A savvy deal I couldn’t do

Just got a flyer from a reasonably active local broker announcing a deal he closed with the following characteristics:

  • In Westlake, a rapidly improving neighborhood situation between Koreantown and Downtown
  • 10 units totaling 9,800 sq ft
  • 15,000+ sq ft lot
  • R4 zoning
  • $1.8MM price

The flyer didn’t specify the rents, but, as I recall, the rent roll was in the range of $8k / month, or $96k / year. That’s $1.8MM / $96k = 19x GRM (!).

This is an excellent example of the kind deal I like but can never actually do. Why?

Well, it’s clearly not an apartment repositioning deal. Between buyouts and rehab, you’d end up all in for, say, $2.7MM, with a rent roll of something like $235k, equating to a GRM of 11.5x and a cap rate of 5.5%. That’s not appealing enough to make the effort of repositioning the property worthwhile.

And it’s not really a development deal, either. 15,000 sq ft of R4 gets you 37 units (if you can park them!). $1.8MM / 37 = $49k / door for the land. Because construction costs are so high right now, I don’t think you can make that land price pencil in that neighborhood (where rents are still pretty low).

And yet… I like the deal. Why?

  • We are not making any more land in LA and every year more and more people are moving here. So, over the long term, the value of land here appreciates faster than inflation.
  • Even without a full repositioning, there is likely to be some cashflow… say, 2-4% / year. That’s not enough for a professional money manager, but it’s not bad for a rich person with money sitting around earning 0% in a bank.
  • And the property comes with the option to develop a 37 unit building at the appropriate time. When is that? My guess is it’s as we’re coming out of the next recession, when construction prices will be relatively cheaper and the neighborhood will have improved measurably.

Can you see what this is? It’s a relatively safe, long-term speculation with some yield.

Because we categorically refuse to factor appreciation or rent growth into any of our financial models, we can’t do deals like this. But someone else clearly did, and I believe she’ll be rewarded by a return in the range of 5-7% / year during the course of the investment (inclusive of both yield and appreciation).

That’s a pretty savvy deal.