One of the smartest decisions I’ve ever made was to purchase investment property. First it was houses and then I added apartments to my portfolio. Key to being successful has been management. Whether it is through my management company or local groups with whom I contract internationally or out of state, quality oversight of the properties is a must.

I have discussed focus on maximizing income and also ways to decrease expenses. Today I want to share some legal land mines that you need to avoid. As I do not know the nuances of eviction laws in every state, one such danger applies to California but may also be a threat in other states.

 

 

Keep your units habitable 

 

While it goes without saying that every one of your occupied apartment units needs to always be in habitable condition, after many years of buying and managing buildings, I will offer the reminder just in case. A rough definition of habitable includes a leak-free, pest free dwelling with heat, lockable doors and windows along with paint and flooring in at least fair condition. To be clear, this is the absolute minimum and hopefully your units are far above this hard deck level.

There are different ways to measure ROI (return on investment or invested capital) which makes for an equation to either upgrade your units to charge higher rents or keep them clean and forgo asking the top of the market rents. In the ROI analysis, one should include the risk of an expensive and time consuming lawsuit as a potential downside.

 

Be careful who and how you hire work for your property

 

When someone is hired to work on your property either independently or through a company, it is vital to make sure that they are covered by worker’s compensation insurance and liability insurance. I have seen countless landlords save money by hiring a person standing outside of Home Depot and putting them to work at their property. On the face of it, there can be a large savings since paying cash doesn’t require insurance payments, tax withholding and other costs. Depending on the state, that person might be considered your employee and thusly is entitled to certain rights under the law. Should a legal squabble occur, there are states which make recovery of legal fees quite easy should they be able to prove even a small portion of their case.

 

Be prepared when evicting a resident

 

The legal scourge to landlords in California right now are lawyers who troll the hallways of the courthouses looking for tenants being evicted. They encourage the residents to demand a jury trial which is currently their right under the law. These lawyers almost never visit the property or conduct due diligence as it is quite easy to check a box and claim habitability issues.

Typically these law firms then contact the landlord and demand many thousands of dollars (we’ve had as much as $10,000 demanded in a single case) to settle the eviction. To be clear, a resident may be 3 months behind in rent and you are simply trying to gain possession of your unit and the tenant’s counsel will tell you to either pay them a large nuisance fee to go away or risk spending (and potentially losing) that amount or more to fight them off. These groups are using the system as a tool to extort money from you.

For landlords (usually self-managed properties) who aren’t focused and haven’t kept their units in good working order, these lawyers will contact ALL OF YOUR RESIDENTS and encourage them to pay them and not you. I have seen lawsuits brought against the building owner at the same time that their rents are not going to them. Sadly, some landlords without deep pockets have lost their properties in these actions.

 

The best way to be prepared is to actively manage your property. I have some simple tools:

 

1. Inspect the interior of every unit you own at least one time per year.

a.  Document the inspection, including getting a signature from the resident(s) that any and all issues have been repaired.

2. Respond quickly to any and all resident complaints/requests.

3.  When a resident is behind on the rent and you are considering an eviction, offer cash for keys. If I can spend less in paying the tenant than I would our lawyer and I can get possession (and re-rent) my apartment in a few weeks, it will save a lot of time, money and aggravation.

a.  As mentioned before, it also gives me finality and takes away the risk of dealing with one of these predatory lawyers.

 

Should you be prepared for that lawsuit and it actually comes, we have encouraged our clients to fight and not give in to the extortion. We have been so ready for the fight that the predatory lawyers have asked to settle for $0 on the courthouse steps. Lastly, we have never agreed to seal the eviction from public record which is now a common request. We want the next potential landlord to know what happened before they make the decision to rent to this person.

If you have the mindset to prepare for a legal attack prior to the battle and take actions to mitigate the chances of a loss, you are prepared to win.

 

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

I am asked on a daily basis where I see opportunity to make money. Even from people who have made vast fortunes investing in real estate.  Too often I hear many of those same investors say that the day to make millions in buying property has passed us forever.

