Invest in Real Estate

New White Paper Available: The Great Housing Workout

The Great Housing Workout White Paper

Arixa Capital has released a new white paper focused on the U.S. housing market and single family homes as an asset class for investors to consider. The white paper is based on Arixa's concrete experience investing in this area in recent years, working with local operators who buy properties in a specific geographic area, renovate them, and either lease the homes or resell them.

The white paper explains various ways that investors can gain exposure to this asset class, which Warren Buffett recently endorsed as underpriced and attractive. The author explains the advantages and disadvantages of various investment strategies for both active and passive investors.

The white paper also explains that the activity of thousands of local operators is already helping to work through the backlog of foreclosed homes. Attracted by appealing profits, local operators will help the housing market to heal over the next several years. Policies that aim to solve the problem on a mass scale are neither needed nor advisable.

For a copy of our white paper, please click here.

Los Angeles Business Journal Quotes Jan Brzeski

Arixa founder Jan Brzeski was recently quoted in a Los Angeles Business Journal article about investing in residential real estate. The article can be found by clicking here.

February 8th UCLA Panel Discussion

To all who registered for and/or attended our event last week, thank you for coming. If you were able to attend, we hope you found it valuable. If you are interested in the photos that were taken of the event, please click here.

To read more about the event, please click here.

The unique value proposition for this event series is the high quality networking and educational opportunity combined with the very low registration fee ($15 for pre-registration or $20 at the door). The fact that beer, wine and appetizers are included in the price is also popular with participants.

For those of you who were unable to attend, or would simply like to listen to the discussion again, the UCLA Ziman Center was kind enough to record the event again this year. We plan to post this video very soon, so please check back on this blog for that link.

If you have suggestions for making the event even better next year, or would like to reach us for any other reason, we would love to hear from you. Please email Jan Brzeski at jbrzeski@arixacapital.com.

Register for the 2012 Annual Real Estate Roundtable Discussion

Join Arixa Capital Advisors and five established real estate investors for our seventh annual real estate investment panel discussion at the Anderson School at UCLA on February 8, 2012. To learn more, click here, or register at http://arixacapital.com/conference/

Jan's New Article Appears on Seeking Alpha

Jan published a new article on Seeking Alpha last week, entitled "Apartments—A Contrarian View." The article analyzes a recent prediction by Moody's Investor Services that apartment values will increase substantially in the next few years. While Jan is not bearish on apartment values, he believes that the projections reveal a substantial misunderstanding of the market and that the projections are very unlikely to prove accurate. To read the article, please click here.

A Real Estate Investor's Approach Towards Chimera Investment Corp.

Chimera Investment Corporation (CIM) is a $3 billion mortgage REIT with an 18% dividend yield. In an article for Seeking Alpha, Jan Brzeski analyzes Chimera the way we at Arixa Capital would analyze a real estate investment, focusing on the income it generates, the dependability of that income stream, and how the investment is financed. To read this article, please click here.

How Risky Is Annaly Capital?

With a dividend yield of more than 14%, it is hard not to be interested in Annaly Capital (NLY), the largest mortgage REIT.  At Arixa Capital we manage a portfolio of real estate loans...a miniature version of a mortgage REIT.  In a two-part article for Seeking Alpha, Jan Brzeski applies his expertise as a real estate fund manager to analyzing the risks inherent in Annaly Capital's business model. To read part 1, please click here.

To read part 2, please click here.

The Case for Single Family Homes (Part 2)

Jan Brzeski is a contributor to Seeking Alpha. The article below is a copy of what he posted on August 30, 2011. To access his article on Seeking Alpha, please click here. In the first article in this series, we explored how "replacement cost" analysis suggests that single family homes in Phoenix are undervalued, and why they are much more likley to go up in value in coming years, rather than moving down.

In this article, we explore a second, independent, strong signal that single family housing in some areas is undervalued. For this article, we will switch to inland Southern California rather than Phoenix, since I know the rental economics better in this area.

Single Family Rental Economics Below is a home about an hour from Los Angeles that was purchased for a little over $100,000 in early 2010.

The buyers of this home are a father and son team who have purchased about 100 homes in the same area in the past two years. They have sold about sixty homes after rehabilitating them, and they have held onto the other 40 homes to create rental income.

They spent about $13,000 rehabilitating this property, so their total cost basis is about $115,000. Today, the house is rented for $1,450 per month. Assuming one month of vacancy each year, rental income is about $16,000 per year. Operating expenses are about $5,000 per year. Net income is about $11,000 per year. On their cost basis, the owners are getting about a 9.6% cash-on-cash return ($11,000/$115,000).

If they bought a similar home today, in need of repairs, direct from a bank, the market is more competitive and they would pay more--probably $130,000 instead of $100,000. Even so, they would still have well over a 7% cash on cash return. Once rehabbed, the property would be worth in the high $100s. This property is appraised at a retail value of $195,000 today.

