Moses Kagan on Real Estate

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Is it too late to buy?

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A lot of people are wondering whether it’s already too late in the cycle to buy.

After all, prices have bounced back up off the floor of 2009-10. For context: I sold a bunch of totally renovated buildings in 2011-12 for 10-10.5x the rents. I would get 11x all day right now, and possibly more. (Ouch!)

So, is it too late?

Syd Leibovitch, the president of Rodeo Realty, doesn’t think so. His prediction is that prices will double from the lows… implying there’s plenty of room to run.

Now, I love Syd. He’s a sweet guy and he’s brokered more deals than I probably ever will. (In fact, before I set up the brokerage part of Adaptive, I considered signing on at Rodeo… before remembering that I don’t play well with others!) But I always get a little nervous when I hear brokers predicting price increases. It’s a little too potentially self-serving.

But let me give you another data point: I’ve bought five apartment buildings over the past 3-4 months for our funds, several more for fee-for-service clients, and am making offers for myself now.

Why am I so bullish on the market?

First, let me acknowledge that I don’t have a crystal ball. Anyone who tells you they are certain which direction prices are going to go is a fraud. There’s just no way to know.

Here’s what I do know:

  1. I don’t pay high prices. The buildings we have bought were all cheap on either a price per square foot or GRM basis, or both. I can’t predict the future, but I know if I buy for less than replacement cost and/or at a price which allows me to lock in a good return from the cashflow (with increases to come), then I don’t really care that much about where the market goes…
  2. …because I don’t use a lot of leverage. If you don’t over-lever, then there’s no way you’re ever going to be forced to sell. If you’re never going to be forced to sell, then you can always wait out bad markets.
  3. Rents are rising. There is a lot of demand for quality apartments in good areas. We put a 2 bed / 1 bath in Echo Park on the market for $1850 and had 40 inquires within 24 hours. I think this demand is likely to increase as the economy improves and jobs come back. More demand in supply-constrained in-fill markets (like Los Angeles, generally, and Echo Park, specifically) leads to rapidly rising rents.
  4. There is a long-term trend away from the suburbs and towards city centers. Long commutes are among the largest contributors to unhappiness. Cities have culture, entertainment, exchange of ideas and, most importantly, good jobs. Over time, I just can’t imagine prices in the 2nd largest city in America not increasing faster than inflation, because living in the middle of a vibrant city is a good life decision for most people.
  5. Interest rates are incredibly low. Sure, they’re not as low as they were six months ago, but they’re really low by historical standards. If you lock in a 4.5% loan for 30 years right now, I can’t see how you will look back and wish you hadn’t done it.

So, there you have it… a slightly scattered, but fairly emphatic defense of buying now. If you buy my logic and want to get serious about buying a good apartment building, get in touch.

Written by mjkagan

07/26/2013 at 10:02 am

Posted in Buying, Debt, What to buy

Are you an investor or a speculator?

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Market prices are up across the entire city. Where you could once buy stuff for 10x GRM, almost everything is now 12x+.

If you’re looking at deals now, it’s important not to get caught up in thinking about buildings relative to each other. At any time, I can tell you what the best thing to buy is in any of the neighborhoods I like. But just because something is a better deal than the other stuff out there doesn’t necessarily make it a good deal.

Now, there are still some genuinely good deals out there. For example, there are stabilized apartment plays at 11x where there is upside because the zoning allows for denser development in the future. And there are non-rent control buildings where the rent have room to move, allowing you to get closer to 10-11x by doing a little management work.

And, if you get one of these reasonable deals and you finance it with reasonable leverage for as long a fixed period as possible, you’re going to do very well.

But there is no magic that transforms a rent control building bought for 14x the rents into a good play. Unless you have (1) a plan to increase rents / reduce costs, and (2) the capital and experience to pull it off, you should probably not buy any rent control building at that multiple, because there is not going to be any real cashflow for years and you’re exposed to re-finance risk in the event rates continue to move (hint: they will).