At the same time, I come into contact with the “hungry to make it” investors. Typically young and without a lot of experience who dream of owning successful properties.  Their vision is that the time is now and someday they will experience the dream of my wealthy investor friends.

 

Since the only time we are guaranteed is right now, I do my very best to stay away from the hindsight mirror. Yes, the one which reminds me of all of the amazing deals I passed on and also validates my housing crash prediction.  While good for brief reminiscence, that rearview mirror can clutter the mind as one looks at the 30 days in September 2014 with the freshness they deserve.

The difference between those who have enjoyed success and those who are just staking their claim is fear or put in a nice way, differing risk profile. When I look back on my own career, I remember the feeling of having nothing and therefore having nothing to lose.  Ignorance was truly bliss as I didn’t have the experience for proper analysis and thusly there was no paralysis.  While I am immensely proud of my education from the University of Southern California, my diploma was not a precursor to my success in investing.  It was my lack of fear to invest my money when the vast majority felt real estate was not a smart buy that set the course for my career as a real estate investor and manager.

If I created a Venn diagram where characteristics of the most successful people I know were charted, several qualities would be common. They are: courage (ability to rise above the fear of failure), an ability to block out the noise, an independent streak and most importantly a commitment to succeeding no matter the obstacle (and there are always many).

The curse of success is how it affects the ego. The natural feeling is pride which conflicts with the freedom to fail.  In other words, I don’t want to lose the prestige I’ve attained.  Quite frankly, this is something I battle because who doesn’t enjoy being asked to be a keynote speaker by industry peers and who doesn’t want to be quoted in the newspaper and respected as a success?  All of that said, I enjoy the feeling I had during my first investments when I told my girlfriend (now wife) that I feel like the “fool on the hill.”

In fact, I recommend going to www.youtube.com and typing in “Beatles and Fool on the Hill.” Even if this isn’t the genre of music you enjoy, if you can see yourself with the independent thinking of the person sitting alone on the hill, it should offer a different perspective on life.  This reminds me that the invitations and other ego gratifications don’t matter and I bring myself back to seeing the world in a solitary and grounded lens.

When I was in college, one of my 3 roommates hung a picture call the “Boulevard of Broken Dreams” on our apartment wall. Thinking it funny, we inserted photos of ourselves next to the celebrities depicted in the poster.  It was during that year that I made a pact to myself that I would not let my dreams turn to regrets.  I would take big risks.

While 20/20 hindsight in the years ahead will determine whether the investments of today were brilliant, acceptable or foolish, I can say that a new breed of investors will find a way to succeed right now. Before I ascend to my happy place alone on the hill, I will share that even the foolish investments have done brilliantly if held long enough.  While there were major ups and downs in the 1970’s and 1980’s, I can’t think of any apartment buildings which were purchased during that 20 year span and are still owned today which are not home runs.

 

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

In my letter 5 months ago, I discussed the “Black Swan Theory” whereby a surprise event shocks the system and later is inappropriately rationalized after the fact with the benefit of hindsight.  It seems in my investment career of 23 years, the recessions have gotten worse and the government intervention has been more pronounced.  A nasty downturn will indeed come but the timing and cause of the Swan’s seemingly sudden arrival awaits us which is why I’m always looking for ways to mitigate these future shocks.

That said, I am on the lookout for that diamond in the rough property to buy.  The prices keep going up (pushing capitalization rates down) as are the rents as the economy feels like it continues to gain strength.  As I talk with fellow investors, I have started hearing some of those old refrains, “there is a new paradigm” and amazingly “I don’t think this cycle will end.”  One of my favorite Warren Buffettisms is “be fearful when others are greedy and greedy when others are fearful.”  To be sure, this is a time to be cautious.

While official CPI inflation is quite low, the price of a candy bar just went up 8%.  Rents in Southern California, Atlanta, Austin and Berlin (the markets we still have properties) are also enjoying upward pressure.

The Hershey Bar Test: Do you remember what a Hershey Bar cost you when you were a kid?  Do you believe the price will continue to rise over the long term?