A Quick Look At Multifamily Rental Economics Let's compare the single family home "fix-and-rent" strategy with buying apartments.

If one were to buy a 100 unit "Class B" apartment building in the same area as this home, it would trade at a capitalization rate of about 6.5%. That is, the income before debt service would represent a yield of about 6.5% as compared to the purchase price.

Given today's low interest rates on multifamily properties courtesy of Fannie Mae (currently under 5% for a 10-year maturity), the cash-on-cash return would be okay from the apartment property--probably about 5% after accounting for principal payments required by the mortgage, reserves and other factors.

However, if interest rates go up, or Fannie Mae stops subsidizing the apartment market by providing such low rates for apartment owners, the value of such assets could easily drop. Investors look at their cash-on-cash returns after debt service, and apartment values have been driven up by very low interest rates for apartment loans. If these rates were to go higher, apartment values would drop, just like bond values.

The Risk Of Buying Apartments Today The bottom line for apartment investors is, they can enjoy low single digit cash-on-cash returns. However, in my view, there is a substantial chance of capital loss, even if rents keep going up, because higher interest rates will lead to higher capitalization rates which means lower values.

For example, suppose we have a change in cap rates from 6.5% to 7.5% (which is historically a more typical cap rate for Class B apartments in secondary markets). A property with annual cash flow before debt service of $300,000 drops in value from $4.6 million to $4.0 million--a 13% drop in value. Now suppose that the property has a loan of $2.3 million. The $600,000 drop in value now equates to a reduction in equity from $2.3 million to $1.7 million, or a 26% drop in equity.

Apartments are currently a favorite asset class for real estate investors, but as the numbers show, there is real risk for apartment buyers when cap rates are at historic lows, as they are now.

Apartments vs. Single Family Home Rentals If, instead of buying a 100 unit apartment building, one were to purchase, say, 60 homes in the same area, there would be certain advantages and disadvantages.

The apartments would be much easier to manage, since they are all grouped together and there are economies of scale. Also, it is easy to get financing to buy apartments, while financing to buy single family homes as an investment is difficult to find and expensive.

The single family homes have the advantage that the current yield (cap rate) is a little higher than the current yield on apartments. Say, 8% vs. 6.5%. They also have one other important advantage. The homes can be sold individually, and if they are purchased from a bank by an experienced operator, they can be bought at "wholesale" prices.

As a result, a home bought for $130,000 and rehabbed for $15,000, for a total cost basis of $145,000, might be worth $185,000 once it is fixed up, because it can then be purchased by a family and once fixed up, the home will qualify for Fannie Mae or HUD financing (which increases the affordability for families substantially). After accounting for broker fees, there is still maybe $25,000 or $30,000 of equity created in the home, by virtue of a favorable purchase and an efficient rehabilitation, both of which create real value.

By contrast, there is almost no way to purchase apartments at "wholesale cost", at least not within an hour's drive of Los Angeles. Anything worth owning will become a competitive auction led by the large number of opportunistic investors who have been trying to buy apartments since the downturn began. The most common complaint from these savvy investors is that there is too much competition, and not enough product available to buy.

Conclusion Most members of the Seeking Alpha community have no interest in being landlords, let alone being landlords for a portfolio of single family homes. The point of this article is two-fold:

The attractive economics of the "fix-and-rent" market today, as compared with the apartment investment market, suggests that home values are near a floor in the most beaten down areas of the Southwestern U.S. It is hard to see values falling much further when already the numbers are compelling for investors to purchase these properties at current prices, given current rents; and The "fix-and-rent" strategy outlined in this article can be accessed by passive investors as well, but only if they know the right people. The key is to find trustworthy operators with a demonstrated track record, and to be able to structure a mutually favorable program to deliver cash flow and a portion of any equity created to the investors. And to insist that the operators have real "skin in the game" in the form of capital alongside the non-operator investors. The Best Of Times For Single Family Home Investors Who Can Execute

For those seeking to gain exposure to real estate intelligently, "small is beatiful." In other words, unglamorous investments like a portfolio of single family homes in a blue collar neighborhood trumps "trophy properties" like pricy Manhattan office buildings--if one is looking for current cash flow and solid risk-adjusted returns.

Several years from now, many investors will look back at the investments that are being made today by obscure but hard-working teams like the father and son team that bought the property pictured above, and they might ask themselves, "why didn't I put some money into that?"

The answer is, this is a truly contrarian strategy and it is non-scalable, so you won't hear about it from any mainstream firms who need to invest on a large scale.

Equity Residential's Implied Cap Rate, And Why It Matters

Jan Brzeski is a contributor to Seeking Alpha. The article below is a copy of what he posted on August 22, 2011. To access his article on Seeking Alpha, please click here.

