Q1 2015 Update

Operating Results:

We report Sandalstone’s Q1 2015 results to be flat to prior year results. Our Quarter to Quarter revenue increased 8.0%. All of the variation in quarterly revenue has to do with the selective activation of our AirBnB unit. In the prior year period we had a full term tenant occupying the property for the entire quarter, while in this one we engaged AirBnB for one month while we had zero AirBnB in the last quarter of 2014. If we remove the effect of this unit - we would have reported record rental revenues as price increases across the portfolio took effect. We plan on activating AirBnB for the summer months as that is the highest demand period so all other things being equal (mostly vacancy) we anticipate higher revenues in Q2 and Q3.

We stayed fully occupied for Q1 across the portfolio. Of course, in the Bay Area we would like to see more turnover as the rapidly increasing rental market allows us to fully capture the uptick with new tenants. When we decide to sell, we will have to plan for tenant turnover, so we have the good problem of being fully occupied. In Las Vegas, we are seeing price increases in the good areas - however we get significant resistance in the C areas. We are aware of one upcoming vacancy in Las Vegas, so we will be managing that turnover carefully as it is in our most expensive property there - and holding in the summer is quite expensive - $400/month electricity as we have discovered.

On the Operating Expense Side, we addressed a few major maintenance issues in the Bay Area.  We replaced a main sewer line which had ruptured and had caused two back-ups into tenant units.  As you can imagine this was quite messy and could have been disastrous had we not caught it in time.  We also acted fast after the second time to determine the root cause.  The fix involved finding the source of the back-up, digging up the driveway, fixing the pipe and then replacing the driveway.  As it turned out, the pavers made the digging and fixing relatively easy.  It appears that the root cause was that the pipes were joined at an uneven slope which led to the eventual fatique and wear on the pipe joint. For those of you interested in plumbing - a really good rule of thumb - is if you are doing it correctly it is less effort, and if you aren't doing it correctly you need to apply/diffuse a lot more force - So if you are having to apply undo pressure to tighten a fitting - its wrong - make sure everything is lined up.  In our case we cut back one of the pipes about a foot and a half and added a new section so that the difference in slope was reduced.  The two joints are now straight with no pressure.   

We also made a major repair on the front stairs / landing on a duplex.  The root cause of the issue was that water had penetrated below the concrete and into the wood underneath.  In the classic scenario - the more we removed, the more rot we discovered.  We ended up adding several inches of concrete so that water would flow onto the ground, instead of in the siding and replaced the main structural components of the stairs along with the siding.  Hopefully this will solve the issue, until we ultimately raise up the building and convert the two units into condos sometime in the next two decades.  This was a known issue when we purchased the foreclosed unit and we tried several time to patch the landing, however ultimately trapped water always wins.  

We anticipate one other large repair/maintenance issue - which will be the re-painting of the Shorey House as part of its Mills Act improvements.  One of the issues of painting it a bright red is that over the last seven years the sun has really lightened the paint.  The after photo will be quite notice-able if we can get the right light.  We are quite pleased with the finishing and selling of the units next door to ours (realtor.com reports a sales price of $715K and $710K for two of the three).  Our influence in the architecture is quite apparant as they share our Italianate style - the streetscape is vastly improved!        

Going forward, we have seen the effects of the high rental rate increases in our market sub-sector as the wave has now fully crossed the Bay.  In light of this we have filed an application to raise rents in one of our Section 8 units and based on that ourcome we will follow.  Of course, our increases are not as strong as if we had new tenants, as we believe that raising rents at a moderate (rather than the crazy current) clip for longer term quality tenants is a sound business practice.  Of course for new rentals we go right up to market, so in this environment we do not avoid turnover.  

We have seen an uptick in Las Vegas as the broader economy continues to improve.  Growth as evidenced by the Unemployment rate and New Jobs created are trending positively.  Las Vegas unemployment moved down to 6.9% in December.  The rate fell with 38,200 more jobs created and 1.7% increase in population.  Looking with a macro lens the strong US economy will help domestic tourism while we suspect the strong dollar will hamper tourism from countries with weakened currencies and/or economic conditions (oil).  Overall, we see the positive trends continuing as the overall outlook is favorable.  We anticipate being able to reasonably raise rents in the 2 to 5% range.    

