Q3 2013 Update

Operating Results:

We report Sandalstone’s 3nd Quarter to be its best quarter while in this rental phase - which is good news. The not so good news is that we project this will be the best quarter looking forward as well.  First the good news: We report record quarterly rental revenue:  37% year to year growth compared to Q3 2012 and 6.3% quarterly growth compared to Q2 2013.  The primary reason is that we were for all intents and purposes fully occupied during the entire period. Going forward we know of one tenant turnover in Oakland and one in Las Vegas. Therefore we expect our quarterly growth to be negative in Q4.

A few quick operational notes.  One the positive side the Oakland properties reported few issues this past quarter.  We were able to get a small rent increase from the Section 8 program on one of our properties - the other one was denied.  At the end of the day there is a trade-off between maximizing rents and the benefits the program offers.  For now the trade-off is still acceptable.  We anticipate raising rents by over 10% on the market rate unit that will be vacated in November.  


In Las Vegas we have been having a few issues with repairs and maintenance.  Most are relatively minor and easily fixed and within our expected budget.  Unfortunately we have had one issue with water penetration that has proved to be difficult in one of our properties.  As always it has nothing to do with our ability to get things fixed right - it is a tenant issue more than anything.  We are working through it presently.  The approach as always is to do the right thing from a building and safety code issue.  Stay tuned for the resolution which will mean fixing both parts of the equation.   The property where we are facing a turnover is likely to be problematic.  It has a pool which is great draw in the summer, however not so much in the winter.  Unfortunately the lease is expiring and we were unable to get a renewal.  So we anticipate low demand for a few months.  

Market Update 

We reference Case Shiller in each of our updates as we believe that index to be the best indicator of asset prices.   Las Vegas and SF were the Top Two markets in the nation registering gains of 27.5% and 24.8% respectively.    While Case Shiller is a lagging indicator -  we believe we have on the ground data that is about 3 months ahead of them - we continue to see the same feverish activity in the Bay Area and Las Vegas as in prior quarters.  

The overall strategy for Sandalstone is to continue to hold.  We believe that the uptick off the bottom is a result of the institutional players coming into the market and follow our strategy of turning single family into rentals.  Unlike the big boys we have stopped our purchases when they no longer made sense using our relatively high hurdle rate - a cap rate on purchase of about 8.  The larger players flush with outsiders capital have continued buying at these higher prices.  One example, our inbox has been getting many emails from Waypoint as they have decided to enter the Las Vegas market this past quarter.  We like getting the yield on our investments and believe that the time to sell will be when the mortgage markets become more accessible to a broader class of people.   It also helps us that our investors value long term yield over short term returns.  We also disfavor paying capital gains and prefer the tax advantaged income our properties yield.  

One other quick note, last update I mentioned two IPOs in the sector - SBY and ARPI.  Both have had a lousy reception in the market - down 10 to 15% from IPO price.  Other than the obvious market similarity these instruments are radically different from the investment vehicle that Sandalstone offers - the most glaring of which is the payment of a monthly distribution.  


Unfortunately no news to report on the Acquisition front.  We have not been able to find deals of the type we are interested in pursuing and where we have identified those opportunities we have been getting outbid.  We remain true to our philosophy of making money on the buy.  This past quarter and the ones to come, in the absense of any deal, will focus on reducing debt and further strengthening the balance sheet.  Our revolving lines of credit are fully open as we have paid back the amount that was used to fund purchases in our growth phase.  Our average interest cost as a percentage is less than 4%.  This is the most sensitive item in our Free Cash Flow and we have worked diligently to minimize this expense while giving us flexibility.  

In thinking about real estate as it was taught to us, we recognize that real estate is cyclical.  In the single family sector the cyclicality has played out as expected (in hindsight of course).  We had a remarkably long and high upcycle which ended in 2007/8.  We are clearly out of the bottom by 2012 in just about every area of the nation.  Investing in the bottom is always the best time as the actual risk is relatively low (perceived risk high) and the returns both from a yield (high cap rate) and subsequent appreciation are the highest.

We spent a lot of time investigating multi-family acquisitions this year.  There was nothing that appealed to us.  Most of the sellers wanted (and received) offers with a 5% or so cap rate.  And these of course were in B and C neighborhoods.  By comparison when we started a decade earlier we were taught that 7 to 8% cap rate was the historical norm.  Just a bit of math to illustrate the sensitivity of this as it would seem this difference is trivial.  Say a Building has a NOI (net operating income) of $1M.  Using a 5% cap rate this building would be valued at $20M.  At an 8% cap rate this building is valued at $12.5M.  Even assuming a conservative leverage ratio of 65% - that means the entire equity position has been wiped out.  Of course the folks buying at these prices are assuming a few things that would help.  One is rent/income appreciation (a 3% appreciation in income for 7 years gets you $15.4M assuming 8% cap rate).  The other is that interest rates stay at these low levels.  If either of these two variables don't work out as forecast then there will be opportunities in this class.  If interest rates rise as multi-family loans come up for renewal (usually in 7 years) there will be distressed sellers who have been buying during the last few years (and who have used high amounts of leverage).  At that time people with strong balance sheets and the availability of financing will do extremely well (again).  

Clarameda Fund, LLC:

  • See commentary above pertaining to Las Vegas.  
  • Continued Partner distributions (every month for past 5 years and going...)
  • Strong cash reserves to cover upcoming costs and vacancy

In Summary,

While we celebrate our best quarter ever (during our rental phase), we are reminded of the headwinds facing us going forward.  As expected Las Vegas will continue to be challenging until the local economy picks up.  We continue to see signs of this as they keep building and tourists keep coming.  The Bay Area of course is in the midst of yet another boom - congrats to Google and Facebook for their strong performance which keeps adding fuel to the economy here - no shutdown in sight!    




Biren Talati
Managing Member
Sandalstone Group, LLC




The Shutdown effectively led to a drop in interest rates which is reflected here...
CURRENT YIELD:  3.9%  Compare to Clarameda...



Bay Area Rents:

Slowing, perhaps?  

Case Shiller:

WSJ:  Q3 Case Shiller - Top Two Markets: Vegas and SF   

This is an interesting Graph which shows cyclicality of the SF market using Case Shiller data

Las Vegas Unemployment:

Mostly good news, as employers added jobs, with construction leading the way. Rate is 9.6% however.