Carpet Removal in Industrial Spaces

As a word to the wise, be sure to include in any lease or sale of industrial property, that if they are removing the carpet in the unit, or any other form of flooring, that you include language that ensures that they return it to a fair and usable condition.

I cannot tell you how many of my clients have been so pleased that they had language in the agreement to cover that: most of the time, removing carpet leaves behind unsightly and problematic glue stains and other spots that may have been otherwise covered by the carpet — and those can really be costly to fix.

For more quick tid-bits of advice on commercial real estate in Los Angeles, please visit our website — Monocle: experience the difference.

Why No One Should Be in a Hurry To Buy a House

It’s tempting to look at the free-falling prices in real estate right now, and start salivating — visions of seeing those prices blip back to their values from two years ago, and realize a 100% profit in a few short years. I only have one bit of advice: wait — it is going to go a lot farther.

Everyone has said that “the other shoe” has dropped on residential real estate, and it is a great time to buy, but in actuality, we are waiting on three more to drop — escalated interest rates, reflected median household incomes, and simple supply and demand.

Interest rates are great right now — in fact, unprecedented…one of the best rates we have seen. Shouldn’t that mean its a great time to buy, since money is cheap and you can get more house for your dollar? In an isolated experiement, yes. And certainly, the rate will deifintely increase. However, in a market in which “value” is tied to the actual and current availability of money, home prices are HEAVILY tied to interest rates, and as rates rise, home values drop significantly. As an example, let’s say a buyer can afford $2,000/mo. in mortgage expenses. If the interest rate (like current) is 5%, he could afford up to a $480,000 house, depending on how much financing he could secure. Now, let’s say available interest rates jump to a historically-normal level of 10% — all of a sudden, that same buyer can only afford up to $240,000 of house — halving his buying pwoer, and thereby, the value of any home he would have been considering. Rising interest rates is not a chance event — it is a certainty. And anyone buying now will have to realize that every point the interest rate rises, the effect will be huge on value.

The second consideration is median household incomes. Though the numbers have not come out for 2008, median incomes are projected to be around $62,000, which is in great contrast to the $255,000 median home price. Traditionally, people can afford to borrow up two times their income, and the disproportionate growth of home values have left this scale still very off-set. And with the general economy on its downturn, it is only likely to greaten the divide. Expect prices to adjust downward to come back into relation to income.

The third is simple supply and demand. Traditionally, a residential property was valued at a point in which the monthly expenses of owning were in equilibrium with renting a comparable building, less a dividend to account for the difficulty of acquiring a down payment. So, the idea would be that a house would cost the same as renting, less a 6-10% return on the total value of a down payment. For the last few years, however, there was no necessary down payment, and therefore no dividend applied to value, and due to the appreciate rates, fell way out of line with renting, because the assumed increase in value would far outweigh the additional monthly costs, which would often be paid by cash pulled from the home’s “equity.” But now that appreciation rates, housing must prove itself once again to be a competitive investment vehicle compared to other elements, or else people will rent.

And so when is a good time to buy? Well, expect this year to be a hard one (30% further drops in value will not be unheard of), and then start leveling off once values are back within reason on the above rules. The nice thing is that after a big boom and bust in real estate, prices tend to level out for several years, which means you can afford to be patient, and wait until things cool down (you can read my article on “sticky-floor” real estate pricing) coming i nthe coming days.

The author is a professional in both residential and commercial real estate in Los Angeles. Please visit his website for more information.

Sorry Home-Owners: 5 Reasons We Haven’t Hit Bottom in Real Estate

With real estate markets across the country in relative shambles, and some of the darkest days in real estate in memory, home-owners are desparately in need of some good news, and some relief.   The bad news? It’s only going to get worse.

Below is a list of the five major indicators that we have not yet hit bottom of the real estate market:

5. Interest Rates and the Tightening of Lending Practices

One of the most important factors that determines the  value of real estate is the Federal interest rate, and the availability of money. 

