Q4 2015 Update

Operating Results:

We report Sandalstone’s Full Year 2015 results to be a record during the rental phase. Full year revenues increased 7.8% over 2014 compared to a 4.3% increase in 2014 over 2013. The primary reason for this was the rise in rents and a decrease in vacancy from 3.5% to 1.4%. Once again we resisted the temptation to purchase new properties during this year so none of the increase is attributable to an increase in doors. Asset prices continued rising in our markets and we are happy to sit on these unrealized gains and return capital to investors. Our Quarter to Quarter revenue declined 5.2% reflecting a seasonality in our AirBnB property and also some lost revenue due to a tenant eviction issue which we categorize as Bad Debt as opposed to a vacancy. We left 2015, fully occuppied. However, with another looming tenant issue. The next Quarter's Update will have that story and resolution.

Sandalstone has also made two other investments, one of the equity side of a newly formed logisitics company and another on the debt side to a trusted builder to help him finance several on-going projects.

For the year, we ended with 1.4% vacancy rate which is a good indicator of rental strength compared with our 6% historical average. If we add the Bad Debt expense the overall number is 1.6% which is still very much in the highly desired range. Drilling down into our two geographic areas, our Bay Area vacancy rate was 1.1% with 15% turnover. We increased rents on those by 20% on new rent. In Las Vegas we had a 2.3% vacancy rate with 11% turnover and new rents coming in 3.0% higher. We are far more judicious in raising rents on good long term tenants. We find it to be sound business practice to have a smoother path up for those customers than in forcing them out just to meet market rents. Overall, it was a very good year on the Revenue Side.

On the Operating Expense Side, we made several long term improvements which we believe enhance the long term value of our houses.  In two properties we installed granite countertops which we believe is additive to value at both re-sale and also in ability to command rents.  

 

We also painted our Mills Act property, the Shorey House as part of its on-going Mills Act improvements.  We had one major expenditure when we had to replace front stairs and siding to repair damage caused by water intrusion in one of our buildings.  The other expense was the usual relatively large cost of tenant turnover.  These costs exceeded our ability to charge the Security Deposit.  We stayed true to our philosophy of keeping units in excellent condition and were willing to incur that expense.  Similar to last year, one of our properties ended up as a poor performer (barely broke even).  And once again it was due to a longer then expected time to re-rent on a tenant turnover combined with turnover costs (to be fair, we also placed granite in the kitchen so our profit was driven down by this improvement).  We did have one "soft" eviction.  The mistake in hindsight was made in letting this tenant rent in the first place. Being more practiced in evictions we were able to negotiate a settlement where the tenant moved out with a net loss of one month rent to us.  Overall, our Operating Expenses were about the same as prior year so for the most part the increase in Revenue ended up going to the Bottom line (and with a few good long term improvements placed).  

As we thought in last years update the Bay Area economy continued another year of torrid growth.  Once again demand for housing has exceeded supply and combined with the great jobs market, rents soar.  We are more cautious this year and have favored tenants whose employment is not as tech / mobile / VC dependent as in past years.   Las Vegas is also seeing upward pressure on rents, however as we suspect like most of the country it is consistent with inflation - at about 2 to 3% overall.  We are content with those results given our return on assets on those purchases - its adding cherries to our rich sundae.  

Almost every time we meet with investors (or would be investors) we get asked for our opinion on where are we in the real estate cycle?  In 2016, it will be 8 years since we purchased the first of our distressed properties in the Bay Area.  The cycle played out exactly as we thought and we are certainly within the 6 to 9 year range we predicted when we thought the next cycle top would be.  Does that mean we believe the cycle will go down? Next year?  We have no idea.  What we are comfortable with is our ability to withstand the downturn and be positioned to purchase more assets at that time.  We have steadily paid down our already low debt levels, re-invested judiciously in maintaining our existing assets and most importantly we have kept/exceeded the expectations we have set with our vendors, lenders and of course our Investor Partners.  

Another question, we get is our opinion on interest rates.  Last year we quite strongly believed that rates were headed up.  With that in mind, we re-financed a good portion of our variable debt into a 30 year fixed product. This had the disadvantage of higher interest expense offset by the certainly of fixed payments over a long time period.  Applying game theory, since we could afford the higher interest expense and might not have been able to afford the upper range of our variable notes we decided to take the hit.  With hindsight this move was made too soon.  The Fed did raise short term rates a quarter of a point, however, with the global weakness and the collapse of commodity prices including especially oil & gas long term rates fell slightly and in our opinion the Fed will be constrained in its ability to further increase rates until the full effects of this are absorbed.  Of course, once again we do not know, and we feel comfortable in our conservative approach to lengthen the duration of our debt this past year.     

 

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 the rapid increase in prices in the Bay Area.  SF registered annual gains of 10.3%.  This placed it in the top 3 national markets with Portland first and Denver third.  Las Vegas registered a 5.8% increase which was about average for the nation.  We continue to be pleased with those results.

We believe this upward move is due to real buyers.  In SF the price appreciation is driven by the strong regional economy.  Cash buyers continue to make purchases and the natural barriers to entry (land and land use policies) ensure the rapid increase.  We believe Las Vegas reflects a more normal price appreciation as the local economy reflects steady growth.  Tourism is still the dominant industry and while domestic travel is up, international tourisism is down.  However, Vegas is doing well with several large projects now coming on-line and as always plenty to do there.  

In summary, while the temptation to sell properties is present, as we recognize a cycle top, we will continue to hold as we enjoy the income from rental operations and are cautiously optimistic that we can emerge in good position through a downturn - optimism which has been rewarded for the past century for holders of real estate.         

BALANCE SHEET

We had an interesting situation this past year where one of our Partners in Clarameda Fund needed their investment back for personal reasons.  This gave the Company a chance to buy back that share at par (meaning at original price without payout on the appreciation).  It is similar to a publicly traded company buying back shares (at an IPO price when the price of the shares is higher).  The Company financed the buyback by drawing upon its credit line, which we anticipate it can pay down with cash flow within a year without sacrificing any other obligations including Partner distributions. While we prsonally hated to see any Partner force to liquidate a great investment such as this one, the Company was financially happy to grant this request.  One of the perks of having a strong balance sheet with liquidity.  

We would once again like to highlight the Note program that the Company has been offering for the past four 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.  This past year we raised the rate to 3.375% in step with the Fed raising short term rates.   Check it out...  Approximately 40% of Partners have used this facility and it has met all expectations.      

Clarameda Fund, LLC:  

-  Continued payout of monthly distribution.  Initial Partners have received over 50% of capital back in the form of distributions.  Zillow estimate of property value is up 87% from purchase price plus rehab costs.  

-  K1s will be distributed later - thanks for everyone's 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 2016 with a strong wind filling our sails.  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.  The duration on our debt has been lengthened as we have replaced short term notes with fixed rate products.  We continue to fulfill all our obligations in a reliable as promised manner.  

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:

SF remains highest priced rental market in Nation

Case Shiller:

Dallas News:  Q4 Case Shiller - Home Prices back above pre-crisis levels   

Las Vegas Unemployment:

UNEMPLOYMENT RATE - 6.2% vs 6.9% - Lowest level of the year in December