On the other hand, you don’t necessarily have to pay attention to cashflow if you don’t want. You could just decide to bet on prices increasing. You can figure: I’ll buy at 13x now and hope some fool down the road is willing to buy at 15x two years from now.

But just understand that, if you’re doing that, you’re a speculator. And speculating right now hoping for multiples to increase, when we know interest rates are also increasing, seems like an extremely risky play to me.

Written by mjkagan

07/19/2013 at 10:29 am

Posted in Buying, Debt, What to buy

Right now, you need soft eyes

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There are no perfect deals right now. Think about it: People don’t generally sell perfect buildings where everything is going great. They definitely don’t right now, when the alternative to owning the building is to hold the money in their money-market account earning 0.25%.

Does that mean you shouldn’t buy anything? No. There are definitely good deals to be done, both relative to the other stuff out there and also in absolute terms. Just yesterday I came across a fairly large, non-rent control deal that a savvy investor could get into for less than 9x the rent in a good area. That works out to a 6.7% cap, which is probably an 8+% / year cash-on-cash return with some decent leverage.

Is this deal being marketed as a 6.7% cap? Absolutely not. It’s more expensive than that on its existing rents. To understand its potential, you need to understand where the neighborhood is going and what you can do to improve the apartments and raise the rents.

In The Wire, McNulty and Bunk, two detectives, talk about having “soft eyes” when they look around a crime scene. What they’re referring to is the ability to avoid jumping to conclusions and to see all the different possibilities. That’s exactly what you need to do good deals now: soft eyes.

Written by mjkagan

08/30/2012 at 7:41 am

The state of the West Hollywood apartment market

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Today I spoke with a broker who has an eight unit property in West Hollywood listed at a somewhat reasonable $187,500 / door.

I say somewhat reasonable because the gross rent multiple is 15x. At a list price of $1.5MM, that means the property is generating rents of $100,000 / year. The rents are obviously very low, averaging just a bit over $1,000 / unit / month.

Those tenants are never, ever leaving, because they’re paying 50% of market for their units. And West Hollywood’s rent control law is, if anything, stricter than LA’s, so there’s no way you’re forcing them out.

If we assume, as I usually do, that the net operating margin to the new owner will be approximately 65% of the rent roll, then the property will generate something like $65k in NOI. (That’s very generous, by the way – when you get up to 15x, the property tax the new owner pays is so disproportionately high that the margin shrinks considerably.)

Recall that you can calculate the cap rate (un-levered yield) on a property by dividing the NOI by the purchase price. Even using the generous 65% NOI margin estimate, that means the cap rate on this property is $65,000 / $1,500,000 = 4.3%.

With a return like that, you have to ask: Who would want to bother with being a landlord for this building?

Guess how many offers they have, a week after going on the market…. five.

Written by mjkagan

07/27/2012 at 4:15 am

Incredible FHA opportunity in Echo Park

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If you fit the following criteria, you should get in touch immediately:

  • Want to live in Echo Park
  • Want to buy a fourplex apartment building
  • Have a good job and good credit
  • Do not currently own property
  • Have at least $60,000 in the bank

This is the kind of deal that ensures a family’s financial security permanently. It will sell quickly.

You can get in touch with me using the contact info here.

Written by mjkagan

07/21/2012 at 10:03 am

Posted in Buying, What to buy

Why no wealth manager has ever called me

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Do you know that no wealth manager has ever called me about getting his clients into apartment deals?

I’m not saying I’m famous or anything, but this blog does come up fairly high in the Google results if you start looking for information on apartment investing in Los Angeles. There are literally thousands of people in LA whose job it is to manage money for rich people. So, if apartments are such a good investment, why aren’t they calling me?

One possibility is that apartments are a bad investment. But I don’t think this is what’s going on, because it’s not like there are tons of tax efficient investments out there offering 5-10% per year cash yields with relatively low downside. So, what gives?

