Rental Properties?

[LC]

In a downturn, SF/NY cap rates may increase 1-2%.

 

Middle of the country may increase 2+%

[bizaro86]

Hey all:

 

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

 

SF was wiped out a bit more than 100 years ago.  Are they overdue?  Hard to say, but the odds are greater than 0.

 

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher.  I'm looking at some commercial properties that are at about a 9%-10% cap rate.  Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

 

OR

 

What happens if the economy slows down/goes busto?  What if cap rates across the country go up 2%?  Everybody take a loss!  Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

 

We'll see!

 

One potential upside to San Francisco is that supply is constrained not only by the water around the city, but by the water between the ears of certain influential citizens. Trying to get permits for new construction isn't necessarily easy there, which reduces competition for existing buildings.

 

I probably wouldn't buy anything that was subject to their rent control though.

[BG2008]

Hey all:

 

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

 

SF was wiped out a bit more than 100 years ago.  Are they overdue?  Hard to say, but the odds are greater than 0.

 

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher.  I'm looking at some commercial properties that are at about a 9%-10% cap rate.  Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

 

OR

 

What happens if the economy slows down/goes busto?  What if cap rates across the country go up 2%?  Everybody take a loss!  Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

 

We'll see!

 

One potential upside to San Francisco is that supply is constrained not only by the water around the city, but by the water between the ears of certain influential citizens. Trying to get permits for new construction isn't necessarily easy there, which reduces competition for existing buildings.

 

I probably wouldn't buy anything that was subject to their rent control though.

 

The water between the ears of certain influential citizens is exactly correct.  Cities like NYC and SF are notorious for there difficulty in bringing new supplies to the market.  There really aren't any giant developable land lots.  Most new development is knock down of older structure and re-build.  It's very expensive to bring on new supplies this way.  Now Hudson yard developments are rare. 

[BG2008]

Hey all:

 

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

 

SF was wiped out a bit more than 100 years ago.  Are they overdue?  Hard to say, but the odds are greater than 0.

 

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher.  I'm looking at some commercial properties that are at about a 9%-10% cap rate.  Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

 

OR

 

What happens if the economy slows down/goes busto?  What if cap rates across the country go up 2%?  Everybody take a loss!  Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

 

We'll see!

 

You're probably right that there should be a slightly higher risk premium for earthquake. Again, the buying of 9-10% cap rate vs a 4.5% cap rate in a land constraint market like NYC.  In the last 10 years, the rent that one can charge in NYC has gone up about 70-80%. So if you bought something at a 4% cap rate, it still trades for 4% cap, but you have a 70-80% appreciation in asset value.  Leverage that with 70-80% LTV of 30 year mortgage and your equity return is about 2-3x.  The thing about owning something in NYC is that the rentals almost never go vacant.  I know a lot of people who have 99+% occupancy in the last 10 years, including the tough patch of 2008/2009.  I have a friend who bought a single family home on Long Island.  His cap rate was probably in that 8% range.  But he has a single family home.  His carrying cost is much higher, i.e. property taxes.  His leasing window is 4 weeks when he rent to college students.  If he had to rent to normal working adults, then he deals with some unsavory characters like waiters and waitress who will destroy his house through partying etc.  The people who can afford his rent are people with higher risk profile to him like someone who wants to run a day care.  If he has an empty house, he's on the hook for over $10k in property taxes alone.  The buildings in NYC, we put a sign up that says for rent and we get calls the same day.  I've seen examples where tenants  decide to move out out of the blue.  For rent sign goes up, shows apt to new tenants and new tenant move in 2-3 days later.  What I'm describing is in the Queens part of NYC where you have a large immigrant renters.  I think they are even better rental markets for the white collar renters in Manhattan.  So each market is little cosmos of their own. 