 

Similarly, there is a push in a number of states and cities to raise minimum wage.  In California, minimum wage last rose on January 1, 2008 to $8.00 per hour.  On July 1^st of this year, it went to $9.00 and on January 1, 2016, it will move to $10.00.  I believe that this will raise prices and inflation.

A sign in the window of a pizza restaurant in La Palma (Orange County), California

 

While it feels much like 2005 when I was a seller of US real estate and was investing my greenbacks in buying opportunities in China and Germany, I am a domestic buyer today.  Certainly the Central Bank policy has been a punishment to savers (a bank bailout on the backs of their depositors) and that policy continues to steal buying power from all of us today.  So why buy now when I screamed that the sky was falling in 2005?  At that time I believed there would be a housing bust which would gut the economy and our overleveraged tenants would not be able to afford our rents.

The economy today faces different challenges and I think we are more likely to see inflation in our rents which will translate into a higher valuation.  I also think currency preservation by buying hard assets which yield (i.e. rental real estate) is advisable in 2014 and the foreseeable future.  The wildcard is a steep rise in interest rates but as a hedge, I am being cautious with either the loan to value, the term of the loan or both.  This approach should allow enough of a cushion for staying power for when that downturn does come.

In specific markets, I believe like a Hershey bar, there will be long term demand for rental real estate and investment makes sense.  As there is plenty of greed out there, some healthy fear in structuring the purchase is advisable.

 

Kyle Kazan

Chief Economist

Contrarianomics

www.contrarianomics.com

 

As someone who has been described as a “deal junkie,” I look at A LOT of properties every day.  My eye immediately trains on what could add value to a property I’m considering for purchase or one we are already managing for a client or one that I own.

To develop the “eye”, there is nothing like getting experience leasing your own properties.  The invaluable time spent advertising your units and coming up with a hook to interest prospective residents so that they ignore the hundred other vacants and call you will hone your attention to your competition.  Then showing, negotiating and closing the deal for a new resident is an experience which imbrues what tenants want and will pay for.

The knowledge garnered from being my own leasing agent revolved around what sets my unit, property, neighborhood and management apart.  Why should someone rent my apartment and how can I generate more income were questions which rolled around my head 23 years ago and still do every day.  If spending a week leasing one of your units isn’t feasible, consider spending time with one of your leasing agents so that you can see the process firsthand.  This is invaluable experience and should be done at least once per year.

As all real estate is local, it is important to understand the pluses and minuses of the neighborhood your property resides.  If you have time to get personally involved with Neighborhood Watch or the City Council or even the School Board, it is a positive.  Making your community better from an organic level is great for your property and for those who live in and around it.  If like me, you have many properties in many neighborhoods, encourage your team who works for you to get involved.  We support politicians and organizations which we believe add alpha to the surrounding area.

Even more local than your city and neighborhood is your property.  Visiting properties, particularly newly constructed or newly refurbished by large institutions can inspire new ideas.  Many of the largest owners hire consultants who poll residents to see what they are looking for and they vet the newest trends.  In other words, you can draft off of the most fashionable ideas for the cost of your time touring the properties.

One trend we picked up on is open meeting space.  Even though everyone has their own unit, a popular amenity is a comfortable lounge in which to connect to Wi-Fi (another popular feature).  Just like everyone could enjoy coffee in the comfort of their own home, many people enjoy a cup at their local gourmet coffee shop for the experience.  Plus it offers a place for collaborative work space away from their own apartment which may be unkempt.  Lastly, all properties have a roof but very few offer a roof deck (another place for a meeting space particularly if you own in area with a temperate climate).

A fitness room can be simply added by purchasing a couple of aerobic machines (i.e. elliptical and stationary bike) and a stretching mat.  We recently did this in a large laundry room in a hip area of Atlanta.  Add a flat screen television and some mirrors and you have a valuable amenity which in our case caused a spike in laundry revenue since people brought their dirty clothes with them to the fitness/laundry room.

