Growing Real Estate Equity
There are two goals for investing in real estate: 1) Growing your equity and therefore your wealth, and 2) creating a relatively steady and passive income stream to help with your bills.
Quick: what is equity? Equity is cash in the form of real estate. If you put 25% cash down on a $1M property then you have $250,000 in equity on the million-dollar property. Then, that amount changes with the value of your property and as you pay off your loan.
When you purchase income property, you may be fortunate enough to have the option to obtain financing or pay all cash. If your rental income covers your expenses, including mortgage, you love that the %$ you borrowed is turning into equity as your tenants pay off your loan over time. If you pay all cash, you enjoy a higher cash yield because you don’t have the extra expense of a mortgage.
Now, the big question: how do I grow my equity the fastest?
I can speak with some authority on this because not only have I doubled my own equity in one year by being an active real estate investor, but I have also helped my clients do the same – in one case growing my client’s equity more than 10X in under three years (this is rare).
Contrary to what some say, if you have a limited budget you have to sell to grow your equity quickly. Unless you are attracting investors or you have unlimited funds, you cannot hold onto all of your properties forever. In order to fully maximize the opportunity in a property, you have to be well capitalized. Not everyone is. And that’s why you sell.
If you bought aggressively, you probably took advantage of an uninformed seller and listing agent, or you bet on a neighborhood that is still up and coming, or both. This automatically puts you in a position to increase your equity by 1) selling with a good listing agent and/or 2) selling when the neighborhood popularizes. (Unfortunately, lenders don’t love to give you loads of cash when you refinance, so that’s not a viable option in the short term.)
Once you sell, a 1031 exchange allows you to trade up without paying taxes, as long as you follow certain protocol. Now it’s time for you to do the same thing you just did, only on a larger scale. Either your new equity will help you a) buy a more valuable building or b) buy two. Now you repeat your previous strategy, but this time in a new up-and-coming neighborhood or from a different uninformed seller.
Wash and repeat. Does it sound simple? Unfortunately it’s not. Because you really have to understand (1) rent control (2) neighborhood specifics (3) deal making and (4) 1031 exchanges, it means you have to be extremely aggressive during the sell/buy period and operate with finesse.
If you have $350,000 or more to invest and you want to actively build your equity/wealth, please get in touch.
Read MoreSelling 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.
Read MoreImproving 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.
Read MoreOwning 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.
Read MoreThe Arts District is Gone
Every 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…
Read MoreBuy 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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