 

I know it's very hard for value investors to justify paying 4% cap rate.  Heck, it took me 15 years to figure this stuff out and the whole time I was fighting with my family about "we over paid!" and "we can get a higher cap rate in Pennsylvania".  There are tax consequences.  For example, your 10% cap rate, you're paying more taxable income tax on it.  The 2-3 x appreciation in equity is tax free.  If you have the right amount in your W-2s, you can even refi that amount.  I was at a conference where David Abrams spoke.  He said that he invested in some distressed real estate with 20% yield on it.  He said that in hind sight, he would've chose to buy the 15% yield but higher quality assets. 

 

For people from the non-coastal, non-land constraint areas of the US, it's a very different game.  To draw a business quality analogy, buying in Detroit is likely like buying a net-net with very high yield, buying in Dallas is likely buying an okay business, and buying in NYC and SF is like buying a Visa/FB/Lubrizol.  The have different business qualities and require different valuation methodologies.  Like I said, it took me 15 years to figure this stuff.  I wish someone else had explain it from the "hard to replace" "Pricing power" and "barrier to entry" approach to me back in 2002. I would've been a lot wealthier.   

 

Regarding the cracked foundation, in NYC, the land is so valuable, you just pay to get it fixed.  Heck, people dig up former gas stations, dispose of the tank and then put a building on it.  In Queens, the value of the land could be $200 a sqft, it cost you all in about $300 a sqft to build (foundation, structure, plus finishing), and you should earn a $100-200 a sqft profit to take on development risk so that the finish product sells for $600-700 a sqft.  If anything happens to your foundation, you pay to get it fixed.  But we tend to have pretty good soil and no earthquake in NYC. So the foundation don't crack as often as in Houston where you need to bind the clay with lime treatment so that your foundation don't crack over time. 

 

Regarding the 4% going up 2% in cap rate.  If rents go up 70-80%, your former 4% is now 6.5-7.0%.  Technically, you still made a bit of money at the new 6.0% cap rate.  The issue is "do you have staying power?"  Is your building positive or negative carry?  In a 99% occupancy, 30 year fixed rate mortgage, rental increase, you can have a move from 4% to 6% and still not lose money.  I don't think anyone will be happy with that outcome.  But you won't lose your shirt like some sap who bought a SFH in Florida pre 2008.  Obviously, if rents stop going up or occupancy drops from 99% to 85%, you have serious issues.  Writing this out makes these investments sound like I am bat shit crazy. But then I've known this market for 15-20 years now. 

 

My little real estate is a local business rant is getting a bit long.  I'm out. 

[oddballstocks]

This is a great thread, love off beat things like this.

 

I've dabbled in this from time to time.  Never rented out, but have looked and purchased land.

 

Location is key.  In RE the market seems to be reasonably efficient too.  That is nicer places near shopping are more than dumps in a crime ridden area.  People seem to ball park the same repair costs too.

 

If you can do things yourself, or cheap that's when you get a deal.  Homes aren't complicated, but there is a learning curve.  What I've found with homes and cars is it pays BIG time to learn and understand everything.  That way when an electrician comes in to do a $1500 upgrade you know if they're doing it right, and know if they're cutting corners.  Tangentially this works with mechanics too.  If you go in and say "I have a weird sound" you will get ripped off.  But if you learn a little and say "I think a tensioner pully is going" they will talk to you on the level and you will know if their logic works or not.

 

My advice would be look for hidden issues.  Everyone sees bad carpet, or an ugly exterior.  Look for knob and tube wiring, look for cracked foundations, water damage, or serious structural issues.  Those are the expensive repairs that can destroy any hope of value.  Everything cosmetic is fixable.

[LC]

Really depends on your budget.

 

About 4 years ago I did a 2 year MBA program in NYC. 99% waste of time (from an educational perspective) - with one exception. I took a class called real estate entrepreneurship. It was taught by a guy who moved to NYC from Iran in the 70s. He bought a bunch of row houses in Harlem with about 10 of his coworkers. 40 years later they have 50 affordable housing buildings across NYC.

