Beware of False Financials

I follow a number of Realtors on Instagram, Twitter, blogs, etc because sometimes oversharers enjoy friendly competition. However, most of these Realtors who dabble in multifamily properties couldn’t understand a financial model if it were spelled out on subway tiles.  One particular Instagrammer recently pointed to 3165 Cazador St., a “turnkey” duplex, claiming it earns $2,000 “monthly profit after expenses” on a $850,000 asking price with 25% down and a typical interest rate.  That would mean an 11% return on investment.  That’s damn good for not doing any renovations. The problem is, that’s also totally untrue.

The reality is, if we’re assuming her rental projections on the vacant units are accurate ($3200 and $2500) and the property needs zero work (this is never the case for multifamily deals), we’re only making 4-5% on our investment with about $800 monthly cash flow.  That’s actually still good for a Los Angeles investment property, but there are a lot of barriers to reaching that profit.

Here is what this agent is missing in describing a $2,000 monthly profit: property tax, insurance, water/sewer, trash, gardener, replacement reserves, pest control, and possibly exterior electric bill.  That’s not including a management fee and repairing deferred maintenance. While many agents have great aesthetic taste, know the owner’s family, or have sold millions in single family homes, understanding the financials of a multifamily real estate investment is key to understanding a good deal.  And not all properties are the same, so these financial models can’t be carbon copied from one deal to the next.

Moses Kagan, the broker at Adaptive Realty, has brought his finance background to the over forty properties he’s renovated in the last five years, and knows firsthand what max rents are in neighborhoods from East Hollywood to Highland Park because of the properties Adaptive manages.  The agents at Adaptive Realty, half of whom are Princeton graduates, fully understand the financial details of real estate beyond the picture that the flashy agent paints.  One of the first things we do with new clients is to go over spreadsheets for three properties in their target market to help them understand what the numbers really are.

Part of me wants to educate all Los Angeles real estate agents on the expenses involved in multifamily investment properties because then perhaps asking prices will come down on bad deals.  Until then, however, I hope you find a smart agent who tells you the truth about your investment property, or else you may find your expected returns quickly chopped in half upon taking ownership.

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The Arts District is Gone

sixth-street-bridgeEveryone investor wishes they invested in the Arts District five years ago. It could be the fastest developed area in Los Angeles’s recent history of rapid gentrification. You know the current story, but here are a few developments planned in the next five years:

1) THE BRIDGE – The new world-class 6th St. Bridge, set to complete in 2019, will become the only bridge worth talking about in Los Angeles with its bike-friendly, eco-friendly awesome swoopy look. It connects Boyle Heights to the ever-fancifying Arts District downtown.

2) HOLLENBECK PARK – In Boyle Heights, Hollenbeck Park on 4th St and St. Louis, already one of my favorite parks in the city for its hills, water and bridges, is going to get a 1-million-dollar upgrade thanks to the money coming into the Arts District.

3) MATEO – The Arts District is going all in on becoming the next East Village  Old Town Pasadena West Hollywood and building an industrial-chic open-air shopping center that will certainly attract ritzier clientele.

So, what does this mean for the Arts District? If it’s unaffordable now, it will fall into the “bad deal” category for investors before you know it. I have heard of a very affordable neighborhood three minutes across the bridge though…

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Buy a Los Angeles condo?

I have a client in a 1031 exchange whose recent fourplex purchase has left very little cash to buy a second property.  So we’ve turned to condos, where the market is great for buyers right now.  I don’t normally buy condos in Los Angeles because if a cheap 1-bedroom condo costs $250,000, that makes the fourplex version of that cheap condo $1,000,000.  Would I buy a vacant fourplex full of 1-bedroom apartments in Westlake for $1,000,000?  Not as of today (10/30/2014), I wouldn’t.

That said, you can’t normally buy a $1,000,000 fourplex with $100,000 down, but you can buy a condo in almost any part of Los Angeles, from West Hollywood to the Valley.  Condominium units usually come in much better condition than a multifamily property, they often don’t have rent control, and maintenance is cheaper because the HOA pays most of it.

So when is a good time to buy a condo in L.A.?

Are you paying more than $2500 in rent? Do you have $100,000 that is making you less than 4% on your money?  If the answer is yes to either of those questions, contact me and let’s look at your options.  While a good 2-4 unit property is largely preferable as a pure investment, buying a condo and living in it can save you money in the meantime.

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Interest Rates Falling

There’s a key time to buy when interest rates start to fall, but before sellers realize it.  That time is now.  Since the stock market has been falling, interest rates have dropped from 4.4% in January to about 4% now.

