Income Property Los Angeles

Category: Essentials

  • Making an Offer & What that Means

    Many buyers think that making an offer means you’ve bought a property. In fact, buyers are heavily protected through many steps of the process before you’ve actually exchanged money for title. For nervous buyers, this can help. Let me explain the steps:

    1. Negotiations: You likely won’t get your offer accepted in a seller’s market. When you’re reaching for a good deal, it’s likely that the seller, in a seller’s market, will come back with new terms. When the seller makes a counter offer, your offer is immediately void until you accept or offer new terms.
    2. Earnest Money Deposit (Days 1-3): Once your offer is accepted, you have three days to send in your earnest money deposit (EMD – usually 3% of the purchase price). Before the EMD is sent, it’s very easy to cancel if you have to. At this point, the seller likely hasn’t changed the property status on the MLS, so they will still solicit other offers. Once you send in the EMD, you settle into the escrow/investigation process.
    3. Physical Contingency (Days 1-17): Depending on negotiations, you have up to 17 days (in some cases) to investigate the physical state of the property. During this time, you can cancel if you don’t like anything about the property, and receive your EMD back. (Out of the 50 or so escrows I’ve brokered, only one company charged a $200 cancelation fee. That is not normal.) During this period, the seller delivers disclosures about the property and we receive the preliminary title report.
    4. Loan Contingency (Days 1-21): Depending on negotiations, you have up to 21 days (in some cases) to get approval on your loan. Given the massive amount of loans being processed in Southern California, this process usually takes 21 days or longer unless you have worked with a direct lender to get approved already. Often, the best we do is get a confident nod from the loan officer to go ahead and remove the loan contingency.
    5. Appraisal Contingency (Days 1-21): Depending on negotiations, you have up to 21 days (in some cases) to get an appraisal on the property for the price that you offered. If the appraisal comes up short, you can invoke the appraisal to cancel the deal.
    6. Removing Contingencies (Day 21): Once you’ve removed all of your contingencies, your EMD is promised to the seller. That said, if you can prove negligence on the seller’s part, an arbitrator may not grant the seller your EMD. During this time, you work with your loan officer for final approval. You still have not paid your down payment, and that is still protected, in most cases.
    7. Funding (Day 30): Once your loan is approved, you sign loan docs, and you transfer your down payment, you can still shout STOP and the escrow company cannot move forward with the deal. If the other party doesn’t agree to cancel and refund your money, you will likely go to arbitration to settle claims.

    In conclusion, it is preferred to be confident in your offer. But if you’re nervous as a buyer, rest assured that signing your first offer doesn’t necessarily mean you’ve made your most important real estate decision. Usually, that comes when you remove contingencies.

  • Real Estate Loans

    Once in a while, I like to touch on the basics. But if this is obvious stuff, skip to the next post. Here are the questions I’ll be answering:

    1. What is a real estate loan?
    2. What loan programs are available today?
    3. How do I qualify?
    4. What are the hidden costs and benefits of a loan?

    1. What is a real estate loan?

    A real estate loan allows you to buy a property whose purchase price (or, value) is a lot more than you have in cash. Banks and mortgage companies will lend you large sums of money so that they earn loan origination fees, plus fees for selling your mortgage to a third party, who then collects interest on your loan.

    2. What loan programs are available today (as of 4/21/2016)?

    For a single family home as your primary residence, you can put anywhere between 3.5% to 25% cash down, or more. If you put down less than 10% of the purchase price, you will likely have to pay hefty mortgage insurance up to 1.75% of the total loan up front, plus 1% annually. These loans are usually 30-year fixed loan (your interest rate doesn’t change for the life of the loan) and government regulated.

    For a duplex the same rules apply, except you’ll pay mortgage insurance if you put down less than 20%.

    For 3-4 units as your primary residence, the same rules apply, except you’ll pay mortgage insurance if you put down less than 25%.