 

Couple of key things I remember:

-Large projects (esp 80/20s) hinge on syndicated tax breaks (IIRC state street has the monopoly here) and low-interest financing provided by the city/state

-Air rights are extremely important. Usually they are obtained by purchasing your neighbors' air rights.

-Lot location on a row of lots is important. End lots can get squeezed out by a developer, whereas middle lots are harder to ignore.

-As someone mentioned, environmental remediation is important. They developed a gas station on a corner of Central park  but had to foot a huge bill for the soil remediation. Negotiation is key here.

 

Use your city resources. NYC is well-developed in terms of available city resources. You can easily search lot information, tax information, DOB permit information. Harder to do but still possible is search all sites with environmental issues.

[LounginMKL]

I live in SF and can give some color on rent-controlled properties here. After talking to a few apartment owners, I learned that

 

- Rent-controlled properties that transact at 3-4% cap rate can be misleading. These acquisitions usually baked in some rent upside through natural attrition (move-outs) and adjusting rent to market rates.

- Existing below market rent offers good downside protection; rent income doesn't decrease during market downturn because it's already below market.

- In fact, property owner can opportunistically buy out tenant during market trough, when the delta between what your tenants pay and market rent is diminished.

 

Through some digging, I learned that the largest apartment owner in SF is funded by none other than one of our favorite value investor- Baupost Group. All rent-controlled properties.

[BG2008]

Really depends on your budget.

 

About 4 years ago I did a 2 year MBA program in NYC. 99% waste of time (from an educational perspective) - with one exception. I took a class called real estate entrepreneurship. It was taught by a guy who moved to NYC from Iran in the 70s. He bought a bunch of row houses in Harlem with about 10 of his coworkers. 40 years later they have 50 affordable housing buildings across NYC.

 

Couple of key things I remember:

-Large projects (esp 80/20s) hinge on syndicated tax breaks (IIRC state street has the monopoly here) and low-interest financing provided by the city/state

-Air rights are extremely important. Usually they are obtained by purchasing your neighbors' air rights.

-Lot location on a row of lots is important. End lots can get squeezed out by a developer, whereas middle lots are harder to ignore.

-As someone mentioned, environmental remediation is important. They developed a gas station on a corner of Central park  but had to foot a huge bill for the soil remediation. Negotiation is key here.

 

Use your city resources. NYC is well-developed in terms of available city resources. You can easily search lot information, tax information, DOB permit information. Harder to do but still possible is search all sites with environmental issues.

 

LC,

 

Please explain more of the end lot versus the middle lots. 

[LC]

Sure. So if you are a developer and you are looking to buy up a bunch of row houses or brownstones and build a high rise, you most likely need the middle lots. End lots you can theoretically cut out, just cut the building off right before the end lot. Middle lots you need: you can't have a gaping hole right in between of the building (obviously), and the numbers won't work to build 2 high rises on either side of the middle lots.

 

It comes into play when negotiating buyouts, because middle lots can stop the entire project while end lots can be ignored.

[BG2008]

Thanks, makes sense. 

[chrispy]

Very informative. Thanks to all that have contributed.

[BG2008]

Just curious what cities aside from NYC, SF, LA, Honolulu, Seattle have natural barriers to new supply?  DC kind of has, but it seems like there's not much zoning barriers as million sqft projects gets readily approved all the time. 

 

Natural barriers - Mountain, ocean, rivers, islands that prevents new supply from coming on

Zoning Barriers - laws that makes new construction prohibitively costly from a monetary and time perspective

[DooDiligence]

This is a great thread, love off beat things like this.

 

I've dabbled in this from time to time.  Never rented out, but have looked and purchased land.

 

Location is key.  In RE the market seems to be reasonably efficient too.  That is nicer places near shopping are more than dumps in a crime ridden area.  People seem to ball park the same repair costs too.