Normally in real estate, prices drop when interest rates rise because buyers can’t afford as much debt.  At 4% you can afford plenty of debt. Prices have leveled off from their peak late last year.  That means now is a great window to buy.

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As a buyer’s agent, it’s a beautiful thing when the bank’s appraisal comes in higher than the purchase price you negotiated. Appraisers are notoriously blind to rental income comps and gentrifying markets, so I make it my business to give appraisers as much information as they need to understand our purchase price.  I’ve never had an appraisal come in short and today I had one come in $25,000 above the purchase price.   In this business it’s important not to take anything for granted, and in the case of appraisals, you can’t trust that a bank will understand the value of real estate like you do.

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Real Estate Psychology

This topic deserves a book. A PhD candidate could write a dissertation about it.

All businesses have their psychological quirks, and I’ve been through a few industries to understand the spectrum.  In any business the bottom line is profit, but in some industries ego steps in the way more than in others.  I’m no longer surprised by how much pride is involved in real estate.

With single family homes, comparable properties are the main indicator of value. That said, unless you’re buying in a cookie-cutter development, no two comps are exactly alike. That’s when personal taste steps in, and that’s where I run to multifamily apartment buildings. With “units” as we call them, there are more numbers involved, which is why I add value in this area of real estate more than I do in SFRs. I’m a math guy. We have costs, CAP rates, GRMs, mortgages, FICO scores, rents, rental increases, gross profit, PITI, cash returns and overall returns.  I love it.  You figure out how much you can spend, decide what return you want on that cash, and we choose the smallest headache that can deliver that return.  Makes sense, right?

I recently removed contingencies on a property in Glendale. My buyer discovered through his physical inspections that the sewage stops up frequently and the electrical panels are out-dated. While every building has its own set of problems, this discovery represented a systems issue that might need major work. We asked for $10,000 off the price to help correct these long-deferred maintenance problems.

I only advise my buyers to ask for credits when there is substantial work needed to sustain a functioning apartment building.  There are always improvements one can make like bolting the foundation for earthquake preparedness or replacing the water heaters with new tankless ones, but those don’t constitute reasons for a price reduction in my book. I only ask for a price reduction if this problem needs to be fixed ASAP.

In response to our formal request, I got this email:

The seller is upset to receive the buyer’s request.  The seller feels that $10,000 is excessive since the buyer was aware that the property isn’t brand new.”

I can take a certain amount of hemming and hawing, but there was no formal counter offer attached to this email.  What is the point of this email between agents?  I am not your client’s therapist. You are responsible for your client’s feelings, as I am for mine.

Do you think I explained to the listing agent my thoughts on her psychological responsibility? No way. I played her psychological tennis match until we came to the inevitable conclusion: a $5,000 price reduction.

I sometimes perform a trick for certain clients where I predict exactly how a negotiation will go, and 90% of the time I’m right. Clients often ask why I suggest offering a certain amount on a property or discourage a particular price reduction. Half of my job is determining what kind of person is on the other end of the deal and where that person’s rationality and interest lies. If I’m working with a good agent who understands her client well, we work together to bypass the back and forth. It’s every agent’s responsibility to interpret his client’s emotional and financial needs into a legally sound real estate deal. That’s what I do for you, and that’s almost always what I do for the other party, as well.

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Closed Vendome at $1,060,000

Closed Vendome at $1,060,000

My broker is calling this the best deal in the history of Los Angeles real estate, but he likes to make grand statements.  The seller of 228 S. Vendome bought this property one year ago, using an FHA-backed loan ($30k down payment) for $636,000.  After spending about $50,000 in renovations and evicting the last remaining tenant, he was able to up the rent roll to $87,000 per year.  We listed the property at $997,000 and got five offers over asking.

For his first-ever property, the seller invested approximately $80,000 cash and ended up quadrupling his money in one year.

Now, please don’t think these deals are everywhere, because they’re not.  That said, something about my synergy with this client makes us work very well together.  He responds lightning-fast to texts, emails, phone calls and Docusigns, remains open to various neighborhoods, asks the right questions, and isn’t greedy.  He’s in escrow to buy another property right now in a 1031 exchange that might just clear him another $350,000 in profit if we play our cards right.

On the buying side, the buyers of 228 S. Vendome are getting a rare 6% cash return and 8% overall return after putting 40% down and investing another $40,000 in improvements.

