All Forum Posts by: Shane Pearlman

Hey Brandon,

It has happened twice to us.  I can only speak about Santa Cruz, CA for this topic as our we haven't owned our Seattle properties long enough to experience a full cycle.

In 2001, the tech bubble burst. Santa Cruz is a 40 minute commute from silicon valley and we were hit HARD. I personally was laid off five times in 2 years. Property prices softened a bit and rents did as well. We had a 3br/2ba SFR go from $2,100 a month to $1,900 a month. Granted it is only a 10% drop, but imagine loosing $200/m on your new rental. Rents did catch up and the property now rents for just over 3k today. We calculated the risk of vacancy VS offsetting the loss and chose the known over unknown (basically we took it in the teeth).

Rents climbed from 2003 - 2007. Then they stagnated something fierce. You can imagine why. Nothing like a great recession to affect earning power. A couple of our properties needed to drop rent a touch during unfortunate turnovers (you know times are bad when the priest renting one of our our 3br homes had to confess that donations to his church had dropped so much that he needed to move his family into a 1br). I had been planning for a typical rent increase at some point to cover what was a narrow margin on a new duplex. In reality, rents did not begin to go back up until early 2012. Nearly five years of stagnant rents and harrowingly tight cashflow. How did I deal with it? I learned to make sure all my leases ended between may - sept to avoid non-optimal turnovers, paid for professional photography to attract higher demand, and invested in stainless kitchen appliances to increase appeal to get a higher rent.

In the last 3 years, rents have done some serious climbing. Going up over 25% across all our properties. 

I personally don't think the face value of your rents will drop rapidly any time soon, but this is my 2c. We are due for a significant wave of inflation. Even if buying power goes down, the upwards pressure in general prices pushed by inflation will prop rents up. If people can afford it, it will drive them quite a bit higher. The actual true (inflation adjusted) value of your cashflow may not increase, but the dollar numbers will be higher.As long as your mortgage is fixed, and you have some safety built in, its a hell of a time to lock down the right property.

Hey @Account Closed - that could be an interesting deal. I just finished doing due diligence on a split use building in Seattle (hair salon + clothing shop at street level + 7 apartments above). Here is what I learned about pricing in the process:

Step 1: Cap Rate.

The price of your building is really based upon the annual profits that it can offer an investor.

The location of the building, its state of repair, desirability, and the market conditions define a cap rate range. Start by figuring that out. In the case of Seattle, cap rates are 3.5-6%. That is what the market (body of investors competing against you) will pay, although good luck finding a 5 cap right now. 

Do you know your local cap range? If not, go talk to other local investors, maybe ask on BP, as well as a few realtors.

With the cap rates in hand, then you can use the NOI to determine a price range.

Step 2: Determined NOI

First income. I had active leases on all units, as well as a property manager I trusted to determine the difference between the current and market rents.

It sounds like you probably can't depend on the historic income. You might consider calling a couple commercial retail brokers to find out what rents look like for the lower space. 

The residential should be easier and a mixture of craigslist + pm's can get you an estimate.

You'll also need to figure out what the vacancy rate is like in the area to factor into your equation. If you have never done commercial before, be aware of what can at times be much longer vacancy periods, as well as the costs of tenant improvements.

Second Expenses. There are a million posts and articles on how to determine expenses. Brandon Turner just did a nice one (http://www.biggerpockets.com/renewsblog/2014/12/02...) and ben had an interesting rebuttal (http://www.biggerpockets.com/renewsblog/2014/12/16...). 

The biggest thing I have personally noticed is missing small things that add up. Like an arborist service I have to get once a year to keep a few trees from eating the roof alive ($300/yr I wasn't expecting on one of our duplexes). That and underestimating the impact of cap-ex. The longer I've owned our buildings, the more long term investments I find myself doing (like buying over 10k of washer / dryer + kitchen appliances this year).

Imagine you had 3,000 in rents and 1,000 in expenses, then your NOI is 2,000 / month. Again, no loans go into this.

NOI = Income - Expenses

$2,000 = 3,000 - 1,000

Step 3: Your Price!

If your NOI is 24k for example (2k / month of profit if you own it outright with no loan) and the local cap rate is 5 - 7%, then the price should be between $342,857 - $480,000.