 

If you can do things yourself, or cheap that's when you get a deal.  Homes aren't complicated, but there is a learning curve.  What I've found with homes and cars is it pays BIG time to learn and understand everything.  That way when an electrician comes in to do a $1500 upgrade you know if they're doing it right, and know if they're cutting corners.  Tangentially this works with mechanics too.  If you go in and say "I have a weird sound" you will get ripped off.  But if you learn a little and say "I think a tensioner pully is going" they will talk to you on the level and you will know if their logic works or not.

 

My advice would be look for hidden issues.  Everyone sees bad carpet, or an ugly exterior.  Look for knob and tube wiring, look for cracked foundations, water damage, or serious structural issues.  Those are the expensive repairs that can destroy any hope of value.  Everything cosmetic is fixable.

 

If you're looking in the coastal southeast, pay close attention to termite damage as well.

 

This could present buying opportunities too, as many will run from a home with visible signs of infestations which may be easy to diagnose & repair.

[LC]

Just curious what cities aside from NYC, SF, LA, Honolulu, Seattle have natural barriers to new supply?  DC kind of has, but it seems like there's not much zoning barriers as million sqft projects gets readily approved all the time. 

 

Natural barriers - Mountain, ocean, rivers, islands that prevents new supply from coming on

Zoning Barriers - laws that makes new construction prohibitively costly from a monetary and time perspective

 

Ski areas may be another good one. Or areas around universities. I would guess the better the mountain/uni, the more stable your rental would be.

[premfan]

s

Just curious what cities aside from NYC, SF, LA, Honolulu, Seattle have natural barriers to new supply?  DC kind of has, but it seems like there's not much zoning barriers as million sqft projects gets readily approved all the time. 

 

Natural barriers - Mountain, ocean, rivers, islands that prevents new supply from coming on

Zoning Barriers - laws that makes new construction prohibitively costly from a monetary and time perspective

 

Population per square mile.  The natural barrier is land. A good example by me is Boulder Co.  Zoning could be a issue since they need to build vertical now.  Yet we don't want to block access to the beautiful mountains. Whats there solution?  Demand is there. Land is scarce. Air rights would seem like a challenge for our hipster neighbors to approve. 30 mins from Denver. Yet more population per square mile than Denver. Overindex Boulder.  underindex Denver.

 

edit: just checked didnt realize how fast denver has grown lately. Population per square mile roughly the same.

[gurpaul88]

Anyone have any experience in student rentals?

[rb]

Anyone have any experience in student rentals?

Not me, but a client of mine had a bunch.

 

They destroy the unit. So every year you have to repaint and make other repairs. You'll need to have laminate or you have to change the carpet every year and that's too expensive. Also you generally need to find new tenants every year. You get to keep the security deposit each year but that's not enough to cover the cost of the repairs. Still you make good returns. He made 8-12% per year ROE without using debt.

 

There were also some issues with late rent but at least in his case he got all the rent he was owed eventually. He sold all his student rentals this year because they were too much hassle.

 

Bottom line you can make good money, but you get to work for it.

[netnet]

Anyone have any experience in student rentals?

Not me, but a client of mine had a bunch.

 

They destroy the unit. So every year you have to repaint and make other repairs. You'll need to have laminate or you have to change the carpet every year and that's too expensive. Also you generally need to find new tenants every year. You get to keep the security deposit each year but that's not enough to cover the cost of the repairs. Still you make good returns. He made 8-12% per year ROE without using debt.

 

There were also some issues with late rent but at least in his case he got all the rent he was owed eventually. He sold all his student rentals this year because they were too much hassle.

 

Bottom line you can make good money, but you get to work for it.

+1

 

The only other thing to add on student housing is that it does make long term demand forecasting easier, with the caveat that projected student population may be going down, which will affect weaker schools without endowments and that are poorly ranked.