Representing both the buying and selling side made the transaction incredibly smooth, as both the buyer and seller ended up extremely happy and even met after the sale to exchange keys with smiles on their faces.  A job well done all around.


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8% Return on Fourplex!

8% Return on Fourplex!

I have a new listing that you should definitely check out. It’s a turn-key fourplex in the red hot Silver Lake adjacent neighborhood – 3 minutes from Sunset Junction. Rents in this area keep going up, and there were multiple applicants for the last unit, which was rented at $1950/mo. The address is 228 S. Vendome St. – here are more photos and a map.

If you put 25% down with a 4.5% interest rate, you can make 8% return on your investment at asking price. That’s incredibly hard to find in this market in quality neighborhoods like this.

Each unit is 2br-1ba with separate gas and electric meters, which means low costs. Here are some features:

hardwood floor in 2 units
new carpet in 2 units
new paint
two new front doors
new appliances
new sprinkler system
some new fixtures
new blinds
new staircase
8 parking spaces
4 in-unit laundry hook-ups

Here’s how the numbers look:

List price 997,000
Units 4
Structure sq. ft. 3,480
Built 1917
Lot sq. ft. 4,807
% down 25.00%
Downpayment 249,250
Total monthly rent 7,250
Total monthly costs 1,678
Monthly net income 5,563
Interest Rate 4.5%
Monthly debt service 3,775
Monthly free cashflow 1,789
Cash-on-cash % return 8.25%

Please let me know if you have any questions!

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Need for Buying Speed

There’s one thing in common with all of the buyers who have gotten into contract with me: they were fully prepared to make an offer the day that the property came on the market.

What does “fully prepared” mean?  Simply, it means I have your pre-qualification letter (which you have gotten by qualifying through a lender) and your proof of funds (a screenshot of your bank statement), and you have your Docusign account set up so you can sign the offer I write for you.  Cash buyers clearly only need the latter two items prepared.

Many new buyers of Los Angeles income property naturally expect the process to be like buying a house: you go to the open house, maybe you have a private inspection, and if you still like it, you make an offer.  Investors think differently from that, and therefore you have to keep up with that mindset.

One major reason for the difference is that there are tenants living in the property.  If every interested person got to tour the property, tenants would have 40 people walking through their apartment.  We’re slightly more civil than that in real estate. Instead, once a buyer gets into contract, she can have her team of inspectors come through.  At least the seller knows that she is serious and not wasting the tenants’ and the listing agent’s time. It makes sense.

One reason why this works is because of your physical contingency period.  Typically, we do two inspections during this period, during which we can cancel the deal and get your full deposit back. And if there’s a serious problem with the property or with the numbers the listing agent gave us, we can ask for a price reduction or cancel.

Because of Adaptive Realty’s experience managing properties in the Los Angeles rental market, we do a very good job of estimating monthly expenses for each property I recommend to you, and based off of those numbers and the rents, we can make a fairly accurate estimate of your monthly profit. In investment property, that is one of your two bottom lines.

Your second bottom line comes from appreciation. While I can give my own predictions as to how properties in certain areas will appreciate, that will come from your own gut as much as mine.  That’s why driving by the property if you’re unfamiliar with the area can be a good idea.

I’ve written before that not all buyers are the same. So when I send listings to by clients, first I determine which clients are the right investors for the property. And if there’s more than one, you can be sure that the one who is ready to offer first will have the best shot at the property.

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A New One

I’m in a fun escrow on a fourplex right now.  My client is buying a property from a slumlord because that’s often where you find upside in turning a property around.  See Moses Kagan’s post on the topic for further explanation on that point.

I’m mostly being sarcastic by calling it fun, except when this slumlord’s listing agent, his ex-wife, today served us with a Demand to Close Escrow. Sounds intimidating, right? A DCE is a signed document that can come from the Buyer or the Seller to demand that the other party close escrow within three days, but not before the agreed upon escrow closing date in the purchase agreement.

I’ll explain more about this particular situation once escrow closes, but receiving this DCE today was a first in that I’ve never gotten a DCE the day after I served the Seller with our own DCE.  Essentially, this seller is demanding to close escrow on the same day we are.  Just a little tit for tat, I guess?  If you play the trump card, so can we?  I’m due to write a post on how real estate agenting is 80% psychology, and this is a prime example.  When you’re dealing with small business owners and not banks, logic doesn’t always factor in to the decision-making process.

If there’s a lesson here, it’s this: make sure your agent knows the purchase agreement inside and out, or you may end up feeling undue pressure to close escrow the same exact day you asked to close anyway.

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