I am a full-time investor and fund manager focused on non-traded real estate investments. Right now I am focused on investing in real estate loans with a nice margin of safety, but that fall outside of bank lending criteria and therefore offer much higher yield than one would expect.

Every now and then, I take a look at traded real estate assets, and frequently the results amaze me. Today, we'll look at Equity Residential (EQR). All analysis in this article is based on the latest quarterly report on the company's website. To see the source document, click here.

Before we go into the details, I'll tell you the bottom line: public market investors pay a huge premium for the liquidity that they enjoy. To my mind, they are paying far too much, especially if the goal is to have steady income and there is no compelling reason for the investor to be able to liquidate an investment from one week or month to the next.

How Much Cash Flow Do EQR's Apartments Produce? In this article, we are not going to analyze EQR the way Wall Street analysts do. Instead, we are going to analyze it the way experienced real estate investors do. And we are not going to be extremely precise about the numbers. A rough estimate will give us a good view of what is happening.

In the latest quarter, operating income was about $146 million. But that is after deducting $159 million of depreciation, which is not a cash expense. If we add back the depreciation, we see the approximate cash produced by the portfolio of apartments owned by EQR, before debt service, is $305 million. Annualizing that number, we have about $1.2 billion of cash flow from operations (roughly the equivalent of "net operating income" to put it in real estate terms).

What Does it Cost to Buy EQR? EQR's balance sheet shows about $10 billion of debt. According to Yahoo Finance, the market capitalization is another $17 billion (rounding). There is a bit of preferred equity, but it seems to be small enough to ignore for our big picture analysis. So the approximate enterprise value of EQR is $27 billion.

The Implied Capitalization Rate Now let's look at the implied capitalization rate of EQR. That is the net operating income of its portfolio of apartments, divided by the price we need to pay to own that portfolio. The answer is, $1.2 billion/$27 billion, or about 4.4%.

Does that represent a good cap rate or a bad cap rate? It depends on one's perspective, but a seasoned real estate investor would tell you that, given EQR's portfolio, which includes plenty of units outside of the coastal land-constrained markets, a 4.4% cap rate is mighty low.

In other words, those who limit themselves to investing in real estate via today's public markets may be overpaying by a wide margin, relative to what's available to those who are willing to cut out the middlemen on Wall Street and in REIT corporate offices.

I am not advocating buying any old apartment building... only pointing out that yield hungry investors in the public markets should take a look at the underlying numbers once in a while and compare what they can get on Wall Street with what is available on Main Street.

As I will outline in future articles, the best risk-adjusted returns for investors seeking yield from real estate today are not in the REIT universe, and they are not even in the universe of acquiring individual real estate assets (except for a small number of very special situations). Instead, the best risk-adjusted returns can be had from making short-term real estate loans. Currently, banks refuse to make loans on certain types of real estate transactions, allowing private lenders to earn higher returns than would normally be possible.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Things That Can Go Wrong when Investing in Trust Deeds

This podcast addresses problems that can come up when investing in real estate loans. The most common problem is a default, but other problems include natural hazards, fire and bankruptcy by the borrower, to name a few. All of these issues can be mitigated with property structuring, however many investors are afraid of having to deal with these types of issues, which helps explain why investors in real estate loans get paid well for the amount of risk they take.

Steering Clear of Owner-Occupied Housing

This podcast explains why we do not make loans secured by owner-occupied homes but instead focus exclusively on lending to professional real estate investors. Lending to homeowners who have poor credit is a separate business and we have no interest in this business for a variety of reasons, some of which are explained in the podcast.

Assessing the Risk: Is a particular SFR Trust Deed Safe?

This podcast explains the pricing and terms private lenders can expect when lending to established, high volume single family residential rehabilitation specialists. It also explains the loan-to-cost and loan-to-value underwriting criteria that are typical in our market as of mid-2011. The current market is profitable for both lender and borrower, and provides an appealing opportunity for real estate investors looking for high current yields with a solid margin of safety.

Maturity of Residential & Commercial Bridge Loans

This podcast addresses the maturity of both commercial and residential bridge loans. The maturity is the length of time that the loan can be outstanding before it must be repaid. The range of maturities is 6 months to three years, depending on product type.

Investors need to be very mindful of maturity because the lender generally cannot accelerate the repayment of a loan. If the lender needs liquidity prior to a loan being repaid, the only option is to sell the loan which might require some discounting as an inducement to other investors. Of course there is no guarantee that a loan will be repaid on its maturity date.

The investor needs to be prepared to foreclose on any loan if necessary, and subsequently sell the underlying property to recoup principal and interest, which generally would add six to 12 months to the investment time horizon on top of the maturity of the loan.

Gallatin Plaza - DOWNEY, CA

Arixa Capital Gallatin Plaza

REFINANCE

Our involvement: Our client and partner Southland Development purchased this property in 2006 based significant potential to add value through rent increases and re-tenanting. We are financial advisors to Southland and have refinanced the property as income increases.