BFP Management Blog

Archive: November 2013

Mixed Messages Abound

Mixed Messages Abound

 

Before I leave for work every day, I read the Los Angeles Times, Wall Street Journal, and Financial Times, along with my local paper.  As I keep seeing the economy’s “recovery” heavily covered in the headlines, I note many retail and office vacancies all around Southern California.  These vacancies in particular cause concern, since those spaces used to employ people, and many of those folks used to be renters.  The juxtaposition, between what I read and what I am seeing is striking.

 

For example, the graph in Figure 1 from the National Real Estate Investor, the headline read “The 10-year Treasury yield climbed more than 10 basis points for accelerating economic growth.”  I studied the chart and thought back to April of 2010 when the yield was 50 basis points higher and remembered Mr. Bernanke calling for more quantitative easing, because the economy was stalling, and he wanted interest rates to remain low.  Now, because investors are selling, or not purchasing, U.S. Treasuries, it is assumed that it is because of their confidence in economic growth.

 

Figure 1

10 year U.S. Treasury Yields

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When bond yields rose precipitously in Portugal, Ireland, Greece, and Spain, the news was greeted as a lack of investor confidence, or the glass being half empty and leaking fast.  In the U.S., that same yield spike is being reported as the glass being half filled en route to running over.  Is Figure 1 really good news when higher borrowing costs put pressure on an already weak real estate market?

 

As a fellow owner of apartments and offices, I wanted to share what I am seeing as far as performance at my buildings in Southern California.  Since I’ve owned many of my properties for over 10 years, I’ve gotten a good feel for their usual profitability, which is primarily driven by vacancy and delinquency rates, respectively.  This year has been extremely challenging as I’ve seen rents drop to varying degrees on all of them.  I’ve also seen both vacancies and delinquencies rise with an overall increase in turnovers.  On top of that, I’ve had to offer concessions (lowered or free rent) to entice new residents to move to many of my properties.

 

A case in point is a 25-unit building in Inglewood that I bought in 1998.  For several years, the property collected over 99% of gross potential rents, meaning that it lost less than 1% from both vacancies and delinquencies combined for the year.  In November 2010, there were 2 evictions in process, with one vacancy sitting for nearly 60 days.  The evictions were both caused by job losses, including a now-former professor at UCLA, who refused to move since she “had nowhere else to go.”  The vacancy was created because that resident (who had lived there for over 10 years) took advantage of the low interest rates, 40% decline in real estate prices, and bought a house.  The year 2010 will be the toughest economically for that property since we purchased it.

 

Some positive news from December was that the Bureau of Labor Statistics released unemployment data. While 21 states and the District of Columbia saw unemployment-rate increases, 15 states experienced declines, and 14 states posted no change.  Hopefully we are seeing a plateau with decreases in unemployment in our future.  In Figure 2, we see that Nevada had its first decline in unemployment in October 2010 before bumping up slightly in November.  Prior to that, the last drop was in December of 2005.

 

Figure 2

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At the same time, California’s unemployment remained the same for the last 4 months at 12.4%.  While these statistics, in and of themselves, don’t immediately show that occupancy percentages should increase, it does say that employment is not in freefall right now as it was.

 

While I’m certainly hopeful that the U.S. and respective state economies are preparing to turn a corner, a “jobless recovery” is simply an oxymoron.  I watch the positive reporting in the media and note the struggles of day-to-day management at properties all over the place.  The mixed messages blare; however, I believe the bottom line and not the hype.  We will certainly recover, but as anyone who is operating rental properties knows, it is likely not imminent.

 

 

 

 

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

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Three Important Lessons

 The three most important lessons for successful apartment ownership

 

“You don’t have to be bright to be wealthy as long as you choose to invest in real estate.”  Yes, I have heard that quote and other disparaging remarks about how easy it is to become wealthy if you just buy and own properties. While I know many people who are indeed wealthy (most don’t consider themselves so) because of rental property ownership, I know more people who have had terrible experiences in property investment.  In other words, if it was simple, everyone would have done it and everyone would be wealthy.