More and more residents care about their carbon footprint.  One thing we advertised in Austin, Texas and Las Vegas, Nevada was our extremely low water usage in “zeroscape” landscaping.  The best part for us is that both cities offered rebates to install hearty low water foliage along with rock instead of grass.  It looks very good and our water bill shrank significantly.  A win, win, win situation.

Lastly, the apartment itself needs your eye.  As boomers are getting older, making bathrooms handicap accessible by installing handrails near the toilet and in the bath tub has become popular.  Things to make life easier for older residents might keep them from leaving your apartment for another property.

 

 

We have found that adding a small pony wall in a large studio can create a delineation that feels almost like a bedroom has been added.  While we don’t call the new unit a 1 bedroom, we do label it a “Grand Studio” and charge a premium.  It is rare for me to walk into an apartment and not find something that could add value.  Test your eye by going into one of your units which you haven’t seen in some time.

The last thing to set you apart is good management.  If you make use of a third party management company, audit them by popping into your property and calling the phone number to see if someone picks up right away.  Check their advertising by going on-line as a prospective resident.

Are maintenance requests handled in a timely fashion, is the property kept clean and appealing and is the manager friendly and responsive to residents?  Does management show good form in enforcing house rules and collecting rent?  These are valuable questions to constantly ask in making sure that you set yourself apart from your competition.

It is a huge positive to develop and hone your “eye” as you will benefit directly from this skill.

 

Last month I discussed whether we are in the late innings of the current apartment recovery/boom.  This month, I’m going to share some thoughts on data swings away from homeownership and towards renting.

Since the Great Recession, total debt to GDP has increased by nearly 35% across the major economies.  The biggest borrowers are Japan, the Eurozone and China.  The graph in Figure 1 supports my theory that bank balance sheets were simply moved from investors to taxpayers.  I was surprised that the US’s share debt to GDP has shrunk given the rise in deficits and Quantitative Easing measures.

Figure 1

Source: Mauldin Economics / Hoisington Management

 

In any case, the government debt loads have increased substantially which will be a burden on businesses and taxpayers going forward.  In the United States, we are seeing a net loss of businesses.  In Figure 2, you can see the trend over 33 years (ending in 2011).  As a business owner since 1993, I’ve seen the environment (particularly in California where I’ve resided my entire life; I have done business in many states and in 2 other countries) continually become more onerous.

Figure 2

Source: Mauldin Economics

In Figure 3, we have had an uneven recovery.  While the low wage earning jobs have more than fully recovered, mid and high wage earning jobs have not come back nearly as quickly.

Figure 3

Source: www.nelp.org/lowwagerecovery2014

 

So how has this effected real estate?  The housing market’s recovery is owed to investors who have been the largest buyer of homes since the recession started.  New Real Estate Investment Trusts were formed to turn those purchases into rentals.  In Figure 4, we see that the young is less likely to own a home now than in the past.

Figure 4

I have read a number of articles wherein the description of Millennials (born between the early 1980’s – early 2000’s depending on the source) are a group of people who care less about ownership.  They will favor renting everything from bicycles and cars to computers and housing.  As someone who employs many millennials, I have seen a mastery and comfort of technology along with technological change.  I haven’t heard of a desire to own any less but have noticed this younger generation has come out of the starting gates strapped with debt.

In Figure 5, we see the rise in student loans (along with defaults) over a 10 year period.  I would argue that the reason for the low ownership in Figure 4 is due to fewer high paying jobs in Figure 3 and higher debt in Figure 5.  Furthermore, the world debt to GDP levels and fewer business starts portend economies which push businesses and taxpayers evermore towards less take-home income.

Figure 5

As we are a nation of immigrants and new arrivals to our country rent on average for over 10 years coupled with our youngest generation of adult Americans who are saddled with loans, I feel comfortable that rental housing will be a strong business for many years to come.  As apartment owners, the data showing a growing market of tenants is certainly in our favor.

 

I’m constantly on the lookout for great deals to buy, new strategies to improve management and information so that I can analyze the market.  Always on my mind is whether the timing is right to purchase the next deal.

