All Forum Posts by: Jon Schwartz

Originally posted by @Corey M.:

Originally posted by @Jon Schwartz:

Originally posted by @Angeli Castrence:

@Jon Schwartz

Yes, I’m interested in the Carmelina property. What do you think about tenants not paying rent due to the pandemic?

They have already started construction in that corner. There’s also a low-income apartment building being constructed in Bundy and Nebraska, where the animal shelter used to be. You’re right, plenty of development in this area.

 Angeli,

Tenant non-payment is definitely an issue because the eviction moratorium is in place until Jan 31, 2021. So a few things are important when pursuing a property now:

Firslty, you want to get the last six month's payment history for the property, and then you want to verify it with bank documents. If the tenants have been paying this entire time, they're unlikely to suddenly stop because there's a new owner. Tenant who have continued to pay rent have maintained they jobs or care too much about their credit to take advantage of the situation or both.

Secondly, you want to go into the deal with additional reserves. If you househacked this property and moved into the lowest-rent unit, you'd be collecting about $6000/month from the other units. You might want to have 6 months, or $36K, in reserves to cover any unpaid rent that might occur. If all tenants have been paying rent, you might only need 3-4 months reserves. Having reserves insulates you against the risk of non-payment.

I've made a spreadsheet that I called "The Househacker Calculator." Enter the basic info, and the spreadsheet auto-populates the rest with a pro forma and a longterm projection. Here's what the results for this property look like:

Given the price and current rents, I think this is a really good candidate for a househack!

Best,

Jon

I also live in LA, and I have some questions about this deal. That insurance percentage you're using seems significantly undervalued. I pay $1600 yr for house+EQ insurance. If there are four units ($6400), it'll be more than $500/mo. Not sure how a fourplex works, but does the owner need to carry insurance on every unit plus a master policy? That would be even more expensive. 

Why would property management be only 5% once she moves out? 10% is the going rate. 

Are there HOA fees in a fourplex?

I have been looking for LA investments, but almost none of them make sense from a cash flow perspective. It's a pretty expensive endeavor to put 300k down for a fourplex. And then each reno would probably cost 40-60k to make them nice. How does that get factored in? 

Corey,

Happy to answer your questions!

First, insurance:

Insurance is toughest to estimate because it's such a case-by-case cost. When I'm deeper into underwriting, I actually run a quote through my provider, who has a website that allows clients to run their own quotes. It takes about 15 minutes, but it generates the actual number.

Insurance is based on rebuild cost. This is a 2-story, 2690-sq-ft building with, I imagine, somewhat outdated and average finishes. I'd guesstimate the rebuild cost at $800K or $900K. I own a 2-story, 3200-sq-ft duplex with a rebuild cost of $1.1M, and my insurance bill on it is $2345/year. I have all of my buildings and cars insured by the same company, so that bundling provides some discounts, but you'll enjoy similar discounts even if you only have 1 building and 1 car. Anyway, I'm paying $195/month for my building; I'm sure this building will cost less than $250/month.

Earthquake insurance isn't included in this calculator because it isn't required. Standard insurance is; you won't get a loan without buying it. Earthquake insurance is up to you. That said, the earthquake insurance on my aforementioned duplex is $3329/year. It would probably be about $3000/year for this property, so you'd need to add $250/month to the expenses if you want to account for earthquake insurance.

Fourplexes, triplexes, duplexes, and single-family homes are all residential property, so they're all insured similarly. You don't have master and individual policies. You buy a standard policy for the building, and it protects against fire and the other standard risks.

Where are you getting 10% as the going rate for property management? Just to give a few quotes: Real Property Management charges 6%; Los Angeles Property Management Group charges 6% for 9 or fewer units, 5% for 10-99 units, and 4% for 100+ units; TGN Property Management charges 4%; and Action Management charges 6%. If I bought this fourplex, I'd utilize a service like www.hemlane.com, which charges a very low fee to act as your call center. Hemlane would charge $148/month to take all the tenant calls, collect rent, and otherwise operate as your slimmed-down property management service.

There are no HOA fees when you own a multifamily property. HOA stands for "home owners association." When multiple individuals own homes that are connected or share services and spaces (ie, condos, townhomes, and developments that share amenities), an association needs to be formed to manage the shared resources. This association is called the HOA, and the HOA dues pay for the maintenance of the shared resources. If you buy a fourplex, you are the only owner. There is no HOA because there is only one owner.

Corey, clearing up these misconceptions will definitely help you more accurately calculate the cashflow on a property.

$300K is a lot of money, no question. LA is an expensive market to enter.

