And…. we’re back.
Want to talk today about partially renovated buildings.
This is a business model we see a lot:
- Guy buys an older building with low rents
- He turns over, say, 1/3 of the units and gets market rents for them
- He markets the building at a very low cap rate (eg a high price) arguing that someone else can come in, replicate what he’s done with the rest of the units, and reap the benefits
And lots of people buy these deals.
Do you know why I hate them?
Think about it from the perspective of the seller. His strong incentive is to turn over as many units as he can, so long as he can turn them profitably (eg create more incremental value from turning a unit than it cost to do so).
If he’s left a bunch of units unturned, it’s a strong signal that he could not turn those units profitably.
So, as a buyer, why would you think that you could do something the existing owner, who has way more information than you do, couldn’t do?
“I know you’re asking $2500 / month. But I really like this apartment and I can only pay $2000. Can we make a deal?”
“Sure. You know what? We searched high and low for months to buy this building, risked millions of dollars to buy and renovate it, spent 12 months of our lives on it. And we’re very happy to light $72,000 of the profit on fire, just because you asked.”
A $500 rent decrease isn’t $500. It’s $500 x 12 months x 12GRM = $72,000 in asset value.
So, no, we will not give you a $500 / month break on the rent.
Curbed had an story yesterday that was 100% predictable: Downtown landlords are having to offer incentives to attract tenants.
Here is why this happened:
- Rents have been going up downtown since the end of the recession in, say, 2011
- Downtown is one of the very few neighborhoods in LA (along with, to a certain extent, Hollywood and Glendale) where you can build huge buildings without having the neighborhood tear you a new one
- Developers generally prefer to build huge buildings, because that’s an efficient way to put out huge amounts of capital quickly
- Seeing increasing rents and lax zoning, developers piled into LA, announcing project after project beginning around 2012 and continuing to today
In isolation, each of these projects made sense. The developers could convince themselves and the banks that their pro forma projections were solid, because they had plenty of rent comps to go on.
The problem is that the projections almost certainly did not reflect the fact that there were thousands of other new apartments opening up. (Why? Because it’s extremely difficult to estimate the effect in advance.)
So, now you have a glut of apartments, which is certain to lead to softening rents. Fortunately, most huge developers are well capitalized, meaning that their projects can tolerate somewhat lower rents / longer lease-up periods. Assuming the economy holds up, we’re not going to see lots of foreclosures by construction lenders. We’ll just see developers and their equity investors making less money than they had hoped.
Incidentally, the above is why Adaptive never went into downtown. We know it’s a highly cyclical market with relatively low barriers to entry. Once we missed the real lows in 2010-2011, we were not interested. Maybe on the next real downturn…
Have a small, new project opening up in Silver Lake shortly.
- Two 1/1s
- Four 2/1s
- One 2/1 house
The property is easily walkable from Sunset Junction (like, fall out of bed walkable). And the lot is elevated above the street and gated, so the property feels very safe and secure.
The units themselves are special… fully renovated, all the modern conveniences, private outdoor space (the house, in particular, has an incredible yard and two decks) and parking. The seven units are spread out over four buildings, so the maximum number of walls any unit shares with any other unit is one.
Why am I putting this post up with no pics? We haven’t even taken them yet… but these units are going to rent so fast that I thought my readers deserved to hear about them first.
If you’re interested in setting up a sneak preview before we officially start leasing this weekend, contact Kayla [at] adaptiverealty [dot] com.
Have been doing a bad job of updating the blog – mea culpa.
In my defense:
- We have a lot going on here at Adaptive
- I’ve grown somewhat weary of seeing people read the blog and then compete with me
On the second point: I’ve always known the blog would inspire competition. That’s life in the big city. I’ve always thought it was worthwhile as a marketing tool to attract clients for our brokerage and investors for our deals. And it has done both, in spades.
That said, as we’ve grown and our ability to attract capital has improved, I’m less and less confident that the trade-off is worth it.
For the time being, I’m going to continue writing. But I’m going to do so with more of an eye towards restricting the information competitors can glean from the blog.
So, if you want the benefit of our expertise, you should probably be a client or investor!!