Selling Your Property

Selling Your Property

The common wisdom in real estate is never to sell.  However, there are several good reasons to sell your property in a bull market like today’s.  You just need to have a plan for your hundreds of thousands of dollars after the sale. Every situation is different, and you may have personal reasons why you need the money, but here are some good economic reasons to sell:

1) Neighborhood Hills and Valleys

Just like the economy, different neighborhoods in Los Angeles can peak in price. Neighborhoods become hot at different times, and if your property’s neighborhood is peaking in interest, it may be a good time to sell.  After all, you were smart enough to invest in this neighborhood before it was hot.  Why don’t you take advantage of the next up-and-coming neighborhood before it pops.  Selling your West Hollywood, Los Feliz or Silver Lake property at top dollar and buying low in Cypress Park or Boyle Heights will increase your equity faster, and more dramatically.

In other words, if the prices in West LA, Santa Monica, or Echo Park are ridiculous (they are), then you should sell to these ridiculous buyers, and then use that equity in a smarter investment.

2) Smart Equity

Neighborhood isn’t the only way in which you can improve the quality of your equity. Maybe you’ve built enough equity in your property that you’re cash-flowing okay, but there’s no cost-effective way to really improve your property.  You feel like it’s hit a dead end, maybe due to rent control, tenant issues, floorplan, neighbors, or you’re not even sure why.  There are buyers out there who will buy your property at a high price (developers, homeowners, foreigners), and you can move that equity into a property that fits your business model better.

3) Low Rents = No Cash Flow

Rent control is a problem for lots of property owners.  And while there are ways to improve your property under rent control, that takes lots of initial cash that you don’t have.  Selling your property with low rents to a buyer with more funds is a great option for getting yourself in a better position to cash flow.  Almost all of my clients buy properties where there is upside potential, and we select the right property for each client based on their ability to improve it.

4) Trading Up

The most aggressive real estate business people will continue to build equity rapidly by buying and flipping, buying and flipping.  To do this using a 1031 exchange, you have to wait 1 year between flips.  But I have had clients successfully sell one property and buy two, increasing the total value of their portfolio.

While selling your property is a big decision, it doesn’t hurt to test the market once in a while and list your property on the MLS to see where it stands.

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Improving and Repositioning Your Income Property

As a rental property owner, you have many options for how to treat your investment. The most aggressive investors will continue to buy and sell, but if you would rather stick to what you have, and you’re willing to spend some cash, improving the property you own is incredibly smart.

Why improve my property?

In Los Angeles, rent control is a fundamental part of the real estate business. In brief, rent control means that a tenant can stay in his apartment forever, as long as he pays rent on time and doesn’t break the law on the premises. In turn, you’re allowed to raise the rent 3% per year.

However, raising the rent 3% per year doesn’t come close to the rate at which market rents increase. For example, an average 1-bedroom in Echo Park has raised in value from $1100 to $1600/month in the last three years. If a lucky tenant moved in three years ago, his landlord would only be making $1,202 on that unit today by increasing rent 3% per year.

How do you beat this scenario? You need cash.

(How do I get cash if I don’t have it? Refinance, sell and buy a new property, or sell other assets.)

Before I explain how to beat rent control, I need to show you how much value you gain by doing it.

Take scenario Echo Park.  In your fourplex, you earn the following rents on two 2-bed / 1-bath units & two 1-bed / 1-bath units:

2/1 = $1775
2/1 = $1182
1/1 = $1098
1/1 = $1595

The current value of your Echo Park fourplex with these rents is approximately $1,015,000 at about 15 GRM (gross rent multiple, or 15 X yearly gross rent). If you absolutely maximized the value of this property, you could raise the value to $1,475,000. (A maximized income property in Echo Park can sell for up to 14 GRM.)

While this scenario leaves lots of room for improvement, let’s focus on the biggest problems: the 2/1 at $1182 and the 1/1 at $1098.

You need to increase the rent, and to do that, you need new tenants. The current tenants don’t want to leave, so the only way to change their mind legally is by offering them cash. There is no standard rule for this, but I know lots of owners who have negotiated with their tenants to move out for a lump sum. When you calculate your property’s value based on GRM,  you can quickly determine what value you’re adding to the property by raising the rent, and therefore figure out a reasonable offer to your tenants. You need a Voluntary Vacancy Agreement from a lawyer to do this the right way.

Once your tenants move out, you need to know how to improve the unit. This means hiring a contractor. Sometimes you just need to clean, but more likely you’ll want to modernize the bathrooms, floors, fixtures and appliances in order to fully maximize rents (you don’t want another tenant moving in below market). That’s what I did on my property in Boyle Heights and I exceeded my expectations in new monthly rent, breaking records for the neighborhood.

So let’s work the numbers here:

You paid the tenants of the two most problematic units $10k each to vacate (this number varies). You paid $60k each to renovate the units, and $20k to improve the exterior and some deferred sewage issues.  You’re all in for $160,000 and you increased rents to $2,595 and $1,795. So how much did you increase your property value? Approximately $350,000 (at 14GRM).

You paid $160,000 for $350,000 in value.

If this seems overwhelming, please feel free to tap into my experience at david@adaptiverealty.com or 310-801-000.

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Owning Income Property in Los Angeles

Speaking from experience, owning rental property in Los Angeles can be a lot of work. It can also be relatively hassle-free if you have a building with good plumbing, electric, sewer, and tenant relations. If you’re not working in real estate full-time, it’s likely that you go through periods where you want to devote time to improving your property, times you don’t even want to think about it, and times you ponder just how much you could get for it on the open market.

Here are four different strategies for what to do with your property once you own it:

1) Reposition Your Property. Depending on how much cash you have available, repositioning your income property is usually your best option, especially if you bought your property more than four years ago. To do this, you need an aggressive business mindset, and cash. If your property is suffering under rent control, there are strategies to doubling your rental income in some cases, and increasing the value of your property by hundreds of thousands of dollars.  I’ve done it and my clients have done it with my consultation.

2) Sell Your Property. This concept is not new to you, but in a true Seller’s market like this, selling your property in an established or hot area means you can reinvest that equity into a developing area, where you can get a much better deal. Selling and buying (usually in a 1031 exchange) is a great way to increase your overall equity faster than if you were simply to wait for your property to appreciate.

3) Sit on Your Property. In Los Angeles, income properties appreciate. Because of zoning laws, rental supply will never keep up with increasing demand no matter how many ugly mixed users are built on major intersections. You’ve done a good thing buying property and it’s unlikely its value will decrease, barring an economic collapse. So if you’re too busy to think about it, sit on your property, increase rents 3% per year, and let the value appreciate as your neighborhood continues to gentrify.

4) Refinance and Improve/Buy. If you’re unfamiliar with leverage, you may be enjoying watching your equity build in your property, and counting the days until you don’t have a mortgage. However, this could be a huge financial blunder. If you have significant equity in your property (50% or more), you could borrow on your property at close to 4%, and make much more than that reinvesting it into more property, or improving the one you have. The numbers don’t lie.

Over the next week, I’ll be going over these strategies one-by-one. Please feel free to contact me at david@adaptiverealty.com or 310-801-0000 if you have any questions, or if you want specific advice on your property.

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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-bridgeEvery investor wishes she 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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Appraisals

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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