A number of Observations have given me pause and I’ll share them with you:

1.      Prices of buildings by any measure in Southern California, Las Vegas, Austin and Atlanta have gone up at a faster pace than rent increases.

a.       At the same time, interest rates on mortgages have moved up.

2.      The volume of letters and calls directly from buyers who are targeting properties which I’ve purchased over the last 3 years has increased dramatically (I receive calls from brokers on a continual basis so that is almost impossible to use as a measurement).

3.      Properties being sold prior to be fully repositioned and/or with financing that must be assumed (in other words, many sellers are rushing buildings to market earlier than planned).

4.      Offers from equity lenders.

 While the first three observations in and of themselves do not necessarily mean that we are at a point of going to the sidelines, the fourth point caused me to re-evaluate my strategy very carefully.  The person who met with me works at a very large debt and equity group with a nationwide footprint.  They provide all levels of debt including a portion of the managing partners down payment which is loaned against the managing partner’s equity and also fees for operating the partnership.

He said that institutional equity (majority of the down payment) is still demanding an Internal Rate of Return (IRR) in the mid to high teens (typically 15-18%).  I asked how one could achieve this as I thought about observation #1 and #1 a. above.  He said that my fellow property syndicators had abandoned fixed rate debt and instead went with “structured adjustable rate mortgages (ARM’s) which initially would lower the interest rate by as much as 3% (in comparison to a 10 year fixed rate loan).

They also moved their buying to tertiary markets where they could achieve another 1 – 2% in Capitalization rate (Cap Rate).  Instead of Atlanta, deals were being bought in Selma, Alabama.  Instead of buying in Charlotte, North Carolina, deals were being bought in Winston Salem.  In California, buyers were passing on Los Angeles and San Jose and were pursing buildings in Fresno and Bakersfield.

Lastly, a syndicator could leverage their own down payment (a portion of the equity invested typically comes from the General Partner) by borrowing half of what they were going to put in.  The cost of this loan would be a hurdle rate (a guaranteed rate of return of 10%), a portion of the profit at refinance and/or sale and also a portion of the fees charged by the General Partner.

If everything goes right in the deal (interest rates stay low, the tertiary market stays strong, income is raised through a reposition and/or market rent growth and the property is sold at a higher price), the General Partner and the investors will do very well in this structure.  If one or two of these factors goes wrong, the margin for error is slim.

That is the point of observation #4, the risk / reward ratio has become more risky.  Given all of the factors, I am deeply concerned and made the decision to avoid tertiary markets.  I still favor fixed rate loans as an insurance policy against a rising interest rates so with my risk aversion, it would make hitting 15-18% IRR’s far more difficult.

While I am still bidding on properties to purchase, it feels like we are getting into the late innings when investors throw more and more caution to the wind.  I hope buyers lower their risk profile organically but people and markets rarely work that way.  It won’t take much to go askew for many of the latest purchases to go wrong which should be a reminder that real estate is a cyclical business.

 

Definition: The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.

It is hard to believe but I have been investing in real estate for 22 years.  Thus far, I am proud of my track record of both investing and also sitting on the sidelines when deals stopped penciling.

As a history major in college, I enjoy viewing past as prologue and don’t mind being viewed by others in the industry as overly cautious.  During the boom days of the mid 2000’s, I called myself Chicken Little as I knew the sky would fall.

Today, my tea leaves tell me that we (the world) survived a massive overleveraging of the intertwined financial system.  This was done through some fantastic financial engineering by various governmental organizations who simply moved the liabilities from banks to taxpayers all over the globe via opening up their balance sheets (printing money / running deficits).  Not to mention savers all over the world who saw interest rates drop below inflation and were encouraged to buy (prop up) assets or face the punishment of losing purchasing power for doing nothing.

What I’m saying is that I believe that the bill for the tech bubble and then the credit bubble (fostered to get us through the dot bomb explosion) never got paid and is hanging over all of our heads.  I am convinced that this house of cards will collapse and the balance sheets of last resorts have been used.