It turns out that most wealth management types are compensated based on how much product they can push to their clients. For example: Say a big bank with a wealth management division agrees to buy a block of stock in a company pre-IPO in order to win the company’s investment banking business (happens all the time). The bank doesn’t want to hold the stock because it doesn’t want to take that much risk. What does it do?

It gets on the phone to the wealth management team and says this: I’ll compensate you X% for laying this stock off on your wealth management clients. So what happens? Rich people all over get calls from their wealth managers touting the amazing growth prospects of this new, pre-IPO company.

Is buying the company’s shares in the clients’ best interest? Who knows? Do you know whose interest it is in? The bank’s! And the wealth managers’!

As usual, it all comes down to fees. Wealth managers aren’t pushing their clients into apartment deals because there aren’t any fees in it for them. As long as that’s the case, rich people are going to keep getting pushed into weird structured finance products and crappy pre-IPO shares, because that’s how the wealth management guys get paid.

Written by mjkagan

06/26/2012 at 6:36 am

Posted in What to buy

Why writers should own apartment buildings

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At first glance, the title above seems pretty crazy, right? After all, writers are creative types. They spend their days conjuring stories from thin air to delight the public. Why should people like that be involved in the nitty-gritty of owning and managing apartments?

Like many things in life, it comes down to money. Writers, especially screenwriters, have lumpy incomes. They can sell two scripts in a year and pocket $500k, then have several years with no income. Or, like many TV writers, they can kill it for 20 weeks or so and then end up on unemployment until they find out if the show’s been picked up for next season.

Owning apartment buildings, particularly 5+ unit buildings, has at least three advantages for writers with income patterns like that:

  1. The cashflow from a building provides some income during fallow periods. Don’t know if the show will be picked up? It’s not that dire when you know you’ve got $50k coming in this year from your real estate (and this is totally possible with $500k to use for a downpayment).
  2. You don’t have to take hack jobs. This is a follow-on effect from #1. Because you know you have passive income coming in, you don’t have to take jobs just to survive. Does this mean you’ll only have to work on things you absolutely love? Probably not, at least not initially. But you’re not going to end up writing dialog for pornos to make your rent payment.
  3. People with lumpy income can more easily qualify for “commercial” loans than for smaller, residential ones. Why is this? Because for loans on larger buildings, banks tend to focus on the asset more than on the borrower. And having a bunch of cash in the bank can make up for having an income that fluctuates wildly.

I get so angry when I see writers who have recently “made it” buy a house in the Hills and lease a fancy car. They’re guaranteeing that they’ll live a precarious financial life, at least until they really hit it big.

Instead, they should delay gratification for a year or two and take down a building. Then, no matter what happens to them professionally, they’ll know for certain that they’ll be ok. And that counts for a lot when you’re trying to lead a life devoted, at least in part, to art.

Written by mjkagan

06/19/2012 at 4:10 am

Posted in Buying, Success, What to buy

How to invest in real estate passively (part 1)

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A few people have asked me recently how you can invest in real estate without doing it full time. It’s a good question, because, as a part-timer, you are competing with other investors who have some built-in advantages, including:

  • Ability to buy all-cash and close quickly
  • A network of brokers who funnel the best deals to the most active buyers, sometimes before they hit the market
  • Ability to more accurately evaluate an asset, given experience with similar assets
  • Better banking relationships, allowing for cheaper debt and faster closings
  • More appetite for dealing with the problems associated with attractively priced assets

It’s certainly not impossible to do good deals without having the above advantages, but it’s not easy.

So, how do you, as an individual, get access to good deals if the deck is stacked against you?

Well, if you can’t beat ‘em, join ‘em. Real estate professionals (like me) are in the capital-raising business. Our business model is to use our expertise to make money for investors and then take a cut of the profits for ourselves. So one good way of getting exposure to good deals is just to invest with professionals.

There are two main ways to do this:

  1. Investing in syndicated deals; or
  2. Investing in funds

Over the next few posts, I am going to explain how these approaches work and the pros and cons of each.