Purchase Price = NOI / Cap Rate

$342,857 = 24,000 / 7%

$480,000 = 24,000 / 5%

If you plan to get a bank loan, then you also need to take their minimum debt service ratio into consideration. If the case of the building in seattle, I need the price to be 50k lower than the seller was willing to go to appease the bank's desire for a 1.2 ratio (or put in another 50k cash). It broke the deal.

Lastly, if you have a loan, then you need to factor it in and make sure the cashflow meets you personal investing criteria. I'd avoid a monthly loss like the plague, and make sure that the cashflow provides enough profit compared to other opportunities. 

Good Luck!!

@Josh James 

It is not common to be able to get an 80%LTV on a commercial loan. Most of the loans on building this size in my personal experience are closer to 65-70% LTV. The bank will also want to see a track record. That said, perhaps you have a relationship that makes all the difference!! Curious to see what LTV you get a commitment for.

Things I don't see explicitly mentioned in your quick $ breakdown. 

* Turnover

* CAPEX (although you might have that in your 20% maintenance - but depending on the state of the building that could be high or low)

* Property management (unless you plan to run it yourself). Even if you don't run it yourself, give yourself some budget for expert help - bookkeeper / cpa etc..

* Landscaping (if applicable)

@Tom Lafferty / @Ben Leybovich - mind a newb question? I'm considering the shift from a handful of 4 plexes to some larger buildings and find this conversation extremely helpful. When you gentleman are discussing payroll, what exactly does that cover? Is that a part time handyman + call center + bookkeeper? Are you sharing those resources with anyone else or doing your own hiring?

Sure do! All my properties are in a non-freezing place, so I don't have those items. These are the items that I deal with in our units. I don't have radiators or air conditioning...

Indoor

1. Smoke detector batteries
2. HVAC filters
3. Fireplace sweep-out
4. Check toilet seat / seal tightness
5. Dust / clean fridge coils
6. Lint from dryer exhaust vent
7. Flush water heater
8. Check the fire extinguisher (expiration date)
9. Check and redo grout / calking in showers / bathrooms.
10. Quick flush shower heads and check faucet filters for hard water buildup
11. Tighten up loose nobs and handles

Outdoor / Under

1. Clean gutters
2. Siding & roofing eyeball
3. Check sump pump
4. Lint from dryer exhaust vent
5. Test garage door auto-reverse feature
6. Check window screens
7. Fix any earth to wood contact (damn you termites)
8. Check trees for power line interference (PG&E will actually fix it for free if you call them)
9. Annual trim up / sprinkler inspection & repairs.

You'll be stoked with ha long bay @Joey Budka . We spent a few days on a teak junk sailing out there and it was a seriously awesome memory. Definitely worth the money. Julie and I spent 3 weeks in Vietnam on our honeymoon in 2005. Hanoi was a solid city to visit (and I rarely like cities) and for some time on the beach our favorite was Hoi An. 

Stoked to meet so many of you.

@Maria Jenson  - what are you flipping?

@Sally Peterson  Just as a note, we call is old santa cruz highway but all the signage is for "old san jose road"

@Mick Sweeney  @Rob Henriquez @Leslie Anderson - welcome!

@Eric Z. where are you going to in Vietnam?

That is a really great reference @Richard C. !! 

So far all my personal investment is in Seattle / SF Bay Area, which is the perspective that drove my question.  

I do wonder if past performance is an accurate predictor of future results. In 2nd tier markets, do those trends continue, or will the urban planners figure out a way to inject vitality into their urban centers, following in the path of 1st tier cities like chicago, seattle, sf, dc ...

@Matt Mason I think you nailed it. Path of progress is exactly the right term. I started the thread because my business partner asked me about investing in a smaller community over a larger metro and the debate began. 

And yes, my title was perhaps more appropriate to BuzzFeed. =) ]. A good hook often leads people to click and read, which lets us get a great debate going. 

@Ray Browne You bring up a huge point about the impact of changing transportation infrastructure. It just reminded me of a fascinating talk I heard by the founders of Zip Car about the future of the car. They basically painted a picture of the future (guestimate 15-20yrs) when self driving cars become the norm. Since 90% of your car's time is not in use, the economics are such that, if the on-demand nature of the system was sufficiently dependable, no one would really need to own a car. They would simply pull out their phone and request one. I saw an article by google showing how this would actually be cheaper for the average user.

Its not 100% obvious to me how the will affect the rise or fall of the suburb, but I imagine it will certainly create a new dynamic.