Do it for your grandchildren

I have always said that the mucky mucks in the apartment association were the grandchildren of European immigrants who started buying property in the early to mid 20^th century. They had the “advantage” of having a tough life and so being tough themselves. The industry had much less regulation back then and was a much simpler business than it is today. The power of compounding, time, and their guts and hard work allowed them to amass huge real estate portfolios that are literally being managed by their grandchildren now and as a result their families are wealthy and will continue to be for the foreseeable future.

My friend’s step-mother is the daughter of just such a man. He spoke with a heavy European accent and passed away in his late 90’s. His daughter manages the hundreds of units that he amassed, all of them now in nice neighborhoods. As the story was told to me, he was a cutter in the garment district for many years, and he saved his money to invest in a chicken farm, which at the time was considered to be a very safe, secure and savvy investment. Being in vogue they were hard to come by. So with his money ready and him standing by waiting for the right opportunity, he was approached to go in on an apartment building. He was forty years old. They did so well, that after a few years he bought his partner out. He kept buying and never looked back.

Discussing my situation with him and his daughter (my friend’s step mother), I was saying how I had finally gotten a troublesome building under control after almost five years of management. I was complaining about a persistent roof leak, that I finally fixed after three tries on my own, and three tries by a roofer whom I paid almost $500 to do the repair. After the 3^rd attempt by the roofer, he went out of business, and not being able to get anyone else interested in a $500 job I attempted it myself. I was saying I don’t really want to spend my time on the roof, but I was left without a choice. The elderly gentleman beamed as my friend’s step mother explained that there were plenty of days when he came home from work, and then climbed on a roof to fix a leak, coming home tired and dirty.

If this sounds like too much work for you, keep in mind that I prefer to hire out that kind of work when I can. You can not achieve success in any field without some hard work. And that this man, and many others like him have amassed a fortune and have lifted their families from poverty to wealth in a single generation.

What Does Cap Rate Really Mean?

Cap rate is supposed to be a measure of price, which is inverse to the sale price: i.e., the higher the cap rate, the lower the sale price, the lower the cap rate, the higher the sale price. This is because the cap rate measures the rate at which an income stream, in the case of multifamily buildings, it's the Net Operating Income (NOI) after all expense, but before financing, is capitalized. If that's a little complicated, look at the table below for a simpler explanation.

Cap Rate	Price	Manageability	Condition
13%	War Zone	Harder to Manage	Poor
12%	Cheap
11%	Cheaper Than Average
10%	Average	Average	Average
9%	More Expensive Than Average
8%	Expensive
7%	Really Expensive
6%	You Can't Make Money	Easier to Manage	Excellent
5%	Fagetaboutit

On This Day In 2002…

July 5th, 2002, I did a roof job on a building I owned in Newark, NJ. The roof leaked and quite frankly needed a total rip down and re-do. But being a cheap landlord of an inner city property, I tried the cheap way out. There was a local guy, Jalil, that did odd jobs in the neighborhood, and I asked him if he wanted to work on this project with me, and could he bring another guy. He said yes and that he could get his girlfriend’s son to come. I told him to meet me at my house at 9:00AM. He admonished the kid to be on time, and then failed to show himself. The Kid showed on time, and we waited for Jalil for an hour before leaving.

I had an Econoline van at the time, which I loaded the day before with about two dozen green five gallon cans of Karnak fibrous asphalt roof coating, and one red can of Karnak roofing cement. It was 102 degrees in the shade, and must have been 150 on the roof. The good news, if there was any, was that there were internal stairs to the roof, so we didn’t have to haul all those cans up a ladder. I brought two gallons of water, one for each of us, and we drank it all. But we sweat so much, we never had to stop to pee.

The Kid wanted to quit in the middle and finish another day, but I urged him to continue on. After we finished the job, I drove him from North Newark, to his grandmother’s house, where he lived, in South Newark. I paid him and he went in. Standing at the rear of my van, I noticed tar on my leg, so I started to wipe it off with a rag soaked in paint thinner. Being literally the only white guy for miles around, people walked or drove by, staring at me like I was out of my mind. As I drove away in my blue van, hot, sweating and stinking, satisfied that I had saved thousands of dollars and had at least staved off the inevitable roof job, I couldn’t help thinking as I so often have, “I went to college for this?” I didn’t…

Screening Tenants

Speaking of mistakes, another big one is not screening your tenants thoroughly or at all. After ten years of landlording, I think I have tenant screening down to a science. First of all, all adult tenants must fill out an application and pay a non-refundable $35 application fee per application (as opposed to per person). Tenants are not given an application until they pay the fee via cash or money order. Prior to requiring the fee be paid before giving out an application, I had several problems. First, I was making a lot of expensive photocopies of application forms, and giving them to people who never bothered to fill them out and return them. Very few, although some, did actually pay the fee and not return the application, but at least I made money on them as opposed to losing it. Second, since my Super was showing the apartment, I was never quite sure who had paid the fee and who hadn’t. Once I required the fee up front, I knew all applications that I received (99% via fax) had the fees paid.