 

If I have one skill above all others which has helped me in life, it is that I enjoy listening and learning from people.  My favorite stories are of failures as I have found that the most successful people have failed the most but kept going.  Michael Jordan, arguably the world’s greatest basketball player said, “I’ve missed more than 9000 shots in my career. I’ve lost almost 300 games. 26 times, I’ve been trusted to take the game winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed.”

 

Early on I figured that if I could learn from someone else’s mistake, I could learn invaluable lessons on the cheap.  To this day, I enjoy sharing real estate and business war stories.  Not surprisingly, I didn’t avoid every land mine just from listening and learning and have made my share of mistakes.  Since many people were generous with their advice when I was starting out, I am always happy to share and still quick to close my mouth and listen as I never stop learning.

 

The 3 lessons I will be sharing come from my own experience along with things which I’ve learned from others.

 

  1. Buy the property right – You make your money on the buy!  It is extremely rare that I don’t second guess myself when I’m under contract to purchase an apartment building.  I think “buyer’s remorse” is natural and for me, I go back to my numbers which is why I decided to buy the property.  I’ve done very well by staying within a tight box which allows for immediate positive cash flow. I budget for a rise in vacancies and conservative expenses just in case.  I also conduct extensive due diligence to minimize surprise unbudgeted capital expenses.  I have never purchased a building that I wasn’t prepared to own forever which allows me to not stress over it going up or down in value.

 

  1. Operate / Manage correctly – I could write a book about all of the mistakes I’ve made in this area.  When I bought my first properties, I wanted maintenance work done cheaply and rarely considered anything other than price.  I did not concern myself with the risks I was taking because of hiring people who had no worker’s compensation and liability insurance.  I even had managers working for me who were only compensated with free rent and without any employment agreement or tracking of hours worked.  Much of this is “old school” management but it is financially dangerous.  The worst stories I have heard and still hear involve “mom and pop” owners who manage the way I used to and get sued over wage and hour or worker’s compensation claims.  It is always expensive as the owner will have to hire an attorney and inevitably pay the plaintiff and their lawyer.  It is always smart to avert obvious risks before they teach a very expensive lesson.

 

  1. Staying power – I was told early on that to be a long-term survivor in real estate, one needed staying power.  As real estate is cyclical and not a secular business and I’ve survived two economic downturns, I understand this lesson well.  During the good times, I do not overleverage my properties even though it is tempting to do so given that it could unlock equity and provide for my next down payment.  As I do when I initially buy my properties, I run the numbers thoroughly when deciding how much (if any) cash to pull out from a refinance.  It is very important to maintain apartments so that maintenance doesn’t get deferred for long.  While there are many reasons for this, one is that it could be very costly if a roof needed replacement at the same time the building needed new plumbing and was suffering from an economic downturn.  This could spell foreclosure as I have purchased properties that got hit by the perfect storm of poor planning by the previous owner who didn’t have the cash to pay for it all.

 

I’m confident that if you follow those three important lessons, you will be successful in your quest for successful apartment ownership and potentially great wealth!

 

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

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What Will be the Straw that Breaks the Camel’s Back?

May 2013

 

What will be the straw that breaks the camel’s back?

 

On Sunday, June 28th, 1914, Archduke Ferdinand was shot and killed in Sarajevo.  That assassination sparked a chain of events that directly lead to the “war to end all wars,” a description for World War I.  Clearly very few people anticipated that the many treaties between countries would eventually plunge much of the world into war and cost millions of people their lives.  It is always so much easier looking at history and giving 20/20 hindsight commentary as opposed to looking out in front of the ship to predict where we are going.

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Archduke Ferdinand

 

Similarly, a few of us saw the housing bubble as unsustainable and publicly predicted a crash.  I knew it would end badly but foreseeing the exact timing and trigger is almost impossible.  Therefore, I made my financial bets on the trends that seemed obvious.

 

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A slide from the author’s presentation on September 20, 2006

 

The housing bubble was caused by rampant speculation and lenders willing to finance anyone with loans larger than the value of the properties at rates that were artificially low.  In other words, the math did not work and greed replaced rational thought on all levels (government, lenders, builders, investors).

