Zoning
One thing to consider when deciding on your best and final offer for a property is the zoning. If you’re buying a duplex on a 8,000 sq ft lot, the zoning makes a huge difference in terms of the property value. If it’s R2, the duplex is all you’ll get, so there’s not much hidden value beyond the obvious: rents, appreciation, future market rents. If the zoning is R3, a developer can build one unit for every 800 sq ft of lot space. So in this case, that’s 10 units.
There are other restrictions involved. Here are some basics:
– Max height = 45ft.
– Setbacks = 15ft. front and back. 10% of width on the sides.
– 1 parking space per 1-bedroom apartment; 1.5 parking spaces per 2-bedroom apartment
For more details, see the L.A. City Zoning Appendix.
Our sample lot here is 160 feet by 50 feet.
One parking space is 10 feet by 20 feet.
Unless our developer is building 3 stories or an underground parking garage, we can only truly fit 8 1-bedroom apartments here because of the parking requirement and driveway.
So a reasonable estimate for the value of this new property will be:
8 units X $1,600 monthly rent ($19,200 yearly) = $153,600
11 X GRM = $1.69 million
If a developer buys the duplex for $400,000, builds for $840,000, that’s a $460,000 profit.
So if you’re bidding $360,000 (12x GRM) on a duplex with a rent roll of $30,000 / year, remember what the developer paying all cash stands to make. The good news is, that developer might be there again when you sell.
Read MoreListing Agents & FHA
I’ve stopped asking agents if they’ll accept FHA loans. I had done that previously so my clients don’t waste time driving to a property they have no chance of buying. (FHA loans are sometimes less desirable because there are a few more steps to closing the deal.) While normally I give agents credit for knowing the difference, last week I actually startled a young agent with the question.
“Yeah, why not. We’ll take whatever the highest offer is.”
This is my kind of agent, I thought. I told my client that we had a good chance to get this place. She went to see it.
Two days later, we came in at the highest offer. The listing agent told me so (are we sensing something amiss?), and that the seller would accept our offer that afternoon.
Several hours of no phone calls later, I get a text saying they’ve countered a lower offer that has a higher down payment.
What could have happened between the morning and late afternoon? Did this agent Google “FHA loans” and get scared? I texted back that this property would surely assess (it had in city records already and had the rent roll to boot), but the agent didn’t want to go back to the seller and look silly.
The truth is, agents should favor FHA loans when they are higher offers, especially if the property will most likely assess. Some agents want cash only if it’s a short sale or the building’s decrepit and they don’t want assessors near the place. But this listing agent’s first instinct was actually the right one.
Now I refer to my client as “my FHA buyer” once to see if there’s a reaction, and if not, we don’t mention it again until the purchase agreement.
Read MoreFHA Loans + & –
The FHA gives hope to many future homeowners who are short on cash.
What is it?
The FHA is a government organization that insures loans. It doesn’t give loans; it insures them. This makes FHA-backed loans very safe for banks because the FHA assumes the risk. But since it acts like an insurance company, you pay a premium and the FHA might not want to insure your loan if they don’t think the property is worth what you’re paying.
Pros:
– You can put down as little as 3.5% of the purchase price.
– You can go through a normal (FHA-approved) lender.
– You have certain move-in rights as an owner-occupier, and can sometimes relocate low-paying tenants and therefore raise the value of your property.
– You get good interest rates.
Cons:
– You technically have to live there for two years.
– If no unit is vacant, you have to pay the tenants to move out (between $8,000-$20,000).
– Because the FHA appraiser is strict, there’s a chance your deal might not go through. This means many sellers will overlook your offer in favor of an all-cash or conventional loan offer. And that means your pickings are slim in Los Angeles.
– You pay an insurance premium:
– You pay a 1.25% upfront premium (UFMIP). Luckily, this can be added to your loan amount.
– Additionally, you pay 1.25% of the total loan per year as a recurring premium.
– You pay 0.25% extra if the loan amount is above $625,500.
– Thankfully, you stop paying the premium when your loan-to-value ratio lowers to 78% (and you’ve already been paying for 60 months).
So yes, there is hope. But you have to know what you’re up against. Let me know if you’re in this market because this is what I specialize in.
Read MoreComps
One thing I often do when a client wants to buy a particular property is offer a list of comparables. I’ll list all the properties that are active, in contract, and that have been sold in the last year in the same area, including relevant details.
Comps show the price per square foot that properties are listed, and at what price they’ve sold. This way we know how low we can reasonably offer (in a seller’s market there are often counter offers).
While price per square foot can indicate upside value, rents will tell you immediate value. In real estate we ask: what’s the GRM? The GRM (gross rent multiplier) is the fastest way to determine an apartment building’s immediate value – divide the price by its yearly rents. The lower the GRM, the better the cash flow.
Comps tell you a story of a neighborhood, but they don’t tell you the whole story. Market activity can shift within months – inventory can dry up, more buyers enter the market – and what you could buy 8 months ago isn’t always what you can buy today. That said, it’s good to use as many tools as you can when making an investment, and comparables just make you wiser.
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