Every now and then I like to take a step back and take a 360 degree look at how I’m operating my properties.  This includes asking those who work in the operations what I can do better to improve how we do what we do.  It is truly impressive to see how much those around you know and often their insights are really invaluable to going to the next level.

I must confess that many of the suggestions which I’ve shared as your Apartment Reporter came from the team and I was simply smart enough to listen and implement.

In preparing for the coming year, one thing we do is to see how the legal landscape is about to change.  A couple of years ago, I shared when the US Environmental Protection Agency came out with their RRP law.  For owners of California rental properties, I will be sharing some changes coming effective January 1, 2013.  If you don’t own in the Golden State, be ready as the laws here are often a bell weather of things to come throughout the country.  It is wise to get ahead and prepare so that you stave off a future headache.

California Senate Bill 183 requires installation of carbon monoxide detectors in all of your units (single family units should have them already) before January 1, 2013.  There are some caveats (for instance all electric buildings) so educate yourself so that you are in compliance.  For more information, please go to this website.

It is vital that you buy the correct detectors and install them in the right places.

Many owners allow only declawed cats or “devocalized” cats/dogs in their units.  Under California Senate Bill 1229 neither policy is allowed.  Meaning if you allow cats in your property, their claw status can no longer be considered.  Also if the barking of a dog is a nuisance, it will be almost impossible to remove the resident for that reason.

A lot of us are enjoying the ease of taking rental payments electronically.  I for one notice how quickly it is accounted for, that nobody has to scan or take to a bank and I have the use of the money quicker.  One landlord tried to make it a requirement and threatened to remove any resident who didn’t comply.  Now we have California Senate Bill 1055 which allows residents to make payments in a form other than cash and electronic funds transfer.

Two laws which I appreciate are California Assembly Bill 2303 and 1679.  Bill 2303 raises the value of abandoned property (from $300 to $700) which can be disposed after the termination of tenancy.  There are some nuances to this law so know it before you throw stuff away.  That said, know it so that you can turn a unit instead of storing property under the right situations.  Bill 1679 allows you to agree with the resident to transfer a security deposit refund electronically and send the itemized statement via e-mail.

Lastly, I can’t tell you how much I recommend doing an annual inspection (if not one every 6 months) in every one of your units.  While there are many good things that come from this, two of the most important are spotting and correcting water leaks along with making sure that your residents are treating your property well.  Getting ahead of higher water bills and/or a severely damaged apartment will save you money.

Happy Thanksgiving!

Recently, I was at a deli in New York City which accepted “cash only” so I paid for my meal with greenback dollars.  Over the last several years, other than handing out tips, I simply use my credit cards and avoid hard currency.  When the cashier handed the change to me, I was stunned at how lite and “tinny” the quarter felt.  It reminded me of my travels around the globe and the quick judgment I made about the financial stability of the country based on how solid their currency felt in my hand.

In September, Ben Bernanke announced the Federal Reserve’s third attempt to stimulate the economy through QE3 (3rd round of Quantative Easing) with the goal of lowering interest rates, particularly on home mortgage rates.  I certainly enjoy the benefit of lowering my home mortgage along with some of my smaller properties (1-4 Units).  As Warren Buffet said in an interview this year with CNBC when describing why he would load up on single family homes, “it’s a way in effect to short the dollar because you can take a 30 year mortgage and if it turns out your interest rate is too high, next week you refinance lower and if turns out it is too low the other guy is stuck with it for 30 years.”

  Figure 1

                                        Source: Los Angeles Times

What do my observations of the quarter in my hand and QE3 have in common?  It has been (and remains) my belief and prediction that the Federal Reserve through quantitative easing is inflating our currency.  As an aside, I am not passing judgment on Mr. Bernanke’s decision and am only sharing my predictions as an economist and investor for the likely result of these policies.

The nickel on the other hand has put the US in a bit of a conundrum.  For the better part of the last 3 years, the commodity prices of the 1.25 grams of nickel and 3.75 grams of copper in each nickel added up to 6 or even 7 cents.  As the value of our money falls against tangible assets (in this case commodities), the US government is going to have to lessen the value of the contents of its coins.                                       

  Figure 2

                                             Source: seekingalpha.com

With this in mind, Congress passed the Coin Modernization, Oversight and Continuity Act of 2010.  This will allow our government to get ahead of a bad metals trade.  While this isn’t new (the content of the quarter dollar changed from 90% silver in 1964 to 75% Copper / 25%Nickel in 1965), I expect more changes ahead as a consequence of the Quantitative Easing.