$40-60K per unit for reno is a good rough estimate. Here's what you're not considering: when you buy a building, it'll come with tenants (most of the time). Unless you're moving into a unit, you can't just evict those tenants and renovate their units. Therefore, it's important to find a property that cashflows, even if just a tiny bit, with the current tenants.

So two years down the road, a tenant moves out, and now you have to do your $50K renovation to get the unit up to market standards. This means you can now charge market rent! If a unit needs a $50K facelift to get to market rent, that means it was mostly likely renting for well under market rent to begin with. In the above example, the most expensive unit was renting for $2088 when it should be at $2925. That's an $837 difference! Annually, that's $10,044. If I asked you to make a $50K investment that would pay you back $10,044/year, would you do it? Of course you would! That's a 20% cash-on-cash.

But Corey, there's more! LA has notoriously low cap rates. I'm not 100% certain, but I'd guest the prevailing cap rate for the above property is below 5%. Let's say it's a 5% cap rate. $10,000 of additional NOI at a 5% cap rate increases the value of the building by $200,000. So not only are you getting a 20% cash-on-cash on your reno cost, but you've created $200K of equity. It's gobsmacking, and it's why LA is such an amazing market.

Do these concepts make sense to you? If not, I'm happy to discuss further.

Best,

Jon

Darius, I agree with this, though I'm still freaked out by Prop 21. Vacancy control seems like a really blunt cudgel. Rent control with vacancy decontrol actually makes CA is a really interesting investment market in my mind. But once rents are indefinitely tied down, oof...

My new questions are:

What if an investor buys a building with a vacant unit? Is the new owner entitled to start from scratch at market rent, or must the new owner find the last tenant's rent amount and base the new rent on that?

And what about househackers? If a househacker relocates a tenant to occupy a unit, then moves out some years later, can he/she charge market rent for the new listing because his/her rent on the unit was $0? Or must he/she base the new rent on the relocated tenant's rent from some years ago?

Will these questions ultimately be settled in the courts?

Thanks!

Jon

Because of ballot propositions??? 

Nic, you might want to read the text. This is a ballot proposition that WILL BE on the ballot on November 3. You've voted in CA before, yes? It's not law now, but if approved by a majority of voters, it will be.

Here's some more information for you:

https://ballotpedia.org/California_Proposition_21,_Local_Rent_Control_Initiative_(2020)

Ballotpedia has a pretty good summation of the vacancy control clause in CA Prop 21, which will be on our ballot in November:

• Allows rent increases in rent-controlled properties of up to 15 percent over three years at start of new tenancy (above any increase allowed by local ordinance).

The actual text of the proposition reads as follows:

• In any jurisdiction that controls by charter provision, ordinance, or regulation the initial rental rate of a dwelling unit, if the previous tenant has voluntarily vacated, abandoned, or been evicted pursuant to paragraph (2) of Section 1161 of Code of Civil Procedure, the owner of the dwelling or unit shall be permitted to establish the initial rental rate for the vacant or abandoned dwelling or unit provided that the initial rate established pursuant to this subdivision, in combination with any increases in the rental rate during the subsequent three year period, is no greater than 15 percent more than the rental rate in effect for the immediately preceding tenancy. Any increase in the initial rental rate permitted by and established pursuant to this subdivision may be in addition to any increases in rental rates otherwise authorized pursuant to local law.

Source for both here.

Here's what that says to me:

If a unit goes vacant, the new tenant can be charged only 15% more than the previous tenant, not including local rent-control increases. It sounds like this 15% increase can be stretched out over three years, but why would a landlord do that? I'd rather raise the rent fully upfront so that I don't attract an unqualified tenant.

Do you read this text the same way? If so, I'm worried. This vacancy control really puts a damper on a lot of CA investing strategies.

For starters, if a building has hugely under-market rents, there's very little upside to renovating the building. If a triplex has three tired one-bedrooms that rent for $1000 when they should be at $2000, and this prop passes, new tenants can't be charged more than $1115. No landlord is going to renovate the old units if new ones will only generate $115/month extra. I mean, CA will just go stagnant, right?

But what about units that are currently at market? Let's math this out....

Let's say a tenant moves into an LA one-bedroom at today's market rent of $2000/month. Let's say that tenant stays for 7 years, the LA County average tenancy length, and rents appreciate at 5.7% annually, the LA average from 2010 to 2019 (source here). Furthermore, let's say that LA RSO allows a 3.5% rent increase every year (I'm just averaging 3% and 4%, which is what each year has been for the past several years).

