How you improve the neighborhood

Sometimes all you need to do to improve your neighborhood is to yell at a priest.

My brother and I own a 16 unit building on Reno St (the one from this story) that’s across an alley from a new church, one of those Latin Pentacostal deals.

The street itself isn’t the nicest one in LA, but it’s not terrible. We try to do our part by making sure that the strip of grass outside our building looks like this:

And here’s how the same strip of grass looks outside the church:

The last time we had our building appraised, I was literally on my hands and knees picking up trash up to the minute before the appraiser arrived because I was so paranoid about the impression the trash would leave on her. (See how glamorous it is to own a building?!)

I’ve been steaming about the trash for months.

Finally, the other day, I was at our building picking up the laundry money (again, the glamor!) and decided on a whim to call the church. I figured I’d get some voicemail, leave a message, and no one would ever do anything about it.

Turns out I was wrong. The minister got on the phone right away and spoke to me (in Spanish). He was super nice and understanding. He assured me the church would clean up. And they did.

Now our litte corner of “Silver Lake -adjacent” is a little less gross. I wonder how many other owners out there would benefit from doing the same thing.

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 to add value to your apartment building

Some people take owning an apartment building as their opportunity to unleash their internal interior designer. It’s like the building becomes their personal canvas to show off their taste in decorating.

Don’t be one of those people.

The only way to make a rational decision about spending money to improve your building is to determine whether the expenditure will increase the value of your building by more than it costs.

Say you’re considering spending $4,000 to install a washer/dryer in a unit (the cost of the actual appliances plus the necessary plumbing work). You need to estimate the additional rent the W/D will generate. In my experience, having a private, in-unit W/D adds somewhere between $100-200 per month in rent. Let’s say it’s $150 / month.

To determine whether it makes sense to go forward, multiply the additional monthly rent by 12 months. So the $150 / month becomes $1,800 / year. Then, multiply that annual additional rent by the gross rent multiple for the neighborhood in which your building is located. In Northeast LA, that’s risen to right around 11x the annual rent. Which means the $1,800 / year adds $1,800 x 11 = $19,800 in value to your building.

If you had the chance to spend $4,000 to get $19,800, you’d do it, right? So there’s your answer on the W/D.

But let’s try the same math on putting in a set of custom cabinets for $10,000, when you could have used a set from IKEA for $2,500. The cost difference is $7,500. Can you justify it? Well, I think you’d struggle to get more than $50 in additional rent for fancy cabinets. The math is $50 x 12 months x 11 grm = $6,600. Not worth it.

In my experience, the things that add the most value to apartments are washer / dryer, dishwasher, replacing carpet with manufactured hard wood, and, for the whole building, painting and landscaping. Things to avoid include expensive light and plumbing fixtures, designer tile, and granite counter-tops.

Remember: If you can’t imagine a tenant paying more rent for it, don’t do it!

Should I hire a property management company?

Not now, maybe later. That’s it, in a nutshell. Here’s what I mean:

On your first building, likely a 2-4 unit building acquired with an FHA mortgage, you don’t want or need a manager. First, you need to learn a bit about the business –  what it’s like to fill vacancies, collect rents, deal with maintenance issues, etc. Second, the 5% of the rents that you pay a management company is money you want to help pay your mortgage. So I recommend against hiring a management company at first.

But I definitely recommend hiring one later, and here’s why: Management doesn’t scale. As you add more units, you add more headaches. This is why my parents, who’ve owned apartments for 40 years or something, never got to be really big landlords. They always insisted on managing themselves. They got every call in the middle of the night, dealt with all the tenant BS, etc. And because of that, they never felt like going to the next level, because it would have added a ton of stress to their lives.

They should have done what we did at first: Hire a competent management company and focus energy on finding and buying more units. In LA, you can get a good management company for roughly 5% of the rents collected, plus expenses (for things like materials and labor for fixing problems, etc.) – that’s a small price to pay to get back your time.

(Incidentally: keep in mind that managers rarely make money on that 5%. Instead, they manage in order to develop a relationship so you’ll use them as brokers when you buy or sell, which is where they make their real money. Read the management contract closely – you’ll almost always find that it includes the manager getting the right to act as broker should you choose to sell the property during the course of the management contract. This is not necessarily unfair, but you should always be aware of what you’re agreeing to before you sign.)

So go manage your first building yourself. But when you’re ready to move out and buy another one, consider hiring a good manager to take over for you. It costs more in the short term, but it’s the only way you’re going to have the time and energy to buy a lot more units. And that, after all, is what this is all about.

What the %#&^ is a “cap rate”?

Can’t remember what a “cap rate” is? Put simply, it’s the return you get on a building in one year, ignoring the financing.

To calculate a return, you need to know how much profit you get in one year in exchange for investing a certain amount of money. So, for example, if you invest $1,000,000 and get $100,000 in the first year, you got a 10% return ($100,000 / $1,000,000 = 10%).

“Cap rate” is just the real estate lingo for “return”. So, if you buy a building for $1,000,000 and it earns you $100,000 in net operating profit in the first year, you bought a “10 cap”. If it only earned you $50,000, you bought a “5 cap”.

Remember that cap rate ignores financing… which makes sense. After all, cap rate is a method for evaluating the relationship between a building’s price and the profit it generates. By ignoring financing (which is different for every building and every buyer), cap rates allow you compare different buildings to figure out which is a better or worse deal.

Remember there is rarely a free lunch. The higher the cap rate (or, put another way, the lower the price relative to the profit), the riskier the property is likely to be. For example, in Beverly Hills right now, it’s very difficult to buy anything at better than a 5.5 cap. In South Central, you can buy 8 caps all over the place.

Why the difference? Because everyone knows that Beverly Hills is a safe place to own real estate, and many investors are unwilling to own assets in South Central at almost any price.

If you have questions about any of the math above, please just ask via a comment and I’ll respond. Or, if you’re shy, email me (moses@betterdwellings.com).