The application fee also weeded out a fair amount of potential applicants who a) weren’t very motivated and b) had money problems. Anyone who can’t or won’t come up with $35 to apply for an apartment either has bad credit (and doesn’t want to lose their $35) and just looks for an unsophisticated landlord who won’t check their credit and/or won’t charge a fee; or money is such a problem for them, they don’t’ want to part with their $35. I believe this policy has saved me a lot of time, money and grief.

The application form itself also weeded out a lot of unsuitable applicants. I could tell nine times out of ten, just by reading the application, whether or not the tenant would qualify. If the application looked like it had been filled out by a four year-old with a crayon, they usually failed. If they left out large blocks of important information, they either usually failed, or they ended up not being processed at all because I never got the pertinent information. On the other hand, if the application was complete, legible and included the required information (last two pay stubs, photocopy of photo ID), and they made enough money, the usually qualified. Either way I checked them, because sometimes I was surprised, i.e, neat complete application from a person with horrible credit, or person with horrible handwriting has good credit…

How much is enough money? My formula is 2.5 times the monthly rent in gross monthly income, or 30 times the monthly rent in gross annual income (These formulas are the same, but are presented annually and monthly for the convenience of applicants who are often math-challenged). For example, to lease an apartment that rents for $600, the applicant needs $1,500 month in gross income (before deductions) or $18,000 per year. Where did I find this formula? I don’t know, I read it somewhere, implemented it, stuck with it, and it has always worked for me.

I have always used First Advantage Saferent for screening services, and never found a need to switch. I found their information worked for me, and they were cheaper than the others. They also provide options for criminal, civil and sex offender checks, which I also always do. I require a minimum Fico score of 600. You have to adjust this down if you own properties in a rough area, or your apartments will just sit vacant. If you have high occupancy rates, you may have the luxury of adjusting the Fico requirements upwards.

The Fico score is key. I see it as an honesty history as much as a credit history. It is also a predictor of how well a prospective tenant will care for their unit as well as common areas. It is not just a predictor of whether they will pay. Fico score can also predict timeliness of payments. For example, most of the time, tenants with Ficos above 600 pay on time or even early, the higher the score, the more true this is. Once, I had some persistent vacancies, and I decided to rent to two tenants just below 600, who were otherwise qualified. One had a 592, and one had a 594. I had to chase both of them for the rent, pretty much every month. When renting in rougher areas, I rented to those with a 575. I not only had to chase them for the rent, I often had to evict them. Yeah, it’s that accurate.

So to summarize, to rent an apartment from me, prospective tenants must have:
• Income of 2.5 times the monthly rent in gross monthly income, or 30 times the monthly rent in gross annual income.
• A Fico score of at least 600.
• No eviction filings on record.
• No hits on criminal or sex offender records.

What Is The Biggest Mistake You Can Make As A Landlord?

I have always answered this question by saying that paying too much for a property is the biggest mistake you can make. I would say, that most other mistakes you can recover from. But I learned a new way to make this mistake: A guy I spoke with bought what he thought was a seven unit building in the same town I owned in. I thought seven units was a weird number, because back in the day, they built a lot of six unit buildings, many of them side by side on the same street. Seven set off alarm bells. I figured, it has to be the result of some remodeling, which is fine, as long as the zoning was changed to conform to the same number of units. Otherwise, you have an illegal unit. Which means you don’t have a unit.

My two recently sold buildings were in fact originally six units that got converted into 11 units. They would probably never let you do that now, but way back, you could do stuff like that. The zoning was properly changed, and when I purchased them, it was confirmed through due diligence, and spelled out in the contract that the seller was representing that the buildings were zoned for use as 11 unit buildings.

