means you can borrow more. Say you bought that original $1.43MM building with a loan of $1.07MM and a downpayment of $360,000. Now say it’s worth $2.0MM. You can go re-finance for 75% of the value, or $1.5MM. You pay off the original loan of $1.07MM and pocket the remaining $430,000 tax free AND keep your building. Booyah.

 

Legalese: I’m not a lawyer or an accountant and this is not tax advice. 

 

What can go wrong with an apartment building

Anyone who tells you that any investment is risk free is full of ish. People thought government bonds in Europe were risk free and look where that got them.

In order to make sure you don’t think I am full of ish, here’s a list of the things I can imagine going wrong with an apartment building investment in LA, in no particular order:

  1. Earthquake. Earthquake insurance is very expensive, so most owners choose not to get it. While older buildings have all lived through earthquakes, you never know when a big one could hit and cause damage you have trouble paying for;
  2. City inspection nightmares. Owning a building exposes to all the bureaucratic BS Los Angeles Housing Department can throw at you. Mostly, it’s fine. But you can find yourself in messy situations with them… which is when you should call Tom Nitti;
  3. Rents go backwards. This happened on our Reno deal. When we bought, rent for a one bed was $1,200 and for a studio $1,000. Then the economy went in the tank and we went as low as $950 for a one bed and $850 for a studio (I think). If you’re highly leveraged, this can cause you problems!
  4. Unforeseen repair / maintenance issues. We recently had to shell out $6,000 for a boiler that broke. It’s tough to negotiate a low price with the boiler company when 16 tenants have no hot water and are calling you about it.
  5. Your interest rate jumps. Not a problem for standard, fixed 30 year loans on 2-4 unit buildings. But on bigger ones, you might come to the end of your rate-lock period (after 3-, 5- or 7 years), only to find that loans are a lot more expensive than they were before.
  6. Bad tenants. Sometimes bad apples slip through. They cause trouble or don’t pay rent and it takes you a few months to get rid of them.
  7. The market tanks. Maybe you bought at a 6 cap and now the market is a 7 cap. As long as you don’t have to sell, no problem. But if you do, you’re taking a loss.
  8. Can’t sell quickly. If you have a stock you want to sell, you can always find a buyer quickly. Not so for an apartment building. Even at a fire-sale price, it takes a minimum of 2-3 weeks to sell; much more if you want a fair price.
  9. Crime. I had an idiot break into one of my buildings a few months ago. No harm was done, but he scared the sh*t out of my tenants, a few of whom broke their leases and moved out.

Unless you’re as dumb as the guy who broke into my building, you know that there’s no such thing as reward without risk. Owning a building is really owning a small business, and businesses sometimes have problems. That’s life.

But the reward is you get a 8-12% return on your money, instead of the 0.0034% you’re getting from a bank right now. And, as a landlord, you learn a hell of a lot about the world and about yourself along the way.

Why Westlake Won’t Gentrify

Westlake won’t gentrify for three reasons: the housing stock, the density of apartments and rent control.

Regarding the housing stock: Westlake is comprised mostly of apartment buildings built around 1920. Some 1920’s buildings are nice, with great lay-outs, beautiful details, and, in some case, parking.

The buildings in MacArthur Park are not those kinds of 1920’s buildings. Far from it. They are, as a rule, center hallway buildings (where all the tenants access their units through a long, shared, central hallway), full of studios (some without kitchens), with no parking. These are generally not pleasant places to live; they are run-down, smelly (due to neighbors’ cooking smells and leaky garbage bags) and inconvenient (where do you park?). So you’re not going to see organic gentrification, where adventuresome renters seeking cheap / cool places move in on their own.

Now, it’s possible to gentrify a building or neighborhood “by force” by spending a lot of time and money to make bad old buildings good again. But it’s not worth anyone’s time to do this in Westlake, because the density of apartments in the area makes it almost impossible to command the high rents necessary to justify the cost of renovating. After all, prospective tenants will be comparing the units you’re offering to the extremely cheap ones next door. The supply is just too great to have any real pricing power, even with newly renovated units.

Finally, rent control. Face it: There are some criminal elements in this neighborhood. That’s a fact of life in a lot of neighborhoods all over the country. But LA’s rent control ordinance makes it almost impossible to get rid of bad apples in a building. So once you have a concentration of them (and Westlake definitely does!), they wreck the neighborhood and there’s very little that landlords (or anyone else) can do about them.

So if you’re looking for the next Highland Park, look elsewhere. Westlake ain’t it.

The Time I Tried to Give Mr. X $5,000 and He Refused

My voice was quivering when I made my final plea: “Please, Mr. X, just take the $5,000 and move out before the sheriff gets here.”

The guy refused. He and his wife stayed right up until the sheriff arrived to lock him out of the apartment. I had to appreciate the pride he carried within him, even if the stupidity made me sad.

How did we get to this point? When we bought the eight unit building on Clinton St. where all of this happened, all the units were occupied. We negotiated voluntary vacancy agreements with the seven of the eight tenants, paying them thousands of dollars to move so we could renovate.

We didn’t even try to negotiate with Mr. X, because he was paying $500 / month for his large apartment. We figured there was no way he’d take any amount of money to leave. But then a strange thing happened.

When the first of the month came around, Mr. X didn’t pay rent. We posted and mailed a 3 day pay-rent-or-quit notice. Still no rent.

I couldn’t believe it. We went to Dennis Block and filed an unlawful detainer case. We went to court.

Before the trial, I offered Mr. X a deal: Take $12,000 and agree to move out before the trial. He refused. I raised my offer to $15,000. He refused again. I asked my lawyer to review the evidence. He thought it was an open and shut case. I offered one more time. Mr. X’s wife asked him to accept. He refused. We went to trial.

We got the judge’s decision in the mail two weeks later. Evicted. Feeling awful, I offered Mr. X $5,000 if he would just move out before the sheriff came. There was no real need to offer the money. But I hoped it would ease the move and, also, my conscience. (In retrospect, I shouldn’t have felt bad. Why should someone get to live in my apartment without paying rent?)

Mr. X declined my offer and moved out. But not before teaching me something terrible but true about being a landlord.