When the interest rate is low, the actual cost of borrowing money is also lowered, which means that people can afford to take on greater debt.   Affordable debt means that people can afford to pay a greater purchase price with the same relative cost to them, and that, in turn, drives of homes values.

In the last 10 years, we have seen unprecedented lows in interest rates, and the availability of money in the U.S.  Not only that, but banks were lending money to anyone that asked for it at rates below the federal interest rate (that is the “sub-prime” part of sub-prime mortgages….but more on that later.)    

To give you a historical perspective, see the chart below, which graphs out the historical mortgage interest rates in the US:

 

As you can see, as recently as 2000 the average interest rate was floating at around 8-9%, as opposed to the 5-6% that has been the average of the past several years (bear in mind, this chart excludes adjustable-rate mortgages…the number of which more than quadropled in the last few years.) 

The reason it has been so low is because of Fed rate slash right after 9-11, which dropped the rate from around 7 to a mind-boggling 1%.  It has been on the gradual incline since then, but it is still well below historical norms.  Extended periods of low interest rates are bad for our economy, because it devalues the dollar.  As such, the government is incentivised to increase the interest rate to promote economic stability, so whenever they can, they will raise it.

On top of that, with the recent foreclosure rates and general replication of the S&L crisis of the 80’s, burned banks are going to have to severely tighten lending restrictions, to ensure that they are making loans that will proform.  Gone will be the 0% down teaser rate mortgages with no credit requirements:  alerady, federal banks and the government have issued requirements that will take effect later this year that will require strict credit checks, and a miminum percentage down payment (likely around 20%.)

HOW MUCH FURTHER WILL IT DROP?

So what does stricter lending requirements and higher interest rates mean to the housing market?  Well, with fewer buyers, and a higher rate, prices still have a long way to go.  To give you a frame of reference, it is a 33% increase to go from 6% interest to 8% interest, that means the negative effect on price from that alone could be a 25% drop in prices which has not yet happened.  On top of that, restrictive limits on lending means with far few buyers, that downward pressure could be incredibly significant.

SHOULD I BE WORRIED?

While the immediate jump in interest rate is highly unlikely (especially given the current economic situation), but over the long term, it will happen if America wants to restabilize the economy.  On those timelines, however, it will likely only slightly affect prices as compared to various other factors, including inflation, appreciation, and population increases. That said, the tightening of lending restrictions is going to happen, and it is going to happen soon; expect it to become a lot harder to get a loan in the coming years, and for that to affect prices accordingly.  

4. REO Bank Holdings and the End of the Fiscal Year

Real Estate is an interesting market – because home purchases are largely not an pure investment choice, housing prices tend to have a “sticky floor.”  What that means is that rather than sell it for a lower price, many home owners would rather sit on the property and wait for the price to return in value.  The effect of that is that instead of housing prices having a natural oscillation between high and low, the prices tend to go high, drop some, and then flatten out for an extended period of time, until they go up again.

That would be good news, if it wasn’t for REO properties.  REO (Real Estate Owned) properties are properties that have gone through the foreclosure process, and are owned by the banks or lending institutions that made the loan on the house. Unlike home-owners, banks ARE investment owners, and sell their homes based on economic need, rather than lifestyle. 

What this means is that with the unprecented numbers of foreclosures and REOs, banks are holding a lot of homes.  And an unoccupied home makes them no money, provides them with illiquid capital, and in fact costs them money through real estate taxation and HOA dues – none of which banks like.  They are extremely motivated to sell, and sell at severely discounted prices, so long as they come close to meetings the balance left on the original loan. REO properties are the single greatest tangible downward market force on home prices, and the more of them there are, the lower the prices will go.

On might argue that banks don’t seem to be slashing their prices nearly as much as I am alluding to.  The reason is two-fold – 1) like any investor, they do still want the best price possible and 2) chances are you weren’t looking near the end of the fiscal year.