A word of caution before we begin: Investing in private real estate deals is, by definition, risky. You can get hurt. So this is the kind of thing you do with spare cash that you can afford to lose. And, just like when you buy a building yourself, you need to do your due diligence on anyone you invest with. Caveat investor!

Written by mjkagan

06/05/2012 at 4:59 am

Posted in Buying, What to buy

What about student housing?

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An old friend from highschool recently posted on the blog asking what I think about student housing as an asset class. Thought I’d go ahead and answer publicly.

First, take all this with a grain of salt. I’m not in the student housing business. But I have spent a fair amount of time looking into it, both in LA and in other parts of the country. With all that in mind, here are my impressions of the business:

  • Students put a lot of stress on buildings. They tend to live in crowded apartments, have guests and throw parties, none of which are great for your plumbing. You’re going to see a bunch of holes in walls, broken windows, etc. Have your repair crews ready, and make sure you include larger-than-normal repair reserves in your pro formas.
  • Student tend not to care about their credit. So you need to get the parents on the lease, preferably with a large security deposit. Threatening a student’s credit won’t get you very far; threatening the parents probably gets you the rent you’re owed.
  • Students tend to move in and out all at once. You basically have the second half of August and the first half of September to lease all of your units. If you fail to rent one, you may find yourself with a vacant or deeply discounted unit for a while.
  • Summers will be slow. If you’re in a market where the landlords have the power, you may be able to force students to sign 12 month leases. If not, you’re probably going to eat 2-3 months of vacancy each summer; be prepared.
  • Financing is more difficult. While there are banks that understand student housing, particularly when the assets are large, your average multi-family lender is going to be uncomfortable looking at a building with two months of vacancy and 100% tenant turn-over each year. So you’re probably going to have to use less leverage and it’s going to be more expensive.

Personally, I’d only be interested in student housing around expensive, private universities where I could offer a truly distinctive product and thereby command really great rents. Otherwise, it’s not worth the hassle.

Written by mjkagan

05/29/2012 at 4:19 am

Posted in What to buy

Never Buy a Building with a Non-Conforming Unit

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I was once in escrow to buy what I thought was a 16 unit building on Clinton St. in Echo Park, one unit in which was “non-conforming”. The owner had taken a common room and turned it into a studio apartment. The listing broker assured me that this was pretty normal in LA and, indeed, if you look at Loopnet or the MLS, you do see buildings like this all the time. I went ahead and did the deal.

The LA Housing Department (LAHD) has a regular inspection program called SCEP, where they go through every apartment building in the city every three or four years. They check for code violations, safety hazards, etc. And they recently started checking for un-permitted units.

We had our regular inspection and the inspector wrote us up for having this un-permitted unit. We were required to either vacate the unit and return it to its previous use or else get it legalized.

Pause for a second and allow me to thank the Lord that the building was not rent-controlled (having been built in the early 1990s). Had it been rent controlled, we would have had to pay the tenant in the unit the city-mandated relocation fee, which in this instance would have been around $7,000, but which can go as high as $18,300. That would have been in addition to the lost rent, the lost value (because that lost rent would lower the building’s profit and thereby it’s re-sale value), and the cost of legalization (if that were even possible).

Fortunately for us, we were able to convince the tenant to move somewhere else (in part because he wasn’t protected by rent control). Even more fortunately, we were able, through an extremely painful, expensive and time-consuming process, to legalize the unit, turning what had been a 15 unit building into a legal 16 unit building (and thereby adding a lot of value to the asset). In this we were lucky… it turned out to be possible to add the additional parking space necessary. This would not have been possible with almost any other building.

But I will never, ever, ever buy a building with an un-permitted / non-conforming unit again. Not only are you paying for an income stream which is likely to go away the next time the city inspectors come through. You are also putting yourself at risk of having to pay a massive relocation fee to the tenant. Let some other schmuck take that risk.

Written by mjkagan

04/19/2012 at 7:18 am