    If any of the above are investment properties only and not primary residences, you have to put down 25% minimum.

    For any residential income properties with 5 or more units, you must likely put down around 50% in order to qualify for a loan, based on today’s market. For five or more units you must get a “commercial loan” which is based on the gross annual rental income, and therefore varies by how much your property currently cash flows. These loans are usually amortized over 30 years, but the interest rate is fixed for a shorter time period (usually around 7 years).

    3. For 1-4 units, you qualify partially based on the rent, but mostly based on your average annual income over the past two years (the rent counts toward your income). Banks use a standard formula to determine if your annual income is enough to secure the loan, despite these loans usually being non-recourse.

    By contrast, for 5 or more units, your personal income is not a factor because the loan is based on gross annual rent from the subject property. This makes these properties better for investors who can’t show regular income on their tax returns.

    4. The hidden cost of your loan is obvious: all the interest and mortgage insurance you pay during the life of your loan adds up.

    The hidden benefit of your loan is twofold: if your rental income is covering your mortgage and expenses, that 75% LTV (loan to value) that the bank gave you is turning into money in your pocket over the course of the loan. In other words, if your interest rate is less than the your annual return on your loan, you are making money off the loan.

    Make sense? If not, feel free to ask any questions you may have at: davidlbrundige@gmail.com

  • 1031 Exchange Strategy

    I’ve had some very active buyers and sellers lately and it feels like everyone is in a 1031 exchange. This is a very important tax strategy in real estate, and it’s important that you know how to operate with precision when trying to execute a 1031. First I’ll explain what it is, and if you don’t need a refresher, go ahead and skip to the Strategy.

    What is a 1031 Exchange?

    Simply put, a 1031 Exchange is when you sell an income property, buy a new income property to replace it, and skip paying taxes on your sale.

    What are the rules?

    1. They have to be income properties – essentially that means that neither property can be your primary residence. I’ve heard of some people doing some tricks like putting title in an LLC and paying themselves rent, but I’m not a lawyer and that is certainly not advice.
    2. You have to name 3 options for your replacement properties (or “uplegs”) within 45 days of your sale property (or “downleg”) closing escrow.
    3. You have to complete the purchase of your upleg(s) within 180 days of the sale of your downleg.
    4. Both the equity (cash down) in your upleg(s) and the total value (purchase price) has to be equal or greater than that of your downleg(s).
    5. All has to be accomplished within the same taxable year and to the same person(s) on title.
    6. You have to own the property for one year before selling.

    These are the most common and basic rules. There are more if you strive to be more creative.

    The Strategy

    By skipping capital gains tax, you could save hundreds of thousands of dollars. But why sell in the first place if you’re just going to buy something else?

    I’ve written about this before, but the fastest way to substantially grow your wealth through real estate is by buying and selling again and again. I’ve been a party to this and I think my clients in question would admit that I masterminded this growth for them. (And yes, when writing a blog your humility sometimes falls by the wayside.) Staying ahead of gentrifying neighborhoods, good deals and unnoticed potential is key to unlocking a property’s value that you can cash in one year later (1031 Rule #6).

    Why sell that unlocked value rather than hoard it? Once you have unlocked a property’s value, you have maxed it out. And unless you have unlimited capital, you can’t simply buy more and more properties; you have to use that unlocked value to unlock even more value, and so on.

    That’s the abstract. Here’s an example:

    Property A, a fourplex, is selling for $780,000 in an up-and-coming neighborhood.

    After closing the deal with 25% down, you fix up a vacant unit and rent it for $700/month more than the seller predicted. Another tenant moves out, and you do the same. Not only did you raise two rents in the property, but those rents are so high that you proved what the other units can get. You may or may not have the cash to renovate the other units, but who cares. You’ve implied the value in the property that no one saw before; you’ve unlocked it. Now your property is worth $1,050,000 (if  your agent knows how to present that unlocked value as current value).