Well this guy, didn’t do his due diligence, and his attorney didn’t protect him. I thought he overpaid for the buildings anyway, but they became that much more expensive because a unit is now missing. When you have someone living in an illegal unit, you have another problem, and that is that the normal tenant landlord laws do not apply to that unit. Which means the eviction laws don’t apply to the unit. If you are in this situation, consult with a qualified Tenant-landlord attorney (who represents only landlords) for what to do. My understanding is that your only option is to buy them out, “Cash for keys,” because you can’t evict someone from a unit that doesn’t exist.

What should you do if you are in this situation? Well, I advised this guy to sue everyone, his former attorney, the seller and the broker, all of whom should have known better. This way at least he may have a chance of recovering a portion of what he paid for the property. Better to do your homework before closing.

Commercial Multi-Family Foreclosures

Several articles in this month’s “UNITS,” the NAA’s (National Apartment Association) Magazine, discuss the coming “Wave” of foreclosures in Commercial Multi-Family properties. Remember, the definition of Commercial Multi-Family properties is a residential property of five units or greater. I mentioned this in my post almost two years ago. But the UNITS guys don’t mess around, they’re talking mostly about properties in the 200+ unit range. These are some big foreclosures, and you have to be a REIT or a very large private player to pick one of these up. The good news for small real estate investors, is that the under 100 unit properties will be facing the exact same thing, so keep your powder dry, because your day will come. And it may be sooner than you think.

Lot’s of talking heads are talking about a bottom in real estate prices, but that’s because they don’t know what they are talking about, or they want to feel good or they interviewed some “expert” that said things are going to get better. There are so many properties entering the foreclosure pipeline, and so many brand spanking new houses that no one has ever lived in just sitting, that there has to be continued downward pressure on prices. One real estate office manager with a large national chain that I recently spoke to said her firm is predicting a 1% per month decline in prices. That’s a 12% annual rate, in case you’re slow on the uptake. If you have been thinking about selling your house, do it now and price it right, because a year from now it will be worth less, I promise.

So are single family home prices tied to Commercial Multi-Family property prices? Yes and no. I would say there is not a one-to-one connection, but commercial property ran up when single family residential did, so commercial must also come down with residential. In part it is driven by bank stupidity. The banks made crazy loans on the way up, driving prices higher and higher. They are now backing away from otherwise sane loans, causing deals to die and properties to be listed at lower and lower prices. A residential mortgage guy I know is bemoaning several files not closing because the bank backed away from solid deals. In a sense, the banks are digging their own graves with this behavior, and several have already jumped into these graves (Washington Mutual & Country Wide to name two).

Think about it, you hold all these real estate loans, some good, some bad, but all are based on the value of the underlying real estate. If that value goes down, the loans get riskier. If the value goes down enough, the owner’s most logical step may be to walk away. For example, if it is cheaper to rent a comparable property to the home you own and live in, and if you have no equity, it makes sense to walk away if you can’t get out. Sure your credit is going to get screwed, but only for seven years. And is it worth say an extra $1,500 a month just to save your credit? Maybe yes, maybe no.

And how about Commercial Multi-Family Properties? If an own is facing increasing vacancies, downward trending rents, and increasing expenses, as I did in the last 2+ years, he may not be able to hold on. If his equity is gone, what is his incentive to keep putting money into the building. If the loans are non-recourse, he doesn’t even risk his personal credit rating and assets. Buh-bye. I hate to admit, but I thought about it few times while my own deal was on life support. Fortunately I was able to close and those bad ideas became just a bad dream.

Meanwhile, as the banks keep pushing down prices by backing away from or refusing to make loans in the first place, they cause more loans to go bad, as owners have less equity and therefore less incentive to hold on. Hold on!

On Life Support

When a real estate deal is in trouble, or dying, the commercial brokers I use to buy & sell my buildings refer to it as, “On Life Support.” That was the status of my deal (see previous blog post) for probably two months before closing. Why? The buyer wanted to buy, the seller wanted to sell. They had agreed on price and terms, albeit grudgingly. Well it’s a long story, but the short answer is, the bank went bankrupt.

The buyer was selling another building, and making money on it. So he would have to pay capital gains. In order to avoid that, he structured the sale and subsequent purchase of my buildings as an IRC 1031 exchange. Properly executed, the proceeds of the sale are rolled into the purchase of the new property, and the IRS gets cheated out of their tax money. I believe this technique is widely know in real estate investment circles.