How does this affect apartments (the asset class which I choose to invest most of my money)?  First, it will become more expensive to build competing properties so the value of an existing portfolio should go up.  In many cities around the US, houses can be purchased at far below replacement cost and when rented will enjoy a nice yield.  If you can get a 30 year fixed rate loan on this investment, I would heed Mr. Buffett’s advice.  Since the government is exploring cheaper ways to make the currency, I recommend looking for the right real estate investments for which to trade your green paper and whatever coin is produced.

The real estate market and the general economy in the United States are about as difficult to read and predict as I can remember.  For instance, in chart 1 we note that Las Vegas was 9th in the nation in percentage of houses with foreclosure filings for the first half of 2012.

On the surface, that is excellent news for the Las Vegas real estate market which has consistently had the dubious distinction of highest foreclosure rate over the last several years.  How did Las Vegas drop from #1 to #9?  When we dig deeper however, we note that Nevada Assembly Bill 284 took effect in October of last year and that same month foreclosure filings fell by 75% month over month.  That begs the question of what is Assembly Bill 284?  The law requires those foreclosing on a home to file an affidavit proving they have the right to bring the action (no robosigning) – and it increases civil and criminal penalties (makes it a felony for the person signing on the dotted line for the lender).  While the lenders took a breather in October to get their arms around the provisions, in November a Clark County grand jury indicted two Southern California title officers on a combined 606 felony and misdemeanor counts.

My focus is not the merits or faults of the law as I’m only concerned with its effects.  It is clear that foreclosure activity has been lowered because of the law and not from miraculous market conditions.

Interest rates are at (or near) historic lows which is a positive for home buyers yet the economy is barely keeping its head above water in almost every area of the country.  While the unemployment rate started going down in 2011, recently it has been inching up in Nevada and nationally as seen in Chart 2.

Chart 2
Unemployment Rate: Nevada, National

Source: deptofnumbers.com

There are also large funds buying homes in big numbers around the country as rentals.  I expect that in the very near future, there will be real estate investment trusts (REIT’s) that own only single family homes.  This is a positive for house prices as inventory is being consumed for rentals (not a great thing for apartment owners).

As the inventory of foreclosed homes has gone down and pricing has moved up, one must wonder if housing has indeed bottomed.  Analytics from RealtyTrac recently found that just 15% of REOs in Washington DC were for sale.  Analytics firm CoreLogic estimated that just 10% of all REOs in the US were listed for sale.

Foreclosed home – Las Vegas, Nevada

As you can see, Adam Smith’s “invisible hand of the market” is being banged around quite a bit by forces other than simple supply and demand.  I believe our very slow economy will continue muddling along for some time with the Fed throwing everything it has left to spur growth.  This means low interest rates (money printing) for the foreseeable future.  At some point however, the US will have a nasty bout of inflation (timing is always the most difficult to predict).  In short, I don’t feel a rush to buy en masse but by finding those needles mixed into the haystacks, long term ownership should bode well for investment.

I’m always looking and over the next few years, I’d like to exchange more green paper for income producing tangible assets (real estate).  As a matter of fact, I’m sifting through a few distressed bales of hay right now to verify that I’m really looking at needles and not more straw.

Kyle Kazan
Chief Economist
Contrarianomics

Recently, I was in a discussion group with some very sophisticated investors of equities and real estate when I was asked if I was bullish about anything in the United States.  I have been openly negative about our rising deficit and the lack of financial consequences for large banks and financial institutions that had been deemed “too big to fail” for quite some time.

I sat back and thought about the question and said that there are a number of things which give me a very positive outlook for the red, white and blue.  Before this Apartment Reporter turns upbeat, I wanted to share a statistic to keep in mind when you see the oft reported unemployment figure that will be bandied about more and more as we head towards November.

It is the participation rate of the working age population that are either working or looking for work.  In Figure 1, we see the percentage today is 63.8% which is 2.3% lower than it was 4 years ago.  This is a 30 year low.

Figure 1

Source: Bureau of Labor Statistics, The Wall Street Journal

Another measure is to divide civilian employed people by the total US population.  It was 63% five years ago and today it is 58.6%.  There is clearly too much slack in the American workforce which is a big drag on our economy and when you think about 4 out of 10 capable people not working, it makes the 8 or 9 percent unemployment rate look meaningless.