    You spent $50,000 to fix it up, and $220,000 on the down payment. After a year, the mortgage pay down is near negligible. But you doubled your equity to $540,000 on a $1.05M value. The bank not only won’t value your property like a buyer will, but it also won’t let you cash out enough to do it again. So you sell to a smart, more fluid, and less hands-on buyer and do it twice more with the newest gentrifying neighborhood / great deal / unnoticed potential.

    If that sounded tricky, buying Properties B and C is where things can get sticky.

    Because you only have 45 days to name your next properties, being sharp and aggressive during this process is absolutely essential. You make strong bids, drive by dozens of properties, and always see the forest rather than the trees.

    When I have a client in a 1031 exchange, that client usually gets my ideas in their inbox first because (a) the 1031 time sensitivity and (b) they reward me with selling their property, as well as their responsiveness and aggressiveness in getting the next amazing deal.

    Do you want to make one of these deals happen? I’ll tell you how you can unlock the value in your property to get top price, and guide you towards doing it again.

     

    IMPORTANT DISCLAIMER: I am a licensed real estate agent, not a CPA nor a tax attorney, and nowhere on this website am I offering you tax advice.

     

  • 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.

  • 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.

  • 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.

  • Property Value & Interest Rates

    When is a good time to sell?

    Interest rates are starting to climb from 2014 when they were the lowest they’ve been in 30 years. Yes, 30 years. With rates starting to climb, the value of your property may drop 7% or more. In real estate economics 101, it works like this:

    1) I, an investor, buy your $1M property today with a 4% interest rate.

    $1,000,000 price
    $350,000 or 35% down
    $3,100/month principal and interest
    $15,000/year net or 4% return.

    I find this acceptable.

    2) What happens next year with a 5% interest rate?

    $1,000,000 price
    $350,000 or 35% down
    $3,475/month principal and interest
    $10,416/year net or 2.78% return.

    I think I’ll invest elsewhere.

    So, your property value drops.

    3) Instead, a 5% interest rate dictates a $930,000 value.

    $930,000 price
    $325,500 or 35% down
    $3,232/month principal and interest
    $14,220/year net or 4% return.

    At this price, it’s worth it.

    However, there are exceptions!

    While it’s hard to find a neighborhood in Los Angeles that isn’t considered “hot” by someone, there are certain areas where patience will help build value in your property. Email me for a free, thoughtful valuation of your property.

    If you’re a buyer, what does this mean? If you’re buying with all cash, WAIT! When interest rates rise inevitably, you’ll have the funds to get those great deals. If you want to use a loan, however, take advantage of great interest rates NOW. This low interest rate level may not happen again in your working lifetime. Just make sure you work with a buyer’s agent who knows how to spot a good deal so you don’t overpay (hint: me).

  • What Type of Investor Am I?

    Every week I see properties land on the market that could work for the right investor.  Not all investors are created equally just like not all deals are created equally.  I’m going to list the types of investors so that you can identify yourself, and please let me know at: david@adaptiverealty.com

    1. Cash-heavy, ready to renovate.

    This investor has between $600K-$3M ready to invest in a property that needs work. We buy an undervalued property, you buy out the tenants, and renovate it to appeal to top renters. This investor should expect at least 8% yearly return on his money.

    2. Cash-heavy, hands off.

    Not everyone wants to get their hands dirty and make a renovation project their part-time job. But if you have cash —  between $800k-$3M — you can still get a decent deal by making a strong cash offer. This investor can likely expect 6-7% on his cash in today’s market.

    3. Cash-medium, some improvements.

    This investor has $300k-$600k cash. You want to be proactive, but you’ll have to pick your deals carefully. You may not buy out all the tenants, or you may consider purchasing a property that is mostly vacant. You can’t do a complete renovation, but you’ll add hardwood floors, update the appliances, and take over for a lazier landlord. You can expect 7-8% on your money if you seize the right opportunity.