[BG2008]

Has anyone owned property in flood zones or areas prone to hurricane damage?  What are some of the surprises?  Obviously, everyone wants something near a pristine beach etc.  Has anyone utilized a weekly rental during the summer or AirBnb?  One thing that is interesting is that many waterfront areas tend to have ocean and bay areas.  The Bays are further inland.  During a storm surge, the ocean side gets hit with the wave but the further inland Bayside tends to get flooded more easily.  If anyone has experience living near water would like to talk about this, it would be greatly appreciated.  How does FEMA price flood insurance? 

[odin]

You should definitely check flood maps on the county's website, but I would also check out the area after a heavy rain.  This will tell you a lot about the area's drainage that the flood maps won't. 

 

Flood insurance is cheap even in a high-risk zone.  We are talking in the hundreds of dollars per year for average single family home, at least where I am.

 

I'd probably be more concerned with the out of pocket cost from wind damage.  A wind deductible is 2% of the home's value, so you may have to eat the repair cost of even moderate damage (usually roof damage).  Check health of trees surrounding the property.  Much of the hurricane damage I have seen was from trees falling through roofs.

 

You'll want to see if the house has hurricane shutters.  Much easier than boarding up if necessary.  Check building codes if you plan to replace windows.  Many jurisdictions require hurricane shutters to be installed if the windows are replaced.  This could cost a few hundred bucks per window. 

 

Hope this helps.

[BG2008]

You should definitely check flood maps on the county's website, but I would also check out the area after a heavy rain.  This will tell you a lot about the area's drainage that the flood maps won't. 

 

Flood insurance is cheap even in a high-risk zone.  We are talking in the hundreds of dollars per year for average single family home, at least where I am.

 

I'd probably be more concerned with the out of pocket cost from wind damage.  A wind deductible is 2% of the home's value, so you may have to eat the repair cost of even moderate damage (usually roof damage).  Check health of trees surrounding the property.  Much of the hurricane damage I have seen was from trees falling through roofs.

 

You'll want to see if the house has hurricane shutters.  Much easier than boarding up if necessary.  Check building codes if you plan to replace windows.  Many jurisdictions require hurricane shutters to be installed if the windows are replaced.  This could cost a few hundred bucks per window. 

 

Hope this helps.

 

What are Hurricane Shutters?

[Pelagic]

You should definitely check flood maps on the county's website, but I would also check out the area after a heavy rain.  This will tell you a lot about the area's drainage that the flood maps won't. 

 

Flood insurance is cheap even in a high-risk zone.  We are talking in the hundreds of dollars per year for average single family home, at least where I am.

 

I'd probably be more concerned with the out of pocket cost from wind damage.  A wind deductible is 2% of the home's value, so you may have to eat the repair cost of even moderate damage (usually roof damage).  Check health of trees surrounding the property.  Much of the hurricane damage I have seen was from trees falling through roofs.

 

You'll want to see if the house has hurricane shutters.  Much easier than boarding up if necessary.  Check building codes if you plan to replace windows.  Many jurisdictions require hurricane shutters to be installed if the windows are replaced.  This could cost a few hundred bucks per window. 

 

Hope this helps.

 

What are Hurricane Shutters?

 

Shutters come in a variety of forms. Some are accordion style that are a permanent part of the structure and can be easily closed, like an accordion. This is IMO the best option, especially for a rental where you may not have the time to get to the unit to shutter it. The mid tier is pre fit pieces of aluminum that already have holes pre-drilled for them on the structure making putting them up quick and relatively easy. Last, is the venerable sheet of plywood - it works, but expecting your tenants to take an interest in your property's safety in the day or two before the storm when they may need to evacuate themselves is a toss up. Impact rated glass is also an option and a lot of new construction here in S. Florida utilizes it.

 

The comment on trees is especially relevant, flying debris is one thing, and shutters or impact glass will protect against it fairly well, but nothing is going to help when a tree falls on your roof. I'd say 60% of the trees in my yard came down during Irma, fortunately none fell on the house, but the vast majority of structural damage here in Miami was from falling trees. For a rental property it would be easy enough to eliminate this risk by keeping trees small or select trees that handle wind well.

