Thinking about the effect of competition on our business

Just started Peter Thiel’s book about start-ups.

Among the more interesting arguments in the book is about competition. Thiel argues that competition is a bad thing for businesses, because economic theory teaches us that, in competitive markets, profit is competed down to zero.

Instead of entering into competitive markets, Thiel advises striking out into new territory, with the aim of building a monopoly business, the kind that reliably generates excess profits.

We’re in an incredibly competitive market. Anyone can just jump right in and compete with me for deals, driving up the prices I have to pay. And obviously there are thousands of apartments competing with my buildings for occupants, driving down the rent I can charge.

Still, so far, we’ve been able to generate excess profits, but I have no idea whether that is a sustainable state-of-affairs.

So I’m going to spend some time over the next few weeks thinking about whether there are opportunities to erect some additional barriers to entry around our business.

If you’re going to allow units without parking, allow lots of them!

One of the iron-clad rules I learned while doing the Better Dwellings portfolio is about to be turned on its head by the city council.

Here’s the rule: Never buy a building with a non-conforming unit.

I learned that rule the hard way at 2117 Clinton St., where we got whacked on a SCEP inspection. Though we eventually permitted the unit, it was only by luck (because we had room to create a new parking space) and spending a ton of money.

Now comes word the city council is considering creating an easier pathway to legalization for unpermitted units.

The theory is pretty simple: In a city with a major housing shortage, it’s crazy to be evicting tenants from perfectly reasonable apartments because they are not permitted.

However, as with almost everything else in LA, the problem is going to come down to parking. Either the city is going to require the units to have parking in order to permit them (in which case the law will be pretty meaningless, because it’s usually impossible to add the parking) or else it’s going to allow units without parking.

If the city is going to allow landlords to permit units without parking because we’re in a housing emergency, why not go ahead and allow developers to build units without parking? That’s the quickest way to get lots and lots of units onto the market.

Against the Broadway people-mover

Yesterday, Curbed had an article about the proposed DTLA people-mover, which is apparently going to travel about the speed of a walking human.

I’ve been a supporter of the project for a while, because I love Broadway and want it to continue to improve.

But I’ve changed my mind, and here’s why:

Two days ago, I walked from Broadway and 9th up to 5th and Main. Along the way, I was pan-handled four times and counted five instances where I had to step over fresh pee. Bottom line: The problem of homelessness downtown is the reason Broadway sucks, not the lack of a trolley.

The proposed streetcar is going to cost around $270MM. That amount of equity would build a ton of housing.

How much? Well, affordable housing deals don’t pay property taxes and never have vacancy. So, they can support enormous amounts of leverage… usually in the range of 85-95%.

If you assume 90%, then $270MM gets you $2.7B worth of affordable housing. How much housing is that?

Well, affordable projects are required by law to use prevailing wage (aka union) labor. So they cost much more to build than market rate housing. But, even if you assume $400k / unit (I cried typing that number), you’re looking at $2.7B / $400k = 6,750 units worth of affordable housing.

My cursory reserch into the Skid Row homeless population puts it in the range of 3,000 people, give or take.

So, instead of building a people-mover that moves no faster than a person, let’s:

  • Build, say, 2-3,000 units of affordable housing spread throughout LA County (so as not to perpetuate the concentration of poverty downtown)
  • Spend the remaining money to step-up enforcement of quality of life crimes downtown (like public urination)

Uh-oh… they’re baaaa-aaaccckkkk

We’ve now reached the point in the cycle where brokers describe their over-priced apartment deals as “condo conversion opportunities”.

Why would a broker do this? Well, if your client demands a price so high that no buyer could actually achieve any kind of yield on their investment, you don’t really have many options.

But, in all seriousness, what does the re-emergence of “condo conversion” as a strategy tell us about the current state of the market?

To answer this question, you first need to think about where we’ve been since 2008 or so. With interest rates at zero, capital has been chasing yields. Apartment buildings are reliable income generators, so capital has flowed into apartment buildings, raising prices and reducing returns.

But two factors are converging to change this state of affairs:

1. There’s only so high prices for cashflowing assets can go. Once you hit the point where the price is so high that the yield is negative, it’s pretty hard to convince even the stupidest buyer that he should go forward with an acquisition.

2. There is no limit to the insanity of single family home buyers in LA. Residential real estate in LA is totally, 100% detached from any fundamentals. No one thinks about what kind of rental yield they could get by renting the house or condo out. No one considers what it would cost to build the same house or condo across the street. Instead, they just convince themselves to pay a bit more than whatever the last sucker paid for a comparable house.

Given the above, it’s no wonder we’re seeing the re-emergence of the condo conversion as a marketing plan: If the price for your apartment building can’t go any higher, just transmute it into residential real estate and float away from the dreary world of actual returns into the beautiful fairy-tale of wanna-be stars living the dream.

Why I love density (it’s not what you think)

Last night, I walked over to the Last Bookstore, bought an interesting old novel for $6, walked home and read it.

What does this have to do with real estate? Everything.

Regular readers know I’m constantly banging on about density. I can’t stand the way city planning works in LA and I’m up on my soapbox every week complaining about it.

You might think this is because I’m in the real estate development business and stand to benefit from looser restrictions on development. And you’d be right… I probably would benefit.

But that’s not the only, or even the primary, reason I love density.

Density is amazing because it allows for diversity. For example: Interesting used bookstores depend for their survival on dedicated readers, who probably represent a tiny fraction of the population. In a spread-out, suburban setting, there aren’t enough of those dedicated readers to buy enough books to make a bookstore work.

But, in a dense city, there are. And the same goes for weird/different/interesting juice bars, gyms, salons, restaurants, etc.

Basically, the denser the city, the more interesting the retail. And, since I prefer to have amazing, non-standard choices for everything I consume, I’m for density.