 

I confess that the government’s reaction to the housing and subsequent economic crash took me by surprise.  Historically, our regulators have forced companies into insolvency and let the market clean the carcasses.  In this downturn, new phraseology was born, “too big to fail” and “quantative easing.”  The housing crisis did not go to the depths that it would have had the market been left untethered.

 

Dear reader, before you shoot me an e-mail or letter complaining about my supposed political stance, I am not advocating or criticizing the policies of the past or the present.  I am looking at the facts as I see them and am gazing out at the horizon ahead of us so that I may predict the most likely scenarios.  This allows me to gauge my investment decisions accordingly.

 

How many times have you heard someone say that if they could go back in time, they would pick the winning lotto ticket and be set for life?  With proper foresight, some of those numbers ahead of us might reveal themselves.

 

Compass reading

  • Almost every country in the world is spending more than it is receiving in taxes.  In other words, borrowing against future tax receipts.
  • Almost all governments are raising taxes and are cutting spending.
  • Interest rates worldwide are far lower than the historical average and in some countries as record lows.
  • Many countries are buying their own debt (printing money).
  • Unemployment worldwide is higher than the historical average and thusly real wages are stagnant.
  • “Austerity” and “Sequestration” are becoming kryptonite to politicians everywhere.

 

Focusing on the United States for a moment, sovereign debt was expanded to soften the blow, particularly for banks and Wall Street investors.  Austerity isn’t punishment and instead is a consequence since the almost $17 trillion borrowed is actual and not notional debt.  While I wish this were a bill that would never need to be paid and was of no consequence, I am planning for that Archduke Ferdinand moment and the likely ramifications.

 

I can’t predict in what form or when the camel backbreaking straw will come but let’s look at some likely outcomes:

 

  • Economic shocks do not come in the form of a slow trend and instead manifest themselves in crisis’s.
  • Higher taxes (through increases and less deductions).
  • Less government spending and services.
  • Higher interest rates.
  • Technological innovations which will lead to lessened need for labor.
  • A severe economic downturn
  • Inflation
  • The next big thing (the internet was the last one and the next one may be energy related)

 

Since almost none of the talking heads who are arguing about the economic events of the day have correctly predicted anything previously, I would encourage you to picture the world in the lens of the outcomes I just listed.  While it may be emotionally painful, it is vital that you see an apartment purchase in this light so that you avoid real financial discomfort.

 

As stated in recent articles, there are attractive apartment opportunities out there and as someone who has several offers pending right now, I wish you happy hunting!

 

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

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Not April Fools!

April 2013

 

Not April Fools!

 

Unbelievable #1: A nation and a couple of its banks are about to default on their obligations and are in need of a bailout so the solution is to take up to 60% of individual depositors’ money?  I can not even label it a tax as the banks / nation simply plundered the money from those who had trusted them with their money.  Oh and to boot, all accounts are frozen to stop the sure run on their banks so each depositor’s withdrawals are capped at 300 Euros per day.

 

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Clearly the EU did not want to set a precedent in bailing out the banks in Cyprus without a concession even though they are large holders of Greek bonds which did not go bust because of a bailout.  Presumably the thinking is that France, Spain, Italy, etc… were watching and would also want to be bailed out without any concession.

 

Can you imagine how you would feel if your bank accounts were frozen and raided?  What precedent does that set for savers in any country around the world?

 

Unbelievable #2: Your tenant fails to pay their rent and among your options is to serve a 10 day notice for “failure to vacate.”  If the resident wants to fight it in court, they must post the entire amount of rent owed.  Should the resident not leave in that 10 day period, a prosecuting attorney will take up the case and may charge them with a misdemeanor.

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The long arm of the law is now on the side of the landlord at least in Arkansas.  Given the games people play to delay evictions in many states, I think it fair to say that this would be a welcome tool for property owners everywhere.  Human Rights Watch labeled this law “abusive.”

 

No, neither of these unbelievables are April Fools jokes; they are indeed real.