Market Update 

We reference Case Shiller in each of our updates as we believe that index to be the best indicator of asset prices.     The index confirms a flattening in the price increases.  Las Vegas and SF registered annual gains of 6.9% and 9.3% respectively.   On a month over month basis, Las Vegas was slightly negative 0.3% while SF was slightly positive at 0.4.  The seasonal adjusted month to month looks better (with Vegas at 0.2 and SF at 1.2).  We will not be selling our properties in winter!  

We believe this reflects the end of the investor phase of the recovery.  The next leg up will require real people to get mortgages.  As we have stated throughout these Updates that will happen when credit loosens up.  We see that happening with the recent Fannie Mae guidelines.  We remain optimistic that this will happen in the 2016 to 2019 time period. Another tracking valuation tool that we employ is Zillow which has its ZEstimate.  Based on their Estimates our properties are up over 41.5% from our fully capitalized basis (including repairs).  This is on top of the income that has been distributed over the years.  We have had our earliest properties return their entire purchase cost.     

In summary, the market has moved quite dramatically up since we purchased most of our properties.  We see this appreciation flattening out over the near term.  We will continue to hold as we enjoy the income from rental operations and believe that the patient investor will see additional upside when the real buyer is able to re-enter the market in a meaningful way.       

BALANCE SHEET

We spend most of our time on these Updates writing about Operational results and Market value.  It seems though that we hardly ever discuss the overall Balance Sheet.  This is another area where Sandalstone has taken an extremely conservative approach.  From the outset we have ended up paying all cash for properties as that enabled us to get the properties at a discount.  Since then we have taken on relatively low levels of debt.  We have preferred to pay Partners a healthy yield rather than interest to debtholders.  Of course it reduces percentage measures such as IRR or ROE.  However it maximizes absolute dollars returned to equity Partners.  We are favor the return / risk characteristics of this approach for the Company.  There have been exceptions with properties we hold in special off-balance sheet situations.  The debt on those transactions have 30 year fixed terms at an interest rate range between 3.75% and 4.0%.  In addition, we have also employed short term and variable debt which has proven to be an attractive financing option these past seven years.  We suspect though that our variable rates may go up at the end of the year and so we are attempting to lock in fixed rates and extend the duration of our debt as the year progresses.  We believe this will position the company well when we head into an increased rate environment. 

We would once again like to highlight the 3.25% Note program that the Company has been offering for the past three years.  Under this program, Partners have had the chance to "deposit" funds with the Company.  The Company has an underlying credit facility which enables it to pay back funds on demand.  If you have excess funds sitting in checking/savings and/or are considering a CD this program might be a suitable alternative.  In addition, the Company can increase the rate payable if interest rates rise so this product, unlike CDs, offers upside.  Check it out...  Approximately 40% of Partners have used this facility and it has worked as anticipated.    

Clarameda Fund, LLC:  

-  Continued payout of monthly distribution.  Initial Partners have received close to 40% of capital back in the form of distributions.  

-  K1s will be distributed this month - thanks for everyones patience - as always this is a tiring time for our Accountants as the Corporate/LLC returns are due.  We have turned in our books to them in mid-February so we are in process.  

In Summary,

We head into 2015 we good financial shape.  The income from properties continues at a strong pace with rents in the Bay Area strong and looking up in Vegas.  The balance sheet has benefited as excess cash from operations is being used to pay down debt.  We hope to further improve our position in the coming months by increasing the duration of the debt and fixing the rate on some of our shorter maturity products.  

My thanks as always to the people who assist us in our endeavors and the Partners who trust us to manage the Company with their capital.  

 

Cheers!

 

Biren
Biren Talati
Managing Member
Sandalstone Group, LLC

 

MARKET DATA

VANGUARD REIT ETF:

 
 
 
CURRENT YIELD:  3.37%  Compare to Clarameda...

 

HEADLINES

Bay Area Rents:

SFCurbed Article on Bay Area Rents - Highest in Nation!

Case Shiller:

WSJ:  Q4 Case Shiller - Slow Down in Appreciaton   

Las Vegas Unemployment:

UNEMPLOYMENT RATE - 6.9% vs 8.6% - Increase in Jobs, workforce and Population