While I don’t know where or when the Black Swan will appear, I suspect it will be a sovereign debt / bond crisis in China, Japan, Europe or the US and will spread quickly around the globe.

Unlike the last bubble period when I found comfort on the sidelines and keeping my cash, I believe my money is safer in hard assets which provide yield.  This is because I don’t know any currency around the world which is tied to anything but investor confidence in that country’s ability and willingness to pay its debt.  So instead of overleveraged fiat currencies, I continue to favor the following: Distressed real estate in Southern California, Las Vegas, prime areas of Atlanta, Austin and farms in Southern Georgia.  I have a few properties in escrow in Southern California but am not sharing any details since I’m working through the due diligence and will be retrading on the price.  I also put a distressed medical office building in Las Vegas under contract but again, it is far from a lock that I’ll make that purchase.  I share these to let you know that I am ready to put my money where my mouth (or pen) is and am actively pursuing that next smart deal even if I come home with nothing in my nets for many months or years.

Overseas, Berlin and Shanghai proved to be smart purchases in the past so I plan on investigating potential opportunities in Southern Europe over the summer.    We’ll see if distressed real estate in the most fun places across the Atlantic looks interesting.

Another area of interest is marijuana.  I see the legalization of that green leafy plant to be a when and not an if and it will eventually happen nationwide.  The significance is that it is a multi-billion dollar industry which is largely being run underground.  Legalizing and legitimizing the industry will open up a massive opportunity for entrepreneurs everywhere.  Like I did when I investigated farm land opportunities in Georgia (consulting with farmers and agriculture professors), I plan on doing the same regarding land in Northern California because it is in my backyard and there is a long history of cultivation in that region.  Again, this may all lead to nothing but I’ll be reporting back my findings.

Too often I hear people lament that the best opportunities to invest in anything were in the past.  While hindsight is indeed 20/20 much like knowing yesterday’s lottery numbers, people will look back at today with the same nostalgia.

 

I am often asked for the recipe for success in real estate.  While my quick response is always “buy right,” that only scratches the surface.  What do you do when you close escrow to maximize your investment?  This is a different answer.

The secret is to LISTEN.  While it is easy to simply think, “of course I already do that” but then you wouldn’t be listening to me.  My entire career has been built on what has come through my ears and I’ll explain through my story.

My father told me while I was in high school that investing in houses had been very profitable for him.  I asked him to tell me why and I learned a valuable lesson: most people will share their knowledge if asked (even if they are not your Dad).  He gave me many ideas to think about and a seed was planted which would later germinate.

After college, I decided I wanted to find a way to make some extra money and enhance a future retirement so I thought back about the conversation with my Dad.  I then signed up for a seminar given by a person who had been very successful in purchasing distressed homes.  At this seminar, I listened intently and asked many questions (and followed up by calling with even more questions).

I bought some houses and was enjoying some success in my new part time venture.  While hanging out with one of my childhood friends, his father (who had never discussed business with me in the past) asked about the investing he heard about from his son.  After sharing, he told me that I should look at buying apartments and explained the lower cost per door and economy of scale.  I listened to him describe the “right deals” for him and how he had made a lot of money buying multi-family properties.

While under contract for my first apartment purchase (a 7 unit foreclosure), I hired some professionals (plumber, roofer, electrician and contractor) to assist me in inspecting the property.  I listened intently as they shared likely problems I was going to have as well as issues that had to be dealt with right away.  In some cases, I have opted to not buy properties which I thought were going to be smart investments based on listening to those who know far more than I do about these different trades. For this initial apartment purchase, their reports assisted in my getting a price reduction from the bank.

When I am at an apartment complex, either one which we own, manage or are considering buying, I ask, “how do you like living here?”  The answers I’ve received are often astonishing and have lead to further investigations which have caused management changes, tenant evictions, police intervention, my not buying a deal or my completing a purchase.  What better local expert than someone who lives at the property and in that submarket?

Further on that thought, who better on your team than the on-site manager to share the problems at the property and more importantly how to fix them.  The danger that we all face after attaining success is that we can fall into the trap of thinking we have all of the answers and dismiss other opinions too quickly.

