All Forum Posts by: Jonathan Twombly

What kind of heat is it?  Energy costs have been very low for a while now.  If they spike, and you have to pay them too . . .

You did not mention how many units there are, but this property could be big enough to require staff, which means you will have labor costs on top of the management fees.  In an expensive market like Boston, I would suspect these could come to $1200/door or more.

For a property of this sale price, your insurance cost is WAYYYYYY too low.  At a replacement cost this high, I think you are looking more at $30K for insurance.  You will never receive the same rate for insurance as the seller has, because their insurance is likely out of date, based on a lower replacement cost from when they purchased the property.  And they may also have the property on a big blanket policy with other deals.  If they own a lot of real estate, they probably have better purchasing power than you do, and that is reflected in the rate they pay.

Taxes are also likely to be much higher than that.  We pay double that for a property of similar value in a low-tax state.  In a high-tax state like Massachusetts, your property taxes are likely to go way, way up when the property is reassessed at the new value, whether that happens on sale or sometime in the next few years.

I'd also cast a skeptical eye on that water/sewer cost.  Is the property individually metered?  Are the costs being netted against some kind of bill-through, like RUBS?  This seems low to me.

Are your only contracted services for snow removal and trash?  Is there no landscaping needed on the property?

I love Beacon as a place to visit, and it might be a great place to invest - I just don't know.  My very strong caution to you is that you base investment decisions on fundamental data, rather than anecdotes about people moving in.  You can hear those stories about Newburgh, too.  That doesn't mean it's a good market.

You want to dig into the data about population growth and business growth.  See if you can figure out whether employers are moving in or moving out.  Look into whether chain stores, which do a lot of demographic research, are opening up or moving out.  (Stay away from chains that franchise - they will sell a franchise to anyone and don't care if they make money or not.  Look for chains that own their own stores.)  Stay away from speculative reasons for investing, especially stuff you "heard."  It's likely that the person you heard it from doesn't know what they are talking about.  

Dig into websites like Hometownlocator.com about the local data there.  Talk to investors who have actually purchased property there, rather than brokers or amateur investors who are just dreaming about investing somewhere, someday.  Also, in the fall there was a study published about the fastest growing counties in New York State.  I would google that article and see what it says.

You might also want to look into Albany.  That has some very boring - and very good - reasons to be a stable market:  state government, which is never going anyway; SUNY, which is never going anywhere; hospitals, which probably aren't going anywhere; and, apparently, an effort by the state to make Albany the Austin of nanotech (we'll see how that goes).  And, Albany seems to have arrested it's 50-year long population decline.  It's probably reached a stable population given the area's economic base of government, education, and healthcare.

Jay, your comment reminds me of when I was first putting my toes into this business, and I had the brilliant idea to invest in Newburgh, New York.  If you are not from this area, Newburgh is a very rough city on the Hudson River, about halfway between New York City and Albany.  Unlike the other cities on the Hudson, it has not recovered - has not become either a commuter city or a cute antiques-and-tourism weekend travel destination.  Part of the reason is that, in the 1970s, in a fit of urban "renewal," it tore down its entire waterfront, which consisted of those 19th century warehouses and mills that now everyone is converting to condos with Hudson River views.

Anyway, I thought I had a brilliant idea - that, because every other city on the Hudson had revived, that Newburgh "had" to be next.  I started doing "research," which consisted of reading blogs about Newburgh, which were of course full of articles about how Newburgh was coming back.  I talked with brokers as well, most of whom were very bullish on how Newburgh was next to gentrify, how it was on the upswing, how "right now" was the time to buy, etc.

It was also super-cheap.  Brownstones just like the ones then selling in Brooklyn for $1.5 million and across the river in Hudson, NY for $300-400K, were selling for $150,000.  What a bargain!

So, I decided to tour some properties, and that was when I had my rude awakening.  It was rough, rough, rough - the whole city was a D area - and the signs of revival were a single cafe.  It was bad.  

I got scared, which was a good thing, because as I watched, prices continued to fall.  (This was right after the crash.)  Those $150,000 properties were soon being offered for $100,000 and then for $79,000.  Ten years later, Newburgh still is not "back," despite the incredible boom in property all around it.  All of the things that were supposed to happen - the development of the local airport, the light rail to that airport, etc. - never happened.

So, the lesson here is - there is often a reason something looks cheap.  It probably isn't because it's overlooked, especially in a very hot market.  If it's cheap and the cap rates are high, it's most likely because people who are more sophisticated than you wouldn't touch the place with a barge pole.

I'm sure all the Newburgh proponents will pile on now, and I'm happy to be corrected if I am wrong.  Nothing would be better than for that once-great city to be revived for real.  I'd love to be wrong.  But I suspect, sadly, that I am not.

@Carlos Casanueva  I'd say that the carpets last 5-10 years, depending on how rough the tenants are with them, though we have had to replace them sooner than that with really rough tenants.  Laminate is supposed to last at least 10 years, and the great thing about it is that it is easy to clean and you can replace individual pieces rather than the whole thing if just a spot is damaged.