Banks and lending institutions are investor-heavy companies, and as such, their business cycles are very much dependent on the fiscal year.  They are heavily incentivised to liquidiate their real estate holdings at the end of each quarter, and specifically at the end of the year, when they must report earnings, and validate their financials to their investors.

HOW MUCH FURTHER WILL IT DROP?

As we get closer to the end of this year, and indeed, even through the end of next year, expect sales volume to start picking up, and prices starting to get slashed.  Some analysts predict a drop of around 10% over the next 5 months, but if the rest of the financial world stays as bad as it is, that number could go even higher.

SHOULD I BE WORRIED?

While this is a very real market condition, and forclosure figures are still very high, this is a more of a symptom than a cause.  The drop will only reflect how worried the market is, and won’t drop anything like it has over the last year.  And if the slump continues through 2009, that drop would be even lower.

 3. The Home Surplus

A very big reason we are not yet at the bottom is our current home surplus . Please look at the chart below for the number of months supply of U.S. homes of the market as of Q2 2008:

 

In a healty market, home inventories tend to stay at or around 6 months worth of homes on the market.  Today, we are nearly at two times that value, and growing.  What it means, simply, is that prices are still to high. 

This is simple supply-and-demand economics: as the supply of homes continues to grow, and the number of willing and able buyers decreases, prices must drop. 

HOW MUCH FURTHER WILL IT DROP?

It is hard to say, because it is closely linked to many of the other causes in this list, but that in order for us to half the supply, it could take up to 50% of of asking prices.

SHOULD I BE WORRIED?

That said, it won’t.  Instead, the return to 6 months supply will be a gradual process that will be part of the “sticky floor” recovery for houses, during a period of stable pricing. More likely, I think it will show an decrease of around 20%, which includes the numbers from the above downward factors.

2.Resetting Sub-Prime ARMs

Ah, the subprime adjustable-rate mortgage (ARM).  This was really the root of so many of our real estate woes.  A near carbon copy of the S&L crisis of the 80’s, where lenders repackaged bad loans to unqualified borrows and passed them off to national investors, only this time, they were international ones.  The fundamental problem was that the teaser rates would reset from the rediculously low rates to something the borrow could no longer afford, and would have to be foreclosed.  Trillions of dolloars of losses later, banks have learned their lessons, and have stopped offering subprime ARMs, and have again started to tighten lending restrictions.  That was only after the hundreds of thousands of bad loans have gone through the pipeline, and left the real estate market in foreclosure hell.  And it isn’t over.

 

Take a look at the graph below, which charts subprime ARM mortagages in the US, and when they are going to reset the rates on those loans (the subprime ARMs are in gray):

 

 While it may look promising that we are nearing the end of resets, bear in mind that the forclosure process is a 6-MONTH process at least.  Go back sizx months on that chart, and you realize that we are barely halfway through it.

HOW MUCH FURTHER WILL IT DROP?

With billions of dollars worth of real estate subprime ARMs in the pipeline, this can again severely boost foreclosure figures, and drop price significantly. 

SHOULD I BE WORRIED?

Yes.  With only 2/3s of the subprime mortgages reset and through foreclosure, we could be looking at a further 100K+ of foreclosed homes in the coming year and a half.

1.Household Income Vs. Median House Price

Instead of doing much explaining, just take a look at the chart below:

 

From just 20 years ago, housing has gone from at or near median household income, to nearly 4 times.  Why?  For many of the reasons above – cheap and unregulated lending, frenzied consumerism, and international speculation.  Nowhere else in the world are these figures even CLOSE to ours, and it is all value that we will eventually have to give back.

HOW MUCH WILL IT FALL?

This is actually a much larger issue than just the real estate market, and has more to do with the US economy in general.  With our rampant overconsumerism, heavy personal debt, and unrivaled international debt, our economy is largely relying on the support of our international connections to keep us afloat.  Could housing plummet to one quarter of its present value?  Yes. 