 

As I always enjoy meeting with economists who see the world differently than I do, I recently met with a fine writer and economist named Liaquat Ahamed whose book Lords of Finance won the Pulitzer Prize for History in 2010.  The book discusses the personal histories of the four heads of the Central Banks of the United States, Great Britain, France, and Germany and their efforts to steer the world economy from the period during the First World War until the Great Depression. The book also discusses at length the career of the British economist John Maynard Keynes who criticized many of the policies of the heads of the Central Banks during this time.

 

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Left to Right: Mr. Ahamed, James B. Rosenwald and your author

 

Mr. Ahamed is an economist and is a hedge fund manager, a Brookings Institution trustee and graduate of both Harvard and Cambridge.  He shared his thoughts on the parallels between the financial crisis of 2008 and the Great Depression.

 

In short, Mr. Ahamed admired how after the 2008 financial crisis, the United States pumped liquidity into the system and raised the currency supply.  He was far less concerned with Debt to GDP and gave an example of England in the early 1800’s who successfully paid off a national debt that was 300% to GDP.  Unfortunately, when I asked for any other example in history where a nation was able to recover after borrowing so much, he didn’t have one.

 

While I respect Mr. Ahamed’s Keynesian point of view and am hopeful that “the next big thing” as he put it (which drives an economy) is centered in the United States, I remain comfortable hedging inflation with commercial real estate.  I expect more crisis’s in Europe as the “can kicking” slowly comes home to roost along with continued Quantitative Easing in the US.

 

While Mr. Ahamed didn’t offer any investment tips, my next big thing is more properties.  Last month I closed 2 commercial purchases and have one more apartment building in escrow so I’m betting my money on real estate.  That said, given my concerns about our economy, two of the three properties were purchased without any bank debt since I want to be careful about any future shocks.

 

 

 

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

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Cash is King

March 2013

 

Cash is King!

 

After determining that the United States was the best place in the world to invest my money, I began a search for my first acquisitions of 2013.  In February, I received a call from a broker who said there was a 12 unit building for sale in a “C” area of Orange County, California.  The property had been purchased in 2004 for $1,780,000 and the owner was suffering from some serious health problems.  His family decided to dump the building and because of the operational issues (5 current evictions), there was no way to finance the purchase.

 

To boot, the roof and decks were shot and in need of replacement and there was a shrine at the corner of the property for a gang member who was shot and killed nearby.  The price was over $500,000 less than it sold for 9 years ago (not the peak of the market) at $1,275,000.

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                                The author in front of a shrine to a gang member who was killed in a nearby shooting

 

The sellers wanted to unload right away and we were able to buy the property because we could close the purchase in 14 days.  We made an “all cash offer” which was very attractive since there were no hurdles from a bank and they had far more certainty that by choosing us, they had a done deal.

 

While this building is certainly not for everyone given the difficulties with cleaning up the management and dealing with the local gangs, there is a tremendous amount of upside when the property is put back on track.  In fact, we should be able to refinance it and take a large percentage of our cash off the table in about 1 year (for the best rates, most lenders want the deal to “season” and be owned for 12 months before loaning to a formerly troubled asset).

 

In the Inland Empire of California, many would be buyers are making offer after offer (all at full price or higher) to buy homes but are being continually rejected.  The reason they are losing out is because they are competing with investor groups who are buying “all cash” and can close quickly.  A lot of these deals are in need of repairs so there is upside for a buyer who can rehab the property in a cost effective way.

 

If you are like me and want to buy distressed assets, my suggestion is to line up cash prior to making an offer on a property for sale.  If you do not have the funds available, some banks will allow you to cross collateralize (pledge other assets) for a line of credit and there are hard money lenders who have money at the ready albeit at rates usually above 10%.  Lastly, you can find some partners who share your appetite for this type of risk / reward investing.

 

Currently I have two “all cash deals” in escrow and have cash ready along with partners who want to participate.  By choosing this option instead of borrowing the money myself, I am sharing the profits and the risks with others instead of keeping it all for myself.

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Given the strength of the rental market in certain areas around the country, properties are trading at seemingly low cap rates so I favor the deals with hair and in need repositioning.  If you have the appetite and team to turn lemons into lemonade, I have found this type of investing to be very rewarding.  My advice is to have your money lined up before the opportunity comes knocking since cash is king.

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

 

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