At different industry events, I’ve met people who have given me fantastic advice and also leads on some great purchases.

My wife who is a traveling occupational therapist was treating a client in their residence which was an apartment in a 51 unit building.  They mentioned that I should buy this building since the owners died and nothing was happening.  I listened intently and did not discount that many leads do not pan out as you just never know.  It turns out that we were able to buy the property through probate at a deep discount.

While I could attribute my success in the apartment business to many different factors, none are more important than the ability and discipline to LISTEN intently.  Besides, the easiest way to convey respect to another person is to simply listen.

And the fringe benefit of listening: “Better to remain silent and be thought a fool than to speak out and remove all doubt.”– Abraham Lincoln

Listen up!  An amazing education awaits…

 

As we start to get rolling in our new year and the President of the United States has given the State of the Union, I want to share my State of the Real Estate Market.  Over the last couple of years, Capitalization Rates (Cap Rates) on apartments around the US have dropped and this includes the last 12 months when at the same time, rates on the 10 year Treasury have risen.  We can see in Figure 1 that the bottom was in May and the high was in December.  From peak to trough, in 8 months, the rates went up 138 basis points.

Figure 1

 

While rates were rising, the Federal Reserve was increasing its holdings of US Treasuries.  The Fed Chairman Ben Bernanke has indicated that Quantatative Easing will be tapering once certain benchmarks are reached and one would believe that those policies will continue under the soon to be Fed Chairperson, Janet Yellen.  In Figure 2, it is clear that while the US is not alone in expanding its balance sheet, its pace of late is the fastest.

Figure 2

 

The Fed has indicated that for tapering its bond purchases (or money printing), it is focused on lowered unemployment and also a target of 2% annual inflation rate.  Almost all of the pundits talk exclusively about unemployment while ignoring inflation.  In Figure 3, we see the unemployment rate (the U3 from the BLS) has gone down for the last three years.

Figure 3

 

The other part of the Fed’s stated equation on ending Quantitative Easing can be seen in Figures 4 and 5.  Clearly government measures of inflation doesn’t seem to be very strong and my bet is that while the Fed continues to give positive sound bites, it will not stop its purchasing in the foreseeable future.  Remember that the rates went up when there was only a discussion of slowing the bond purchases even though they didn’t actually taper.

Figure 4

Figure 5

 

Generally speaking as someone who operates many thousands of apartments around the United States, it feels like the economy is doing alright.  Not as strong as the bubble years but stronger than 2008 – 2010.  In Southern California, most buildings have few vacancies if any.  With Cap Rates teetering around the level of the borrowing rates, we are in bubble territory again unless one believes that rents will be rising faster than expenses and interest rates.

Remembering that I have stayed out of financial trouble through my investing career by not gambling on greater fools buying from me so that I can flip for a quick profit, I am focused on cash flow and hopeful upside potential.  Distressed properties are disappearing and an example is Figure 6 showing home sales in California which was one of the worst five markets in the US after the bubble popped.

Figure 6

 

My biggest concerns revolve around a potential economic shock which hampers occupancy and/or collections.  Most purchasers don’t factor a down market into their numbers.  The other concern is stagflation which would mean higher interest rates without a rise in rents.  While I don’t think this is likely, I could see several scenarios where it could occur.  Remember, it is always healthy to picture the rainy day and how you would react if such a situation happens.

I am currently looking for opportunities to purchase in three states and of course will not buy if there is negative leverage in the pricing. For downside protection, I am putting more money down on my deals and taking on less debt.  While this might well lower my future Internal Rates of Return, it is my insurance policy just in case a nasty scenario plays out.

When I was a college basketball player over 20 years ago, my coaches stressed visualizing positive results.  I remember the difference which a positive attitude meant to my free throws when I walked up to the line and instead of thinking “don’t miss,” I said to myself, “sink this.”  Renowned coach Jim Valvano had his North Carolina State team practice cutting down the nets (the ritual after winning a championship) at their very first practice of the season.  Months later, they cut them down for real after winning the 1983 National Championship.