Because I had prepayment penalties on the loans underlying my buildings, and because I wasn’t getting a great price, part of the terms were that the buyer would assume my loans. The loans were assumable, and the interest was pretty good. The problem was that the buildings were selling for less than they had been appraised at when I refinanced. The bank insisted on cramming down the loans so that the LTV, Loan-To-Value ratio didn’t exceed 75%. The buyer was okay with that. It meant he had to come up with more cash, but cash wasn’t a problem for him due to his sale. The bank still insisted on a prepayment penalty on the crammed down portion of the loan. I’m not sure if the mortgage contract allows that or not, but they won. The pre-payment penalty was split three ways between the buyer, the seller (me) and the broker, making it palatable for all.

Somewhere in there the bank, Washington Mutual, went under and got bought out by JPMorganChase, which has swallowed so many banks in the last few years, it’s hard to fathom. It’ll be business as usual they insisted, but it wasn’t. Processing ground to a halt, I had verbal approval for the deal, one key signature and was waiting for the second key signature. I waited two months. The deal was supposed to close before Christmas 2008. Sometime in the beginning of February, the team working on the deal got laid off. The clock was ticking, and I had granted several extensions to the buyer, what else was I going to do? He wanted to close, and was ready, willing and able. In fact, he was willing to come to the table with all cash just to make things happen. A good buyer and honorable too! But I needed for the loans to be assumed, or half my profits would disappear in prepayment penalties.

My lawyer wrote a “Nasty-gram” to JPMorganChase threatening to sue them if they caused the deal to fail. They then resumed processing the loan assumption, and we closed on the very last day we could close and the buyer could still get his tax break. It was a great effort by the broker, and the lawyers for both the buyer and the seller.

I got lucky I guess. The buildings are most likely worth less now than what I got for them. They were in need of some upgrading and renovation, and I was getting a little tired after eight years. I also knew things were going to get worse for rental housing before they got better. The previous two years were tough, and mentally I wasn’t prepared to hang on. Also I had been (and still am) contemplating relocating to the Pacific Northwest, and would need to sell in order to do so. The buildings are no longer a barrier to my relocating. Also, after a little rest, I intend to start over, either as property manager working for a company, or independent again, but in nicer neighborhoods.

I’m not sure what the moral of the story is, or if there even is one. Life sucks, maybe? Or perseverance? Nothing ventured nothing gained? Never give up? It’s frustrating to me when things are out of my control and I’m trying to make something happen. Use good professionals, and hope for the best.

I Am An Ex-Landlord!

Well it’s been official for just about three months now. I managed to close the sale of my buildings as of the end of February, 2009. Is this a good thing? Yes and no. I feel a certain sense of lost identity, having been a landlord for 10 years. People used to call me “Carlton Sheets,” “Donald Trump” and “Slumlord.” It was a badge of honor. They used to screech with laughter, when after calling me a slumlord, I would correct them, informing them that I was “A professional property manager, focusing on the affordable housing sector.” There were times for sure that I felt like I was a slumlord. There were times that I hated my buildings, and when I visited, I just wanted to get away from them. It was amazing that so much of my net worth and identity was tied up in these properties.

There was a time when I was highly leveraged, and it freaked me out. I was making money hand over fist for about a six month period when I owned a total of four buildings with 48 units. But then the leverage got to me. So did the rough buildings. They have a saying on Wall Street, “If you can’t sleep, sell down to the sleeping point.” So I sold my buildings in Newark. I slept much better afterwards.

I feel like I got out just in time. I wish of course that I had sold when the market was higher. I knew when that was. I recently read on-line a comment from a laid off economist, “Just because you know a freight train is coming, doesn’t mean you can get out of it’s way.” I feel like that. Even though I had the sense that the market was near a top, I didn’t know what I would do if I sold. I thought I was a “Long Term Investor.” I thought the buildings would not only pay for my kids’ college education, I thought it would be the only way to do so. I still do.

My home is probably under water by $100,000. Not that I’m upside down on my mortgage, just that it’s worth that much less than I paid for it. I knew this was happening. So why didn’t I sell? I need a place for my family to live. Of course I could have sold and rented, but rental units are scarce and expensive in my town. I did talk about just renting when we bought this house, but ultimately I didn’t want to simultaneously be a landlord and a tenant. Financially it was the right move, but lifestyle-wise it was not. Also, even though I called a top in the real estate market, I didn’t call a freight train. As always, a crystal ball would have been helpful.

Tenant Rant 2

Tenant Rant 3

Late Rent