Now, please let me share some good news which will hopefully lead to higher employment and a better economy.  Of course that will hopefully include full buildings for us all!

1.  Energy independence.  While I have not enjoyed paying higher prices at the pump, this has lead to more Americans buying vehicles with better fuel efficiency and has increased our expansion of domestic fuel sources. Through breakthroughs in “fracking,” we are tapping into oil and natural gas reserves that are abundant domestically.  Before I get letters, please let me say that I too want this done in a way that doesn’t harm the environment. As manufacturing often requires a lot of energy, if US costs are cheaper than most places around the world, I think that we will see more “on-shoring” of manufacturing jobs.
2.   Technology innovations.  We are still the home of some of the best research and development in the world as evidenced by cutting edge companies continuing to form in the Silicon Valley.  To be more specific, cloud computing, nanotechnology, battery innovations, green energy and yes, even social networking.  While there are developments coming from around the world, the US is still the place to be if you are an engineer or an engineering student.
3.   Stability.  I hear this more and more from foreign investors as there are serious concerns about the viability of the European Union (which I think will end up disbanding) along with the transparency of China.  While I understand that we have our governmental issues, strong property rights and our legal system to work out disputes makes our country more attractive as a safe haven.
4.   Deleveraging.  Since 2008, our real estate market has gotten kicked in the teeth.  That said, we have seen a massive amount of debt get recast through foreclosure and also through refinancing we have seen debt payments plummet because of lowered interest rates.  There was a finite amount of these toxic loans made during the real estate bubble and I would argue that we are more than half way through the cleansing process.
5.  Belief in the spirit of the USA.  While I have had the luxury and pleasure of traveling around the world and respect the drive and focus that I’ve seen, there is nothing like the ingenuity and can-do spirit of Americans.  Perhaps because our country is a melting pot who welcomes those with a desire for a better life or because I have witnessed American greatness during my lifetime, I feel strongly that the US will figure out its problems and continue to be a positive force in the future.

Some of you may be thinking that I am an overly patriotic homer who has lost objectivity and to some extent you are right in that I am thankful for a country which has provided so many opportunities for me.  That said, the reasons for optimism that I listed are real and while I’ve invested in Asia and Europe, my money is currently purchasing real estate right here in the US so as usual, I eat my own cooking.  Today, I wired money for an investment cooked up in Atlanta and it tastes good!

Kyle Kazan
Chief Economist
Contrarianomics

Last month I discussed cash on cash yields on new purchases.  This month, let’s talk about our current holdings and what to do about increasing income.

Last week, I was presented with current rent rolls on a number of buildings along with rent surveys of the each property’s submarket.  I was asked by the Regional Property Supervisor why I hadn’t raised rents since 2008.  Actually I was surprised that I raised rents in that year since the peak of the market was in 2007 and the crash began the next year.

During the last 4 years, I have been focused on occupancy and am happy that concessions are largely gone from these markets (the properties being discussed are in the South Bay of Southern California).  This year, I have been pushing the rents very aggressively on vacant units after spending some money upgrading them.  Now I’m comparing the rental amounts for each floor plan to see how large of a discrepancy there is between our latest rentals (the market rent) and those that rented last year or before.

You too may notice that you have a decent gap between your lowest and highest rents for the same units.  I found the highest difference to be almost 20%.  Thankfully most were not that large but if I could wave a magic wand and raise all to the highest, it would be a substantial jump in topline cash flow.

During the last 4 years, expenses have continued to increase like property taxes (2% per year in California if it was below market) and utilities.  Any bump in income to off-set these increases would be welcome!

I am well networked with many landlords and know that there are different ways to attack the situation.  I’ll breakdown the 3 most common strategies and discuss the benefits and drawbacks with each one.