In seven years, when there's a newly vacant apartment, the situation looks like this:

Market rent will have grown from $2000 to $2948. Meanwhile, your tenant's rent would have grown from $2000 to $2545. With your rental increase for the next tenant limited to 15%, the maximum you can charge your next tenant is $2926. That's not too terrible.

Let's look at a fifteen-year tenancy and see what happens:

Market rent grows from $2000 to $4594. Actual rent paid grows from $2000 to $3351. The most that a new tenant can be charged, then, is $3853. Oi. That's looking a lot worse.

Prop 21 really freaks me out for this vacancy control clause. How's everybody else feeling about it?

Best,

Jon

@Jack McWatters, grinding savings isn't your only option! This site is full of techniques of how of how get to working in REI with little money. That's just not my focus!

Originally posted by @Susan Tan:

This image shows today’s air quality index for Portland, OR. I wonder how these annual wild fires will affect home prices in another 10-15 years from now along the entire West coast as folks change their mindset on what makes a “good quality” large city. Will there be a mass migration of more folks out of OR, WA, CA as these wildfires continue to swallow up millions of acres of land? If yes, to which cities?

A large city that has year-round warm weather, no hurricanes, no tornadoes, no wild fires is what will win in massively appreciating home prices 10-15 years from now. I think that such a PERFECT city is certainly not on the West Coast!! Folks, as climate change decimates wildlife, what city do you think will emerge as winners for real estate investors?

 Good question!

I feel like climate change has to factor into our thinking more and more each year.

I think about Phoenix, AR: huge population gains, really attractive real estate market, but for how much longer can that city be livable? The average high temperature is over 100 degrees for 100 days of the year!

The Sun Belt is getting warmer too...

Forest fires aside, the Pacific Northwest might be the best best in America.

Jack,

It's great that you're already thinking along these lines as a 20-year-old!

FHA loan or conventional, your borrowing ability will be based on your credit score and your income. Do you have a good credit score? If not, start paying off your credit cards! Do you have income?

The minimum down payment on an FHA loan is 3.5%. You'll also pay 1.75% of the loan balance as up-front mortgage insurance and closing costs of about 1% of the purchase price. So, whatever the purchase price is, you'll need about 6.2% of that to buy the house, minimum.

For a $500k house, you'll need at least $31K in the bank. Do you have that? Can you make a plan to save that in the next year?

As far as finding renters, if the rooms are priced right and match well with the area (ie, if you're in an area with a lot of young people who are more likely to rent rooms instead of whole apartments), you'll find renters. Finding renters is always scary, buy the vacancy rate in most of CA is very low.

Good luck!

Best,

Jon

@Marlon Ribunal, awesome! And I’m happy to be a resource in the meantime, so don’t be a stranger!

Dan, I've been arguing that appreciation builds more wealth than cashflow since I ran the numbers and saw the math for myself. I'm so glad to see a post that confirms the math with longterm, first-person experience!

My only caveat when urging others to invest for appreciation is that an investor needs to have stable income outside of their RE investments to pursue this path. If an investor needs income today, it's difficult to sell them on the promise of future returns.

Beyond that, the arguments against investing for appreciation are silly.

For example: only cashflow-negative properties appreciate, especially in California. Simply not true. Even in CA, even in Los Angeles, even around me in the center of the city, cashflow-neutral (or even just slightly cashflow positive) deals exist!

Another argument: appreciation is speculative. Hogwash! There's risk in expecting appreciation, but there's also risk in expecting modest rental increases, expecting turnovers to be infrequent enough to actually profit, expecting your property not to be destroyed by tenants, expecting population gains in your market to continue, etc... Our task as investors is to mitigate risk. I mitigate the risk of not realizing appreciation by thoroughly analyzing the submarkets of LA County. I don't buy any old building and cross my fingers; I study demographic trends, development plans both private and public, retails openings, etc., to identify areas that are most likely to realize appreciation in the near term.

Another silly argument: appreciating markets are too expensive, especially in CA. I'll admit that highly sought-after properties are more expensive that less desired properties; that's basic cap rate stuff. Properties in CA trade at a lower cap rate because they're safer, more sought-after investments. I think this argument stems, though, from the sticker shock of a $2M fourplex, for example. You can buy 40 doors in Little Rock for $2M! But those Little Rock doors rent for $600/month and those LA doors rent for $6000/month. You're buying income, not doors. (I'm pulling these numbers out of my rear end, FYI. I know income streams are more expensive in LA, but like I said, that's cap rate stuff. Such is the case because investments here are safer and more desirable.)

Anyway, Dan, bravo for taking on the BP orthodoxy! I'm right there with you!

All the best,

Jon