 It’s important not to get caught in the newbie trap of thinking that, because a market is cheaper than yours, it’s a bargain.  We’re at the tail end of a very long national bull market for property that has pushed down returns everywhere.  When looking at a market outside your own, you need to compare it to its own historical returns, not the returns in your expensive area.  If not you could be in for a nasty surprise when the inevitable correction hits, and when it hits, it will hit these “bargain” markets the hardest.  They are cheaper for a reason.  

 The rule of thumb should be that whatever capital you put into the unit should result in a 20 percent annual return.  In other words, if you put $1,000 into the unit, will it generate an additional $200/year in rents?  

If you are looking to do the upgrades you suggest, you need to determine whether you are going to get those additional rents by looking at the comps in your area.  What do they look like and what are they getting for rents?

You may just want to put in new carpets with a more modern look or laminate wood grain flooring, which is cheaper in the long run.  Also just freshen up by painting cabinets and putting on more modern cabinet pulls, etc.  perhaps new Formica countertops as well.  If you are in a C property in a C area, that’s really all you should do.  

As my buddy @Gino Barbaro knows (since we talk about this once/month), I am a bit more bearish than he is. It's my nature.  So take what I say with a grain of salt.

Usually the top of the market draws in a lot of new investors.  They have been watching people profit for years, and they finally feel it's safe to put a toe in the water.  They think it's safe now because they have been watching people making money for a long time.  Seems like a good time.

But the people taking profits now are the ones who purchased when other people were afraid to buy.  Back in the period from 2009-2013.  Back before Bigger Pockets took over the world.

The people buying now who will be okay are the seasoned investors like Gino who understand how to weigh the risks and are investing for the long run.  Gino expects ups and downs and is preparing for them accordingly. so his investments will be alright.

The danger is for people who believe that real estate always goes up and that will make it all okay.  Perhaps you are right that, in the long run, real estate goes up over time.  But that does not mean that it goes up ALL the time.  The upward slanting line is not straight and smooth.

There are two risks that you need to prepare for if you are investing right now.

The first risk is the end of the real estate cycle.  Given that cap rates are at historic lows, that the bull market in property is one of the longest in history, that completions are at a 30-year high, and that inflation (and higher interest rates) may be on the way, suggests that the cycle has mostly run its course.  Does it have a little room left to run?  Probably.  Does it have a lot of room left to run?  Probably not.

This first risk you can deal with if you invest in cash flowing properties with a lot of margin of safety.  You can look at a cap rate as an indicator of your margin of safety.  The lower the cap rate, the lower the margin of safety, so if you are buying at low cap rates you need to be sure that the deal is commensurately low-risk.  Right now, I am not sure that the cap rates are commensurate with the inherent risk.  However, if your properties are cash flowing, then a rise in cap rates after you buy will not affect you.  You will lose money on paper, but as long as you do not have to sell or refinance while cap rates are still high, you will be fine.  The key here is to lock in long-term debt at fixed rates.  If you have a strong margin of safety then you will continue to make your debt service and the temporary fluctuation in cap rates won't harm you.  You just  wait until the next period of cap rate compression to sell or refinance.

The second risk is harder to deal with.  That is the risk of recession.  People are saying the risk is low, because we are at full employment.  However, the risk of recession is highest at full employment, because that is when wages rise, the Fed starts to worry about inflation, and it raises interest rates, which causes the economy to contract.

While inflation is good for rents, economic downturns are not.  Vacancy will spike in a recession, and the way that our economy has changed, it means that unemployment (and vacancy) will spike disproportionately among C-class renters. 

This is a danger because, if you are buying a property at a very high price relative to NOI (i.e., a low cap rate), you are locking in a very high level of debt service. The higher vacancy rises, the more difficult it will become to meet your debt service. The owners who lost properties in the Great Recession did so because they loaded up with debt and, when vacancy spiked with unemployment, they could not make their debt service. The fact that cap rates rose had nothing to do with it.

It's said that rental property does well in a recession, but that is not technically true.  During the recession, vacancy spiked.  AFTER the recession, when many people lost their homes, they moved into rentals and rentals did very well.  That won't happen again, because we won't see a foreclosure crisis next time of the magnitude we saw last time.  The people who lose their jobs in the next recession will take a long time to find new ones, and they won't be replaced by displaced homeowners who still had jobs (by definition they had jobs, or landlords would not have rented to them).

So, if you are buying now, you need to make doubly sure that the property can withstand a large spike in vacancy for several months if there is a recession.  There is very little room for error right now.  Very little margin of safety.

Wework is already the largest commercial tenant in New York City. 

I rent space from another coworking company - a local one. It’s a great service.  Who wants to be tied up in a long term lease before you even know your business is viable or that you really like the space?  And you get to have social interaction with the same people every day, as if you’re going to an office. And no need to justify your space by buying numerous cups of coffee.  

I think coworking is great as a tenant.  

Is the buyer taking out a new mortgage on the property?  If so, and you are in second position, if the buyer defaults on the primary mortgage and the lender forecloses, your second position will be wiped out and you will be left with nothing.

The fact that the buyer has no actual skin in this game at all, because you are financing the downpayment, seems risky to me.  You are taking all the risk of a default, because all the equity is yours.  The buyer is taking no risk at all, so he can just walk away if things don't go well.