Positive thoughts alone don’t win championships.  Meticulous planning and focus of attention are essential as well.  Legendary coach John Wooden said that “luck is the residue of hard work.”

As we enter 2014, how will your properties perform?  Will they be champions or will the results be subpar?

As all properties and markets are different, let’s discuss the strategies necessary for successful operations.  First, we must define what a successful year looks like.  I compile the previous 12 months numbers (commonly known in our industry at the “Trailing 12”) and break it down from top to bottom.

Here is my check list for the income generation:

1.  Are your rents at market?  It is important to know what the comparable units in your submarket are renting for.

2.  Are your rents level?  Is there a big difference between what you are charging for two similar units?

3.  What was your vacancy, delinquency and concession loss?  Were those better or worse than the market?

4.  If there is on-site personnel, have you evaluated their performance and their compensation?  Be careful not to be penny-wise and pound foolish with the team at the property as they are the most important people other than you in the operational equation in my opinion.

a. Consider a competitive compensation structure with a generous bonus system which rewards the team in a way that aligns your interests with theirs.  For example, giving bonuses based on collections and not simply rentals.  A new warm body occupying your apartment doesn’t do you any good if they are not paying.

5.  Do you see positive momentum in the rents?  If so, budget increases during the year.

Once these questions are answered, you are ready to budget what a successful 2014 will look like for your rental collection amounts.

The check list for expenses also continue with a review of your Trailing 12:

1. On a macro-level, did you have any expense items which jumped out as surprisingly high?  Often times when I am considering buying a property, I notice that roof or plumbing repairs grab my attention.  After due diligence, it is clear that a major capital expense to replace either of these systems is needed which will drastically lower the expense item in my budget going forward.

2. The biggest line items are typically property taxes, insurance and utilities.a. For taxes, can they be contested as too high per the local laws?  If so, in many areas around the world, there are services who will handle this for you and their payment is a percentage of your savings.

a. For taxes, can they be contested as too high per the local laws?  If so, in many areas around the world, there are services who will handle this for you and their payment is a percentage of your savings.

b.  Insurance should be bid out annually to ensure that you are getting the best coverage at the best prices.

c.  Regarding utilities, there are several ideas:

i.      Can these be lowered making you a more green owner with more green in your pocket?  In Las Vegas and Austin, we changed our landscaping to “zero scape” which will cut our water bills.  In Las Vegas, the city heavily subsidized this procedure.

ii.      There are often utility programs (i.e. lighting and insolation) which are subsidized by the utility companies or government which can lower the property’s usage.

iii.      Can you submeter or institute a RUBS (resident utility billing system) whereby the residents pay for a portion or all of the utilities?  When people pay for something, they are far more likely to monitor its use and thusly it is common for usage to go down after the payment responsibility transfers.

3. Have you negotiated with your biggest subcontractors?  When you are going through your last 12 months of expenses, you might be surprised how much you paid for painting, flooring, plumbing and landscaping.  Bidding the services out annually is healthy.

As you review your expenses, be careful to make sure that your property looks sharp.  You want to be able to compete favorably with your competitors who will be vying for the same residents.  Be realistic in your spending so that you do not cut your nose off to spite your face.  This includes taking care of your residents.

It is nice to include at least some amount of money for resident appreciation.  It can be for prizes at Halloween or a community building activity where a BBQ is hosted or sandwiches are catered.

I recommend breaking the budget down for all 12 months and then comparing the year-end 2014 totals with your 2013 results.  Hopefully your budgeted profit will be up from last year.

Now that you have completed the budget, it is important to review on a monthly basis.  When I go through my numbers, I do it via a budget comparison which shows how the properties are doing that month and also year to date against the budget I created.  Adjustments often have to be made during the year for unforeseen situations but that is what property and/or asset management is all about.

If you take the time to define and plan for success and then actively review that plan throughout the year, you will enjoy positive results.  Good luck as you enter the 2014 season with your building(s)!