1.  BE AGGRESSIVE – Move all of the rents to market so that nothing is being given away.  The benefit is that the rents are being maxed out and there is no concern that any money is being left on the table (on the top line at least).  The negative to this approach is that turnover will be much higher and maintenance costs will also be higher because of it.
2.   STAY JUST BELOW THE MARKET – While there is no perfect number, I know many landlords that try to keep their rents between 5 -10% below market.  They may push the rent on vacant units but once living at the property, the management works very hard to retain this tenant which includes not raising the rent until it has fallen below the percentage barrier set-up by the owner.  The drawback is that there is a loss from the topline on a monthly basis while the positive is that renters considering moving within the submarket will likely have to pay more and will be less inclined
3.     DO NOTHING – Some of you may shake your head and say nobody would do that.  I recently testified in court as an expert in a lawsuit between family members who owned a 40 unit building where they did just that.  I have also managed and purchased properties like this where there is tremendous upside in the rents.  The positive is that the tenancy is amazingly stable and residents are not quick to ask for any maintenance as they don’t want to rock the boat.  This makes management far easier as there isn’t much to do.  The negatives are that a lot of rent is left on the table and when someone moves out, there is often an expensive unit turn due to deferred maintenance.

I decided to go with option #2 and will be sending out a letter with the increase notice to share that we are not raising the rents to the market.  We will share our empathy for the difficult economic times and discuss the increases we have faced in expenses and note that this is the first raise in many years.  While nobody likes an increase in rent, most people are reasonable and appreciate an empathetic explanation.  In other words, sell the rent raise to your residents.

Lastly, on buildings that are master metered for gas and/or electricity, we are establishing RUBS (Resident Utility Billing System) programs so that new residents are billed for these utilities.  This will help off-set expenses which increases the bottom line.

At the end of the day, my focus is less on the top line as it is on my net profit.  While I know many who are adamant about running their buildings under option #1, I think the economic winds won’t reward being too aggressive in today’s climate.  Good luck in increasing your bottom line this year over 2011!

Kyle Kazan
Chief Economist
Contrarianomics

I love owning and managing rental property all over the world.  It has provided for a nice living and given me great satisfaction in being able to offer steady employment to many people and contributing to the betterment of communities through our pride of ownership management style.

At the same time however, it is important to understand that as a landlord/property manager, you are a target and must protect yourself.  While I know many who spend a lot of effort in elaborate ownership techniques which often times include showing mortgages (from another non-obvious owner controlled entity) in excess of the property value to make lawsuits more difficult, I have simply chosen to hold most of my properties in different limited liability companies and do my best to navigate smartly in operations.

I am going to share some of the issues that I have witnessed or experienced in our business that deserve your attention.  Remember that failing to prepare is preparing to fail.

1.      Keeping your property in good condition

While I’m sure you have property insurance that covers many liabilities, in an effort to ensure safety, keep residents happy, lessen your headaches and keep your policy premiums as inexpensive as possible, I recommend a system to monitor your property’s condition.  At a minimum, someone should visit your property monthly (preferably weekly) and inspect the physical condition.  Furthermore, at least one time per year, the interior of the units should be inspected.  For both types of inspections, it is positive to have a checklist of items to be reviewed.  For example:

a.       Trip and fall hazards – sadly there are people looking for this type of liability so that they can try and                   collect money from your insurance company, even if they aren’t residents of your property (I was amazed when I was sued by a stranger “visiting” my property even though she didn’t know anyone living there).  Identify and grind or correct any lifted concrete over ½” as well as any cracks or divots in your driveway or sidewalks.

A trip hazard of over ½”

                      b.   Correct all “growth” from water intrusion or lack of ventilation in your units.  Almost all insurance companies see this type of claim as non-corrected deferred maintenance of the ownership/management.  I always identify how the water intruded or steam wasn’t ventilated and then deal with the growth.  We immediately jump on this type of complaint whether found on our annual inspection or if reported by the resident.

Growth in a kitchen caused by a plumbing or roof leak above

     2. Wage and hour complaints

Hiring people to care for your property the old fashioned way of a free or reduced rent unit on a handshake opens you up to huge liability.  If you self-manage, consult an employment attorney and have them advise you on the appropriate contract, reporting/record keeping, insurance and tax withholding necessary.  I know people who have had to come out of pocket for many hundreds of thousands of dollars on this claim in California.  Some of my colleagues make managers and maintenance people independent contractors in an effort to save money and headache.  I think this is a very dangerous approach and am always quick to pay for good legal advice before a claim is made.

3.   Insurance coverage by your contractors

I have never met a rental property owner who doesn’t watch his or her expenses closely.  We are all looking for the best deal in paint, carpet, plumbing, roofing and general maintenance work.  When I started in the business with my first rental house in 1991, I didn’t check to see if the people I hired had worker’s compensation and liability insurance.  Even though it almost always costs more, I will only use vendors who are properly insured and give me proof of coverage.  If they do not, you are essentially self-insuring them for woker’s comp and liability and one claim could cost you massively both financially and emotionally.