    4. Cash-medium, hands off.

    This investor is looking for a long-term investment. You want a property that will cash flow now, but you’re more interested in the appreciation and equity building in your property. You can expect 3-5% cash return now, but it’s more about the value in 5-10 years.

    5. Cash-poor, you better be hands on.

    If you have between $35K and $250K, you can go for long-term or short-term investments, but you’ll have to get involved. Whether you live on your property or you’re fixing it up to livable condition, you’ll want to be proactive in protecting your investment.

    Please let me know which type of investor you are so I can send you the right deals for you. And if you don’t fit any of these descriptions, please let me know that, as well.

     

     

  • Section 8 and Los Angeles Rent Control

    section 8 and rent control

    Many clients ask me if they can evict Section 8 tenants. Are they different from normal tenants under rent control law?  Yes and no; let me explain.

    First, what’s a Section 8 tenant? “Section 8” is the common name for the Housing Choice Voucher program, funded by the U.S. Department of Housing and Urban Development. Basically, it provides substantial rental assistance for some low-income tenants. The craziest contract I’ve personally seen was a tenant paying $4 / month for a $1,040 unit.

    When it comes to eviction, you have to separate the Section 8 contract from the Section 8 tenant.  You can cancel the Section 8 contract with 90 days notice, but the Section 8 tenant has the same rent control rights that anyone else does – and even more.  DO NOT cancel the Section 8 contract.  Once you do, the tenant is now only responsible to pay you the smaller portion of the rent that he was paying.

    That said, Section 8 benefits you in one way. If you pay the tenant to relocate, that tenant can be assured that the amount of rent that he pays remains the same when he moves into a new, Section 8-approved unit. His Section 8 status moves with him. The tenant pays the same amount for the new place and the government pays the price hike.

    The bottom line is that out of all the tenants you’ll want to relocate, Section 8 tenants have the most incentive to do it peacefully. They won’t pay more for a new place; they’ll simply get a hefty chunk of cash to deal with the annoying hassle of moving.

  • Would I live here?

    One question a real estate investor inevitably asks herself is: “Would I live here?”

    There’s a pitfall in this question. Unless you’re a FHA buyer or you’re after a duplex, chances are that you’re not going to live where you invest. So before you ask yourself whether you would live there, ask yourself if you are your ideal renter.

    How do you know?

    The basic way neighborhoods turn from low rent to high rent is the following 4-step process:

    1) there’s something interesting about a poor neighborhood,
    2) under-employed artists & hipsters move in,
    3) employed artists & hipsters move in,
    4) youngish executives and entrepreneurs move in.

    Which one of these are you? I’m guessing you’re either category 3 or 4, or the fifth category – you’re established elsewhere.

    So which stage of the process do I invest in? Ideally, stage 1. However, that’s the riskiest and you need a strong imagination. Stage 1 areas include Boyle Heights, Lincoln Heights, most of Highland Park, San Fernando Valley, and Westlake. You’re in these investments for the long haul and you’ll need a good management company.

    It’s easier to invest in stage 2 neighborhoods because there are already tangible signs of gentrification. These include the best areas of Highland Park, Glassell Park, Mid-City, Virgil Village, and USC. You won’t get top rents now for these units, but give it five years. Here you’ll find cash-flowing properties with good upside.

    Stage 3 neighborhoods include Echo Park, East Hollywood, and Atwater Village.  You’ll overpay in these neighborhoods because everyone wants them.  That is, unless you know how to buy out tenants and renovate.  You missed the boat by about two years on good turnkey deals, unless you’re spending north of $1.5M on 8+ unit properties.

    Stage 4 neighborhoods are Silver Lake, West Hollywood, Hollywood and Downtown.  These areas have been established for a while and the only good investments you’ll find are $1.8M or more, with cash to develop.

    So rather than asking yourself where you would live, ask yourself what kind of renter you want, and how long you can wait for her. The longer you can wait, the more upside you’ll find.