All Forum Posts by: Jon Schwartz

Hi gang,

I'm reviewing some of my underwriting spreadsheets, and I'd love your opinion on this:

When you're projecting income and expenses into the future, how do you calculate the growth of capex? Do you base its growth on inflation or on rent growth?

For example, let's say you're underwriting capex at 15% of rental income, which is currently $100K/year. You're also underwriting rent appreciation at 4% per year and inflation at 2.5% per year.

(Let's not get into a disagreement over how reasonable these numbers are. This is just a hypothetical.)

In three years, rental income will have grown to $112,486. If you continue to calculate capex at 15% of rental income, then capex comes out to $16,872. However, if you increase capex at the inflation rate for three years, you come to $16,153.

In this example, it's not a huge difference, but what if you're projecting income and expenses 10 years into the future? What makes more sense? Tying capex to the rate of inflation or tying capex to rent appreciation? (And let's assume that rent is appreciating at a faster clip than inflation. Let's assume we're in Phoenix!)

Looking forward to your thoughts!

Best,

Jon

Yeah... I appreciate your thoroughness, though I think you're over-accounting as relates to our ADU scenario.

A 10% property management allowance? I mean, I understand the logic behind accounting for your own time, but that 10% will never actually accrue (as opposed to capex, which will). Plus, in LA, property management rates are between 4-6%, even for smaller portfolios.

Also, LLC cost? Who's going to open an LLC to collect income from an ADU in the backyard? You can argue that having an LLC for the ADU is important for liability protection, but that's a canard.

You're also neglecting that a lot of these costs *don't* increase with the addition of an ADU. Adding an ADU doesn't require more personal office space, doesn't incur more cost from my accountant, doesn't increase my landscaping costs.

So no, I haven't done a thorough capex worksheet, so I can't *prove* that a 40% expense ratio on a newly built/converted ADU is too high. But I do think you're being too conservative in your considerations as regards a newly built/converted ADU in LA.

Best,

Jon

Ian,

Three years is a pretty short timeframe to bank on appreciation or market rents catching up to the mortgage on a Socal property. What's your rent payment now? If you're in a comfortable situation with a low rental rate, I'd hold tight and save your money for Portland.

Are you handy? If you can find a slightly distressed condo to buy at a discount and improve, I think you'll be fine on a three-year timeframe. You can sell the condo on your way to Portland or probably rent it at a profit.

Renting out the second bedroom (ie, house hacking) will definitely help the numbers! Factor in principal paydown. If you buy and rent out a bedroom, how much out-of-pocket will you be each month? How much principal will you pay down? If you sell in three years with no appreication, how much equity in principal paydown will you recoup?

To put it another way, owning with a roommate might cost more per month now, but when you sell in three years, you might gain back more than you put it -- even without any appreciation gains.

Best,

Jon

Wow, that's a huge question.

By population, CA is about the size of WA, OR, NV, ID, UT, AZ, MT, WY, CO, and NM combined. We have 58 county governments and 482 municipal governments.

So first question: where in CA are you looking to invest?

Best,

Jon 

Dan, in Los Angeles, a 40% expense ratio on a newly built or newly converted ADU is insane.

In my neighborhood, a 400-sq-ft garage converted to a studio would easily rent for $1800/month. Underwriting $720/month for expenses is way, way off. Capex on the kitchen and water heater? Neither need to be replaced for a decade. What will it cost to replace them? Let's generously say $20K. That's $167/month in capex reserves -- and that's if you're holding the property in a decade.

ADUs are most needed, and most financially rewarding, in CA's high-density cities.

Love your posts, by the way!

Jon

I have contractors come during the inspection period.

After helping a number of clients with house hack reno projects, now I know what things cost in my area. Replacing electrical or plumbing is in the $6-8K range for a one-bedroom apartment. A full cosmetic facelift for the same apartment will run about $20K. I just know the ranges now.

If you're doing your first deal, I recommend you first take a few weeks to find the absolute best agent for your situation -- one who is involved in house hacking or flipping and can give you good ballpark estimates.

Then have contractors come in during the inspection period!

Best,

Jon

 I have a 3/2 apartment in my portfolio that rents for $4975, so my answer is "no."

Best,

Jon

Ane,

I think you left out the most important info:

- What's the square footage?

- How many bedrooms?

- In what city in CA?

Thanks!

Jon

@Stephanie Zheng, I definitely attended a few meetups at westside restaurant pre-pandemic.

I suggest going to meetup.com and searching for "Los Angeles real estate," "Santa Monica real estate," etc. I'm sure some groups are back to meeting in-person.

Best,

Jon

No, the fourth unit is its own residence (and should have its own address, even if it's the same street address and a specific unit number).

If it's a legal fourplex, each of the four units is a unique residence.