SHOULD I BE WORRIED?

Will it?  No.  The US government, and our foreign allies have a vested interest in propping up the US economy for as long as possible.  If that were to happen, we would have to see catastrophies not only in the US, but in European economics, as well as Asia.  It is the one of the interesting elements of global economics: things tend to be far more complicated and interrelated, and, as a result, more stable.  Maybe over 50 years, we will see those numbers back where they belong, but for now, we are safe.

 

SO WHEN DO WE HIT BOTTOM?

This is the multi-million dollar question, and probably why you read this article. 

It is impossible to know for certain when it will happen, or how far it will drop.  My predictions, based on historical housing booms and slumps, seems to indicate that late 2009 to 2010 will have seen the majority of the downward swing, and that when we get there, prices will have dropped a further 20-35%.

That said, there will be clear indicators when we do hit bottom.  The interest rate will have risen by around a point, housing prices will have remained consistent for several months, and the surplus of homes will be on the gradual decline, back towards 6 months. 

As I’ve talked about before, real estate markets have a “sticky floor” for pricing, and tend to have extended periods of nearly flat prices when we have hit bottom, which will remain that way until things go up again.  In the last slump, that flat lasted for 5-7 years, depending on the area.  This crisis was far larger, and far uglier, and I would not be surprised if that flat period lasted for 8-10 years.  My advice to first-time buyers and investors is to wait for 6-8 months of stability before you consider purchasing, and when you do, expect appreciation rates to maintain only with inflation for severla years to come.

 

 

Darren Guttenberg is a real estate broker in Los Angeles, CA, and specializes in commercial real estate investing.  For any of your Los Angeles Real Estate needs, please visit his website.

 

 

Financial Nose-Drive and the Real Estate Market (pt 1)

Whew. What a day in Wall Street. The bill was declined, and it has sent shockwaves across the country. Why was is not passed? Contrary to the (oversimplified and sophomoric) argument that it a partisan issue, the core conflict at hand is trying to determine what the role of government is in the financial sector.

I was opposed to this bill. Why? Obivously, I am a social and financial anarchist. I’m kidding. The actual reason is that the problem is not the hemorrhaging of capital, and the slowdown is NOT caused by a lack of capital. It is a consistent lack of regulation and oversight. The government SHOULD be creating a bill that severely punishes and regulates lenders from making those foolish subprime loans, repackaging them all golden shit, and selling them on the free market. The problem is that it is not in a financial institutions best interest to UNDERWRITE THEIR OWN LOANS. That is the fundamental problem — not that of capital, or market fear, but rather a necessary reinstitution of the kind of loan underwriting and qualification process that existed for the last 100 years.

What does that do to the real estate market? More in part 2.

For more information about Los Angeles commercial real estate for sale, visit our website!

Commercial Real Estate for Beginners — Due Diligence

The due diligence period is an incredibly important period in any real estate transaction — it is the time in which the buyer reviews all the material information on a property, and perform any onsite or off-site inspections that are relevant to the property.

There are several important things to remember in negotiating due diligence, and performing it. Here are some bits of advice:

-Get on it quickly. The typical due-diligence period lasts between 20 and 30 days, which will slip through your hands quicker than you could guess. The moment the time period begins, start ordering your necessary inspections, and finding all the necessary vendors. I can’t tell you how frequently deals fall out of escrow because of an ill-planned due-diligence period.

-Make sure it only starts AFTER you sign off on having recieved all the due diligence papers from the sellers. A slow-moving, or disorganized seller can otherwise put a severe dent in your due-diligence period.

-Ensure a positive affirmation in writing to remove the condition continency. You don’t want to be late on the due diligence period, only to have your silence mean that you have removed the contingency, lost your ability to disaffirm, and moved the deal forward. This is a big one, and is almost never understood.

