Archive for the ‘What to buy’ Category
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.
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.
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.
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.
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:
- 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).
- 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.
- 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.
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:
- Investing in syndicated deals; or
- 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!
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.
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.
The 14 unit deal I mentioned late last week is going out to the mailing list around 5pm today.
If you want to understand how the numbers work on a larger apartment project, this is a good one to take a look at.
To join the mailing list, click here and follow instructions. Should take about 3 seconds.
Pro tip: You don’t want to buy a building, only to find yourself in the middle of a war with the Los Angeles Housing Department (LAHD).
Under the standard California real estate sale contract between seller and buyer, the seller has a duty to disclose any on-going issues that may effect the value of the property, including any problems with regulatory agencies like LAHD. However, it is downright stupid to entrust yourself to the seller’s sense of honor or propriety in this regard.
Fortunately, LAHD does provide an online system for checking if there are problems with the building. Unfortunately, they make it kind of a pain in the ass to find.
So here’s how to do it:
- Go to http://lahd.lacity.org/
- Click on “Code Enforcement” on the left side of the page
- Click on “Prop Info / Complaints” in the gray window that opens on the left side of the page
- Click “Property Profile”
- In the boxes that appear: Type the street number and name of the street (exclude any directions, like “North” or “N.” and also the type of street like “Ave.” or “Dr.”
- Click on the address of the property
At this point, you’ll get a list of complaints, violatons, etc. Understand that almost all rental properties have had violations before, so you shouldn’t be scared off. But here’s what to look for:
- All complaints should include the words “Complaint closed” or “All violations resolved date”. If they don’t, they’re still open and you could be entering a world of pain;
- If you see the word “REAP”, proceed with extreme caution – this is a serious city program that you want to avoid unless you really know what you’re doing;
- If you see lots of complaints, you need to be aware of two potential issues, neither good: (i) the building could have a lot of deferred maintenance issues that will require you to spend money fixing, or (ii) there are one or more tenants who delight in causing trouble for the owner by calling in bogus complaints;
The city being the city, there is no guarantee that the list you see on the website is comprehensive. There could be complaints that have been made that have not yet made it into the system. But checking online is a good place to start and I highly recommend doing so BEFORE removing your contingencies on a property.