 

For storm surge induced flooding this is a useful interactive map to determine a location's risk. http://noaa.maps.arcgis.com/apps/MapSeries/index.html?appid=d9ed7904dbec441a9c4dd7b277935fad&entry=1

 

Rain caused flooding like that from Harvey will be different and you can rely on county flood zones for an estimate.

[netnet]

Has anyone owned property in flood zones or areas prone to hurricane damage?  What are some of the surprises?  Obviously, everyone wants something near a pristine beach etc.  Has anyone utilized a weekly rental during the summer or AirBnb?  One thing that is interesting is that many waterfront areas tend to have ocean and bay areas.  The Bays are further inland.  During a storm surge, the ocean side gets hit with the wave but the further inland Bayside tends to get flooded more easily.  If anyone has experience living near water would like to talk about this, it would be greatly appreciated.  How does FEMA price flood insurance?

 

My theory or mental model has been to be at least .5 miles from the flood zone or the beach, i.e. enjoy(rent) beach and buy the dry land, but that's just me.

[oddballstocks]

You should definitely check flood maps on the county's website, but I would also check out the area after a heavy rain.  This will tell you a lot about the area's drainage that the flood maps won't. 

 

Flood insurance is cheap even in a high-risk zone.  We are talking in the hundreds of dollars per year for average single family home, at least where I am.

 

I'd probably be more concerned with the out of pocket cost from wind damage.  A wind deductible is 2% of the home's value, so you may have to eat the repair cost of even moderate damage (usually roof damage).  Check health of trees surrounding the property.  Much of the hurricane damage I have seen was from trees falling through roofs.

 

You'll want to see if the house has hurricane shutters.  Much easier than boarding up if necessary.  Check building codes if you plan to replace windows.  Many jurisdictions require hurricane shutters to be installed if the windows are replaced.  This could cost a few hundred bucks per window. 

 

Hope this helps.

 

Flood insurance is NOT cheap here.  We looked at a $270k house about 250ft from a little stream.  It was going to be $300/mo for flood insurance at the old rates, and $500/mo at the new rates.  I don't remember what year the rates changed, 2014, 2015?  It was a deal breaker.  RE agents said it's almost impossible to sell a house in a flood plain.

 

So we purchased a house five houses up on the same street.  We're about 100ft higher and out of the flood plain.

 

[DTEJD1997]

Has anyone owned property in flood zones or areas prone to hurricane damage?  What are some of the surprises?  Obviously, everyone wants something near a pristine beach etc.  Has anyone utilized a weekly rental during the summer or AirBnb?  One thing that is interesting is that many waterfront areas tend to have ocean and bay areas.  The Bays are further inland.  During a storm surge, the ocean side gets hit with the wave but the further inland Bayside tends to get flooded more easily.  If anyone has experience living near water would like to talk about this, it would be greatly appreciated.  How does FEMA price flood insurance?

 

I owned some commercial property outside of Houston.  It was subjected to and went through a couple of hurricanes.  In each hurricane, the property suffered some damage, but each time it was relatively light and not really worth filing a claim as there was a deductible, and I'm sure the insurance would have gone up AFTER a claim.

 

As the years went by, there was only ONE insurer for hurricanes in the area that I was in.  Rates went up & up & up & up.  It was a TREMENDOUS cost and was one of the things that caused the business to shut down.  If we could have gone without it, we would have.  Unfortunately, we had a mortgage on the property and could not go without hurricane insurance.

 

In all the years that my business owned the property, we sure paid a LOT of insurance but never even filed a claim.

 

So my advice is that if you are considering a property in a floodzone/hurricane prone area, get a quote on insurance...BUT ALSO get multiple quotes to see how many competitors there are.  If there are only two or three carriers, I would be VERY cautious.  Can your business withstand a doubling or TRIPLING (or more) of rates if some of the competitors leave the market?