-Make your financial contingency separate from the due diligence period. You don’t want to have two different contingencies come up at the same time, unless you are not looking for traditional financing.

This is a delicate part, and often overlooked part, of real estate negotiations. For more advice, or to search with our Los Angeles commercial real estate agents, please visit our website.

Commercial Real Estate for Beginners — Mello Roos

Mello Roos tax is an interesting and new development in real estate markets as an additional tax and work-around to proposition 13. The problem was this: the theory was that home owners property tax was in large part used to upkeep the necessary streets and infrastructure. The only problem was that prop 13 capped the inflation of that cost, which did not keep up with the infrastructure costs of keeping up a city.

Mello Roos is a special assessment that provides particular charges for street and infrastructure costs — similar to a non-elective HOA. The only problem is that these assessments only come from new homes with that assessment, and do not cover the old developments. So while they have helped to stem the influx of underpaid infrastructure expenses, it is not a permenant fix.

What if you are in a place that assesses Mello Roos? We’ll good news and bad news. Good news is that you are likely paying less purchase price, and will have a well-kept area, but the bad news is that the price reduction will not be equal to the overall cost of the tax, and it does hurt your resell value. Plus, there are no assurances that it will only be used for your area.

For more information on Los Angeles commercial real estate, visit Monocle Real Estate Services.

Commercial Real Estate for Beginners: What a Broker Can’t (or Shouldn’t) Do

Well, I will consider this venting, but this is actually very useful — there are many things that people in the commercial real estate (and real estate) world should know that brokers cannot, or at least legally should not, do:

-They are not CPAs — they cannot give tax advice. Remember when I gave that caveat about 1031s? That’s because I am not a certified CPA (nor are nearly all brokers), and therefore we cannot give tax advice directly. Of course, it is a gray line — because we can make you aware of certain information, and advise you to go see a CPA to learn more about it, but if you choose not to do it, it is not our fault.

-We can give law advice either. We are not lawyers. Technically, we should not even be writing up offers and contracts (though we normally do), because we are supposed to only “advise” and we cannot provide you with the same level of protection that a real estate lawyer can.

-We can’t make sellers buy your property. Many people blame the agent if their property isn’t selling (and you know what, a lot of time they are right), but many times, it is because the owner is unwilling to make the price match the market demand. No matter what amount of money they put into marketing, brokers cannot make buyers buy the property.

-We can’t lie to you, or to anyone else. …I know, sit back down — shocking, right? Actually, we are legally obligated to provide “complete disclosure about any physical or material information regarding a real estate transaction.” That means no lying, and in fact, no abstaining, either.

-We can’t all call ourselves “brokers.” This is a touchy one, because people tend to use the words agent and broker interchangeably. I will get into more later, but essentially, not all agents that call themselves brokers are in fact brokers — they are real estate agents, or salespeople. A broker’s license requires a 4-yr college degree (or similar experience), and about 4 times more real estate education, and a much harder exam.

I’ll stop there, but if you want more information, or if you are looking for a Los Angeles commercial real estate BROKER, please visit me at Monocle Real Estate Services.

Commercial Real Estate for Beginners: NNN Leases

The phrase “NNN” (or “triple-net”) leases comes up a lot in commercial real estate, so here’s a quick heads-up on what that is.

In its essence, a triple-net lease is a lease in which the tenant pays a base rent, plus NNN charges, which are meant to pay for common-area maintenance, real estate tax, and other expenses (the three N’s…duh!). In essence, this lease type allots the tenant to pay for everything, on a pro-rata share, for the building. This is a common practice mostly in retail, but is becoming more and more popular in other property types. Obviously, the appeal to a landlord is that they do not have to worry about paying anything to keep the property running, and in fact can cash the base rent like it is his NOI, because it is.

Why do tenants do it? Typically, it allows the tenant for lower rents, greater control over the property, and sometimes big concessions, such as veto power over what other tenants move in, or help paying for TI.

