Executive

 Summary  
It’s  not  often  an  
REO  investment  
makes  the  front  
page  of  the  Sunday  
edition  of  a  
national  paper,  but  
that’s  exactly  what  
happened  on  April  
25th  2010  in  the  
Los  Angeles  Times.  
So  we  thought  it  
With  a  few  clicks  of  the   would  be  a  great  
keyboard  we  found  the   opportunity  to  do  a  
unlisted  address  was  4832   quick  case  study  on  
2nd  Ave,  Los  Angeles,  CA  
90043,  the  Hyde  Park   this  particular  
neighborhood.  Which  you   purchase.
can  see  here  in  the  photo  
we  took.    Please  note  that  
this  is  just  a  fun  exercise  
and  not  nearly  as  thorough  
as  the  property  evaluations  we  provide  investors.

Let’s  Run  the  Numbers

The  Investor  states  his  goal  is  to  rehab  this  property  in  4  
months  spending  $45,000.  And  we’ll  assume  2  months  to  
sell  it  and  that  he  used  all  his  own  cash.

Type Beds Baths SQFT Lot Size Purchase $ $/SQFT Year Built Condition

SFR 5 2 1784 6500 sqft $180000 $100.90 1914 Definite Fixer

Purchase Sale  6  Months  Later

Purchase Price 180000 Sale Price Owner Expects 320000

Purchase Expense 1000 (Sales Expense 8%) -25600

Repairs 45000 Depreciation Expense 2400

Taxes and Insurance 2000 (Total Acquisition Cost) -228000

Total Acquisition Cost 228000 Profit 68800

Return  on  Investment:    30%

Sensitivity  Analysis
So,  $68,800,  for  6  months  work.  But  let’s  do  a  little  sensitivity  analysis.  First  let’s  build  in  
some  “Oh  Sh%t”  room  into  the  projections  and  assume  the  renovation  will  take  $55,000  
and  seven  months  and  lets  also  include  the  cost  of  capital  at  14%  annually,  since  the  article  
mentioned  that  this  investor  sometimes  partners  with  a  hard  money  lender.

Purchase  &  Finance 9  Months  Later

Purchase Price 180000

Sale Price Owner Expects 320000
Purchase Expense 1000
(Sales Expense 8%) -25600
Cost of Capital (140,000 @ 14700
Depreciation Expense 3500
14%)
(Total Acquisition Cost) -252700
Repairs 55000
Profit 45200
Taxes and Insurance 2000

Total Acquisition Cost 252700 Return  on  Investment:    18%

We  haven’t  included  taxes  because  we  don’t  know  whether  this  Investor  will  sell  and  pay  
the  taxes  on  the  gain  or  do  a  1031  exchange  into  another  property  and  defer  all  the  taxes.  
However,  it  should  be  noted  that  there  would  be  no  beneYit  from  a  lower  capital  gains  tax  
rate  if  he  sold  as  planned  and  we’re  assuming  he’d  be  able  to  use  the  depreciation  expense  
of  around  $3,500.

The  Market
On  the  left    you’ll  Yind  
trend  data  generated  
from  Zillow.  We  include  
this  because  the  
“Zestimate”  for  this  
property  is  around  
$275,000.  That’s  $95,000  
(50%)  more  than  it  sold  
for  .  As  great  as  it  is,  
having  access  to  this  and  
other  varieties  of  online  
data,  it’s  never  an  
adequate  substitute  for  
walking  a  property.  It’s  
also  reYlective  of  the  
value-­‐add  opportunity  
this  investor  has.
 Blue  Collar  Employment  Centers

Location,  Location,  Location

The  article  smartly  points  out:
“Along  with  low  prices,  real  estate  
investors  are  drawn  to  the  area  
because  of  its  proximity  to  the  ports  
of  Los  Angeles  and  Long  Beach,  Los  
Angeles  International  Airport  and  
other  job  centers,  including  factories.

