Moses Kagan on Real Estate

Why we don’t have a long-term lending relationship

Got a call from a lender the other day.

He had seen a loan broker with whom we work shopping one of our deals and was irked that we hadn’t come to him first.

I get where he’s coming from, on one level. We’ve done several loans together, so he feels like he should have first crack at my business.

But here’s the thing: When I let him know what terms we were being offered by his competition, he told me he couldn’t compete. He went back to “but we have a relationship…”

Now, there is definitely a way for a lender to win all of our business, even when his take-out (or permanent) financing isn’t quite the cheapest: He could commit to providing good bridge financing for our projects in exchange for getting the take-out loan, too.

Why would that make sense? Well, bridge loans are short duration (typically 12-18 months), so we’re much more concerned with the lender not being a pain to deal with than we are with getting absolutely the best rate.

A lender who wanted our permanent financing business would simply commit to (i) being our best source of bridge money, and (ii) being easy to work with on both the bridge and the permanent financing.

Then, we would work with that bank, even in situations where they weren’t the absolute cheapest money around.

So far though, neither the banker who called me, nor any of his competitors, has offered the above arrangement. So we shop for the cheapest money we can find.

What we talk about when we talk about appreciation

Have been doing some thinking about appreciation and how it affects our business.

First, what is appreciation? It is the tendency, over time, of the price of real estate (in Los Angeles, anyway) to increase.

A bit of clarification:

Obviously, there is no guarantee that real estate will increase in price over any particular time frame. Prices could fall tomorrow. But the general pattern, over many, many years, is for the price to increase; and
By increase, I mean “at a rate in excess of inflation”.

But appreciation in real estate is a very weird concept. After all, when you buy a property, part of what you’re buying is a physical structure which is, by definition, depreciating. If you don’t constantly repair your building it will degrade and, eventually collapse. Tax law recognizes this fact by allowing you to write off against your income 1/27.5 of the value of the structure each year you own it.

So, if the physical structure is always in the process of falling down, why do properties in LA tend to increase in price? If it’s not the structure, it must be the land, the other thing you’re purchasing when you buy a property.

That makes sense, right? The amount of residential land in LA is capped (both physically and, in terms of the number of people it can carry, by our insane zoning laws). And demand is growing, fueled by our amazing weather and strong, diverse economy.

Any time you have capped supply and increasing demand, you’re going to see price increases. And that is what fuels long term price increases in LA; it’s the land, not the structures.

What to build in LA right now

Periodically, I’m asked to answer the following question: What part of the real estate business is most attractive for a new entrepreneur right now?

So I think about this question a lot.

And my answer right now is: Condos for old people.

As I’ve said here before, I’m among the oldest Millennials. Therefore, I’m experiencing the various life milestones just ahead of a huge group of people. And my parents have just retired and are in the process of looking for somewhere in LA to live for at least six months out of the year.

Since my parents are doing this, I think it’s likely that many other Millennials’ parents will be doing it, too, several years from now.

So, if you’re thinking about what kind of project to do, consider what these kinds of aging Baby Boomers want / need in LA housing and figure out how to deliver it to them profitably.

363 S Leslie is fully leased

You may remember 363 S Leslie, a 4plex we recently completed in Highland Park. Here’s a pic to jog your memory:

Am happy to report that leasing is done.

Better yet: Our rents came in materially higher than we originally pro forma’d. So, instead of the 6.3% unlevered yield we expected out of the property, I think we’re looking at more like 7%.

When you consider that people are buying crappy buildings with all kinds of deferred maintenance at prices equating to 4% unlevered yield, you can see why our business model is popular with investors.

Attack of the zombie street dedications

All over the city, there are zombie street dedications increasing the cost of housing.

Wait… what? (You say.)

A street dedication is how the city responds to old, narrow streets that don’t meet modern standards. It can’t start ripping down peoples’ buildings and taking away their front yards (well, it could, but that would require eminent domain and, therefore, expensive compensation to the victims).

What it does instead is create a “street dedication”. That’s an imaginary line running across the front setbacks of a whole street. If you don’t do anything with your property, the line stays imaginary. But, if you want to develop your property, the city takes away the portion of your lot between the line and the street as a sort of trade.

Here’s a picture of a street dedication line (the thin green line):

And here’s what happens when the city actually takes the property (see the notch cut out of the property:

One thing you might have noticed from the above: It takes a hell of a long time before the city gets enough land via these dedications to actually widen a street. That’s because owners only develop their property slowly, over decades. So, many of the street dedication ordinances that are presently in action were actually created decades ago, when the city’s priorities were very, very different.

But street dedications are increasing the cost of housing TODAY. How?

Well, the good news is that, for the purposes of calculating how many units you can build on a lot, the city lets you include the square footage that will be lost to the dedication.

But they still take the land. And the setback for your new building is then going to be 10 or 15 back from the new street line. That means you’ve got less room to fit structure and, crucially, parking.

That means that, for streets with dedications, each of the impacted lots can carry fewer units, further limiting the scope for development and, therefore, housing supply.

Are there instances where the city should take land to widen streets? Obviously. But these kinds of regulations impose higher housing costs. And, in an era of housing emergency, we should think very, very carefully about whether the benefit of wider streets at some day in the distant future is worth the cost of increased housing costs right now.