For more information on commercial real estate, please visit our website.

Commercial Real Estate for Beginners – Expenses

So I have warned about the dangers of “pro forma” — now, I want to talk to you about the other danger in commercial real estate investing: expenses.

Let’s say you find a property for sale that seems incredible — $200K / Year NOI, offered at a 10% CAP rate. You’ve checked to see if these numbers are real, and they are! Time to rejoice — you’ve found a diamond in the rough!

…Except for one thing. The expenses for the property are $10K / year. But wait, you say, they have the receipts to prove it: they have a trash, maintenance, G&E, and everything else you think you need.

The problem with expenses is this: no two people can own and run a property the same way, and “their” expenses are NEVER “your” expenses. In the example above he must have slave labor to do all the tasks, and incredible subsidies from the state to have that low of numbers, not to mention they must have owned it forever — your real estate tax alone would blow that 10K way out of the water.

The bottom line is that you cannot use their numbers. Ideally, you have real hard market data for the area, and have spoken with other owners to see what different things cost for your particular property type. If not, you are going to have to call local places up, and get “bids” from them to see what it will all approximately cost.

In the next post, I will list what it is you need to pay particular attention to, to calculate your own expenses for any purchase.

For more Los Angeles commercial real estate information, please visit us at Monocle Real Estate.

Commercial Real Estate for Beginners: Commercial Flipping

So, all you house flippers out there have probably felt a little discouraged…with housing prices in a freefall, your job has quickly become fixing broken fixtures in your rentals, and wishing for a housing miracle. Too bad there is no other way to use your skills…

Oh wait! Residential’s nerdy stepbrother, commercial real estate is a phenominal place to apply your skills, and make big profits flipping apartment complexes, office buildings, industrial complexes, or retail. Like everything else in commercial real estate, it has a different name for it — called “repositioning” — but guess what? It is strikingly similar.

So the theory behind house flipping is that you increase the appeal, usability and overall percieved quality of the home, and thereby increase the value. Commercial real estate seems like, with all of its “hard economic” valuation methods (cap rate valuation), the same model would not apply. But it does.

Let me use an example, one that is most like housing: apartment buildings. Lets say its valued at $1,000,000, and brings in an net operating income (total rents – expenses) of $50,000. That means it is a 5% CAP. Now, at 50,000 / year NOI, you know that the rent values are below market value for the area, and there is room for doubling that number — all it needs is to be brought up to the standards of the rest of the block (sounds ambitious to an outsider, but seasoned house flipper’s ears should be starting to hear something very familiar….) You put $100,000 repainting, fixing up the individual problems, and doing whatever else it is you houseflippers do, and behold! Renters are willing to pay twice the rent because of the “percieved value” of the apartment! But what kind of value did you add to it?

Let’s go back to our “hard economics” — if the NOI is now twice what it was (as the improvements did not increase the monthly or yearly expenses of the property), that means that the NOI is $100,000 / yr. Now, if you were to sell it at the same 5% Cap rate — it would be worth $2M!

Now here’s the REALLY cool part: if you’ve been reading this series, you remember that “cap rate” represents the “percieved risk” associated with a property — it correlates to how likely it is to command the full suggested NOI. Well, in fixing up the property, giving it new paint job, and improving its percieved value, that also decreases its percieved “risk.” And NOW you can sell your property at a lower cap rate — Let’s say you made it a 4% instead of a 5%. $100,000/.04= $2.5M!

And in putting in your initial investment, and doubling the rents, you have mor than doubled the value of the property. And this same logic can be applied to offices, retail or industrial — remember that all these building’s values are based on what people “feel” the space should rent for.

Pretty cool, no?

There is a lot more depth that I can go into commercial real estate flipping, but I think I will hold off for another post. For all of you Los Angeles commercial real estate needs, feel free to contact us at Monocle Real Estate Services.