4. Property Postings

Depending on the country and state, there are always some laws regarding postings and notices that you must have on your property.  An example is California’s Proposition 65 posting on rental property (Figure 1 is a sample posting).  My suggestion is to join a local association (there are many for apartment owners) and stay up to date on laws and regulations effecting your investment.  Even if you contract with a property management firm, it is incumbent upon you to know whether they are handling your property as it should be.

Figure 1

I look back over my 21 years of rental property ownership and management and I’m amazed by how many things I didn’t know.  While ignorance is bliss, knowledge is power and will make property ownership far more pleasant and profitable.

Kyle Kazan
Chief Economist
Contrarianomics
www.contrarianomics.com

If you are a longtime reader than you know that I love statistics.  In fact, I like to close my door and review charts and graphs in a vacuum with absolutely no commentary to see what conclusions I come to on my own.  As a fellow commercial real estate investor, I’m in search of the “road not taken”.  As Robert Frost so aptly wrote, “that has made all the difference,” to which I happily share that my best purchases were made with little competition.

As an economist, I do my best to evaluate the trends, dig beneath the surface, understand history and human behavior to formulate a current conclusion as well as a likely scenario for the future.  If it were easy than bankruptcy attorneys would be broke and we’d all be Warren Buffet.

In this issue of the Apartment Reporter, I’m going to let many graphs tell a story and share my interpretations.

The Federal Reserve announced that it plans on keeping the Fed Funds Rate the same into 2014.  In Figure 1, we see that the effective rate for the Fed Funds is at a historic low (from 1955 – 2012).

In Figure 2, we see the correlation between inflation and the Fed’s fund rate.  Current Federal Reserve Chairman Bernanke is famously quoted as saying he would use a “helicopter drop” of money into the economy to fight deflation.  Watching the Core PCE price index is a good indicator on inflation.

In Figure 3, we note that 30 year fixed rate mortgages which follow the Fed Funds rate have also dropped to historic lows.

In Figure 4, we note that housing starts are also at a historic low.

In Figure 5, we note that the shadow inventory of homes for sale (which includes REO’s and likely short sale listings) is far higher than the less than 1 month it was in 2006 (peak of the housing bubble).

Number of Months (Not Seasonally Adjusted)

In Figure 6, we see that out of every 100 houses sold in California, more than 25 are purchased as non-owner occupied.  This doesn’t count those that buy a house as a “2nd home” for the owner occupied financing but decide to rent it out instead.

Lastly, in Figure 7, we note a favorite slide for all of us is that we are starting to see some rent inflation.  This is a macro figure so it is quite possible that you may own in a location(s) which isn’t yet experience this growth.

My conclusion is that the Federal Reserve is seeing that the economy is struggling to gain traction.

AN OBSERVATION: My cousin and I recently dined in a packed Fleming’s Steakhouse in downtown Los Angeles before a sporting event and she said, “looks like no recession in here”.  I have heard this comment many times in the last few years but as someone who manages over 5,000 units in 5 states, I will share that far more tenants are struggling to hang on than was the case in 2007.

The Fed is making clear that they will do everything they can to keep interest rates in the United States very low for the foreseeable future.

Even though mortgage rates are at historic lows, it isn’t enough to encourage people to purchase homes.  I think this is due to the economy and also very tight loan regulations (which were non-existent during the boom) that blocks people with a foreclosure on their credit from this cheap financing.  These requirements are also making more people renters

There is a massive oversupply of homes on the market and coming through distress.  Home prices are now below replacement cost which has sidelined the builders for the foreseeable future.  The distressed housing market is also creating more and more renters which is starting to push rents.

With that yellow light blinking in the background, I have told some friends and family that buying a rental house right now makes sense (pricing and rental market specific).  I bought a house late last year and am yielding over 10% on a cash on cash basis.  I am planning on rolling out a fund to buy many more so I see a green light.

For those who are savers and need yield on their money, I like this investment.  Especially if one can take advantage and lock in at these very low interest rates (I could not and bought all cash.  It still worked for me).

If you share the same conclusion from the story the 7 graphs told then Happy Hunting!  If not, I don’t think believe there is a rush as we likely have years of a tough economy ahead.

Kyle Kazan
Chief Economist
Contrarianomics
www.contrarianomics.com