Are you an investor or a speculator?

Market prices are up across the entire city. Where you could once buy stuff for 10x GRM, almost everything is now 12x+.

If you’re looking at deals now, it’s important not to get caught up in thinking about buildings relative to each other. At any time, I can tell you what the best thing to buy is in any of the neighborhoods I like. But just because something is a better deal than the other stuff out there doesn’t necessarily make it a good deal.

Now, there are still some genuinely good deals out there. For example, there are stabilized apartment plays at 11x where there is upside because the zoning allows for denser development in the future. And there are non-rent control buildings where the rent have room to move, allowing you to get closer to 10-11x by doing a little management work.

And, if you get one of these reasonable deals and you finance it with reasonable leverage for as long a fixed period as possible, you’re going to do very well.

But there is no magic that transforms a rent control building bought for 14x the rents into a good play. Unless you have (1) a plan to increase rents / reduce costs, and (2) the capital and experience to pull it off, you should probably not buy any rent control building at that multiple, because there is not going to be any real cashflow for years and you’re exposed to re-finance risk in the event rates continue to move (hint: they will).

On the other hand, you don’t necessarily have to pay attention to cashflow if you don’t want. You could just decide to bet on prices increasing. You can figure: I’ll buy at 13x now and hope some fool down the road is willing to buy at 15x two years from now.

But just understand that, if you’re doing that, you’re a speculator. And speculating right now hoping for multiples to increase, when we know interest rates are also increasing, seems like an extremely risky play to me.

Right now, you need soft eyes

There are no perfect deals right now. Think about it: People don’t generally sell perfect buildings where everything is going great. They definitely don’t right now, when the alternative to owning the building is to hold the money in their money-market account earning 0.25%.

Does that mean you shouldn’t buy anything? No. There are definitely good deals to be done, both relative to the other stuff out there and also in absolute terms. Just yesterday I came across a fairly large, non-rent control deal that a savvy investor could get into for less than 9x the rent in a good area. That works out to a 6.7% cap, which is probably an 8+% / year cash-on-cash return with some decent leverage.

Is this deal being marketed as a 6.7% cap? Absolutely not. It’s more expensive than that on its existing rents. To understand its potential, you need to understand where the neighborhood is going and what you can do to improve the apartments and raise the rents.

In The Wire, McNulty and Bunk, two detectives, talk about having “soft eyes” when they look around a crime scene. What they’re referring to is the ability to avoid jumping to conclusions and to see all the different possibilities. That’s exactly what you need to do good deals now: soft eyes.

The state of the West Hollywood apartment market

Today I spoke with a broker who has an eight unit property in West Hollywood listed at a somewhat reasonable $187,500 / door.

I say somewhat reasonable because the gross rent multiple is 15x. At a list price of $1.5MM, that means the property is generating rents of $100,000 / year. The rents are obviously very low, averaging just a bit over $1,000 / unit / month.

Those tenants are never, ever leaving, because they’re paying 50% of market for their units. And West Hollywood’s rent control law is, if anything, stricter than LA’s, so there’s no way you’re forcing them out.

If we assume, as I usually do, that the net operating margin to the new owner will be approximately 65% of the rent roll, then the property will generate something like $65k in NOI. (That’s very generous, by the way – when you get up to 15x, the property tax the new owner pays is so disproportionately high that the margin shrinks considerably.)

Recall that you can calculate the cap rate (un-levered yield) on a property by dividing the NOI by the purchase price. Even using the generous 65% NOI margin estimate, that means the cap rate on this property is $65,000 / $1,500,000 = 4.3%.

With a return like that, you have to ask: Who would want to bother with being a landlord for this building?

Guess how many offers they have, a week after going on the market…. five.

Incredible FHA opportunity in Echo Park

If you fit the following criteria, you should get in touch immediately:

  • Want to live in Echo Park
  • Want to buy a fourplex apartment building
  • Have a good job and good credit
  • Do not currently own property
  • Have at least $60,000 in the bank

This is the kind of deal that ensures a family’s financial security permanently. It will sell quickly.

You can get in touch with me using the contact info here.

Why no wealth manager has ever called me

Do you know that no wealth manager has ever called me about getting his clients into apartment deals?

I’m not saying I’m famous or anything, but this blog does come up fairly high in the Google results if you start looking for information on apartment investing in Los Angeles. There are literally thousands of people in LA whose job it is to manage money for rich people. So, if apartments are such a good investment, why aren’t they calling me?

One possibility is that apartments are a bad investment. But I don’t think this is what’s going on, because it’s not like there are tons of tax efficient investments out there offering 5-10% per year cash yields with relatively low downside. So, what gives?

It turns out that most wealth management types are compensated based on how much product they can push to their clients. For example: Say a big bank with a wealth management division agrees to buy a block of stock in a company pre-IPO in order to win the company’s investment banking business (happens all the time). The bank doesn’t want to hold the stock because it doesn’t want to take that much risk. What does it do?

It gets on the phone to the wealth management team and says this: I’ll compensate you X% for laying this stock off on your wealth management clients. So what happens? Rich people all over get calls from their wealth managers touting the amazing growth prospects of this new, pre-IPO company.

Is buying the company’s shares in the clients’ best interest? Who knows? Do you know whose interest it is in? The bank’s! And the wealth managers’!

As usual, it all comes down to fees. Wealth managers aren’t pushing their clients into apartment deals because there aren’t any fees in it for them. As long as that’s the case, rich people are going to keep getting pushed into weird structured finance products and crappy pre-IPO shares, because that’s how the wealth management guys get paid.