Unlike  many  of  the  remote  suburbs  

ravaged  by  the  housing  bust,  the  
economy  of  South  Los  Angeles  and  its  
neighbors  was  never  tied  to  housing  
and  development.  And  these  urban  
communities  were  largely  spared  the  
rampant  overbuilding  that  has  left  
areas  like  the  Inland  Empire  littered  
with  boarded-­up  subdivisions.  
Subprime  lending  was  prevalent  in  
South  Los  Angeles,  making  
foreclosures  common.”

So  this  area  beneYits  from  both  its  

abundant  supply  of  REO’s  and  it’s  proximity  to  employment,  something  we  stress  at  
Sequoia.  Over  the  next  seven  years,  we  feel  this  will  lead  to  a  greater  and  faster  increase  in  
this  property’s  value  than  the  homes  in  the  distant  subdivisions  of  the  Inland  Empire  
referred  to  in  the  article.  That’s  why  we  stress  locations  like  this  close  to  employment.

Grades  and  SWOT  Analysis

Here’s  what  we  like  and  dislike  (via  letter  grades)  about  this  purchase  along  with  a  quick  
SWOT  analysis.
Strengths Weaknesses
Single Family Home A Proximity to Employment Tough Neighborhood
5 Bedrooms B Purchase Price Old Home
2 Baths B
2+ Bathrooms Poor Schools
SQFT: 1784 A
Good SQFT for the area
Lot Size: 6500 A-
Large Yard
Purchase Price: $180,000 A

Year Built/1914 Let's Talk

Opportunities Threats
Condition/Fixer B

Proximity: Employment/Schools B+ Future Employment Gains Crime Could Increase

Additional Reductions in Crime More Foreclosures

Tightening Supply in 2011 Cost Overages

Single  Family  Home:  A  
We  presently  like  SFR  in  a  portfolio.  If  it’s  purchased  at  the  right  price  and  with  the  right  
conYiguration,  it  can  give  you  strong  yield  from  rents  AND  good  capital  appreciation  as  its  
price  rises  with  the  health  of  the  economy.

5  Bedrooms:  B
We  get  what  the  Investor  is  going  for  here,  a  5  bedroom  home  with  a  large  yard  that  he  
probably  feels  will  entice  a  family  buyer,  and  it  should  be  noted  that  family  size  in  lower  
income  neighborhoods  tends  to  run  larger  than  in  higher  income  neighborhoods.  However  
it  limits  his  yield  if  he  has  to  choose  a  different  exit  strategy,  namely  renting.  If  something  
happens  that  forces  him  to  rent  instead  of  selling,  his  yield  is  not  going  to  be  as  strong  as  if  
he  had  bought  a  smaller  3  bedroom,  2  bath  for  less  money.  And  so  many  bedrooms  in  a  
home  with  this  square  footage  lead  us  to  believe  it  may  have  a  less  than  stellar  Yloor  plan.

2  Baths:  B
One  of  the  biggest  problems  you  Yind  in  older  homes  is  that  they  are  under-­‐bathed.  And  
there  is  a  huge  difference  between  a  home  with  1  vs.  2  full  bathrooms.  Families  and  renters  
need/want  at  least  that  second  bathroom  and  it  helps  a  lot  in  your  exit  strategy  whether  
selling  or  renting.  Three  baths  would  have  been  an  A,  but  they  are  seldom  found  in  this  
neighborhood.

SQFT:  A
For  this  neighborhood  1784  sqft  is  not  bad.  Comparable  homes  run  around  1611  sqft.  
However  with  5  bedrooms  (assuming  that  is  accurate)  they  are  going  to  be  very  small  by  
modern  standards.

Lot  Size:  A-­

Comparables  typically  run  a  bit  smaller  than  this.

Purchase  Price:  A
Comparables  (liveable)  run  around  $175/sqft.  This  purchase  price  is  $100/sqft.

