Answering some questions

Time to start getting to some of the questions sent in by readers. I’ve lightly edited these, but they are from an actual reader (hey K A-M!):

1. Do you like LA particularly because of any demographic reasons (ie. local universities, business push, etc. ) or is its just important that you live in close proximity to your properties so you can be a physical presence?

Here’s why I love LA as a place to invest in apartment buildings:

Diverse mix of industries, so employment isn’t super vulnerable to a downturn in one
Growing population
CA Prop 13 keeps property taxes low
LA rent control creates arbitrage opportunities, where you can buy at prices based on artificially-low, rent-controlled rents
Clear path of progress (gentrification has proceeded down through Silver Lake and Echo Park and into the older suburbs north of Downtown)

Also, I live here 🙂

2. Who, in general, should consider buying apartment buildings? I’ve thought of doing something like this before but I didn’t think I have any value add that would make me a better property manager than the next guy and thus able to wring every penny out of the asset.

In general, I think buying and holding apartments is a reasonable path for anyone to take.

I think it’s best if you do it on the coasts, where vacancy rates are very low. In-land, there are places where you can earn higher nominal returns (at least, on a pro forma forecast). But those places can experience very high levels of vacancy in downcycles. If you stick to high employment areas, you shouldn’t get hurt too badly on the revenue side.

On the cost side, you’re not going to do as well as a professional, but you’ll do fine with a good management company. Will they do an amazing job? Probably not. Will they do a totally adequate job, assuming you regularly look over their shoulder? Almost definitely.

3. So how do you get blown up? How does this all go pear shaped [in a “black swan” kind of way]?

For smaller buildings where you lever up to 80+%, you can blow up through rent decreases or vacancy if you’re not personally strong enough to carry the debt from your own income.

For larger buildings, the banks won’t let you go past 70-75% and a 1.2 debt service ratio, so even if the rents go down by 20%, you still scrape by. In real life, this happened to me on a 16 unit deal. It sucked, in that the value went down and our equity decreased (a lot). But we never missed a mortgage payment, there was always cashflow, and the rents have come back (as has the equity).

My story is reflected in the numbers. There was never a big wave of multifamily foreclosures because people in LA always need a place to live and the loan under-writing was never crazy.