Year  Built  1914:  Let’s  Talk

Let’s  face  it…  it’s  old!  But,  you’re  not  going  to  Yind  a  modern  home  in  this  neighborhood  and  
the  craftsman  architecture  could  yield  some  great  curb  appeal.  Always  beware  of  the  big-­‐
ticket  systems:  RooYing,  Foundation,  Electrical,  Plumbing,  Heating  &  Cooling,  and  Floor  
plan.  This  is  the  expensive  stuff.  The  more  these  need  work  the  more  expensive  this  Ylip  is  
going  to  be.  We  don’t  know  what  this  buyer  has  got  here,  but  he  needs  to  be  very  careful.  
Odds  are,  any  or  all  will  need  upgrading.  $$$.  When  this  house  was  built,  3/4”  galvanized  
pipe  and  knob  and  tube  electrical  wiring  were  the  norm.  Nobody  had  even  envisioned  
computers,  TV’s  and  the  myriad  of  other  devices  that  put  a  much  larger  strain  on  the  homes  
electrical  system  than  it  was  designed  to  carry.  For  those  of  you  unfamiliar  with  “knob  and  
tube,”  look  it  up  in  wikipedia,  along  with  the  “Model  T”  and  “Yire  hazard.”  Also,  if  for  some  
reason  this  owner  changed  his  mind  and  decided  to  hold  and  rent,  he  should  expect  higher  
annual  maintenance  costs  because  of  its  age.
Condition/Fixer:  B1
This  allows  the  investor  to  make  a  value  add  play.  Most  homeowners  want  to  walk  into  a  
turnkey  house,  not  a  Yixer,  and  it’s  unlikely  a  bank  will  Yinance  this  in  its  present  state.  This  
is  an  advantage  to  the  investor.

Proximity  to  Employment  &  Schools  B+

This  beneYits  the  investor  regardless  of  whether  the  exit  strategy  is  to  Ylip,  or  rent  and  hold  
for  higher  prices  down  the  road.  However  as  long  as  were  talking  about  location,  we  need  
to  point  out  that  the  public  schools  in  this  area  are  rated  very  poorly.  With  regards  to  public  
safety,  though  it  has  greatly  improved  during  Police  Chief  Bratton’s  tenure,  it’s  still  a  
concern  in  this  neighborhood  and  Chief  Bratton  just  retired.  Those  gains  could  reverse  
under  a  new  administration  or  an  extended  period  of  low  employment  in  Los  Angeles.

Alternative  Exit  Strategy

We  took  a  look  at  our  rental  databases  and  then  spoke  with  a  local  realtor  and  rental  agent  
and  determined  this  property  would  rent  for  about  $2100/mo  once  refurbished.  Assuming  
it’s  rented  11  months  a  year,  a  10%  discount  rate,  it’s  eventually  leveraged  about  50%,  it’s  a  
California  investor  (taxes),  it  appreciates  5%  per  year  and  inYlation  averages  4%,  insurance,  
maintenance,  management  fees  and  all  that  other  fun  stuff,  here’s  how  it  breaks  down:

NPV yr 5 cashing out $33,213

Annual  after  tax  cash  Ylow  
NPV yr 5 1031 exchange $53,940
approximately      $8,000
IRR after cashing out 16.5%

So  although  we  would  have  preferred  a  property  with  slightly  fewer  bedrooms  and  a  lower  
acquisition  price  to  increase  the  yield,  a  16.5%  after  tax  internal  rate  of  return  is  not  bad,  
not  great,  but  not  bad.  If  our  assumption  regarding  the  appreciation  rate  is  too  
conservative,  obviously  the  return  will  be  greater.

So,  what’s  your  vote?  

Assuming  the  Investor  has  done  a  thorough  inspection  and  has  not  bit  off  more  than  he  can  
chew  regarding  the  needed  repairs  and  upgrades,  we  give  this  one  a  moderate  thumbs  up.  
It’s  by  no  means  an  economic  grand  slam,  but  we  feel  the  dual  proYitable  exit  strategies  and  
other  positive  factors  mitigate  the  challenges  and  make  the  risk  worth  the  return.  However,  
not  to  sound  like  a  broken  record,  if  those  repairs  are  going  to  be  more  costly,  maybe  he  
should  have  moved  on  to  the  next  one.

Best  regards,

Bruce  &  Tim

1However,  this  is  based  on  the  assumption  that  the  cost  of  upgrades  is  reasonable.  As  
mentioned  above  regarding  the  home’s  age,  the  investor  wants  to  avoid,  as  much  as  is  
reasonably  possible,  having  to  upgrade  the  home’s  major  systems  which  can  be  very  costly.