Q4 2017 Update

Operating Results:

We report Sandalstone’s Full Year 2017 results to be a record during the rental phase. Full year revenues increased 17.3% over 2016 compared to a 8.3% increase in 2016 over 2015. We added a new property with full year results for 2017, which lead to a significant portion of the gain. Our Vacancy rate remained low - with an overall vacancy on long term rentals at just 1.17% which was up slightly from 2016. Asset prices continued rising in our markets with Las Vegas picking up strongly. Las Vegas which was lagging has picked up steam in both rents and asset prices so we are bullish in that half of the Portfolio. Quarter to Quarter revenue increased 4.1% reflecting a seasonality in the AirBnB property and also the full quarter impact of rent increases in our Oakland properties. Year over year our Quarterly revenue increased 11.6%. We left 2017, fully occupied and continue to be in a good position to raise rents as the fundamental economic conditions in our markets remain strong.

Our first year with the Squaw rental property coincided with a great year of snow. The year's snowfall restored the prior three years of drought water levels and for us resulted in nearly full occupancy. We also benefitted from a 4 month stay during the laste summer and fall shoulder season which provided for a nice steady stream of income. The only downside to the great results was that we didn't get to ski as often as we would have liked!

If you want a great place to stay in Lake Tahoe - check it out!

Unfortunately the investment made in AIS ended at a full loss. Lessons learned to not invest in a venture which was not fully capitalized to fulfill its mission. The Manager had to pivot to a more capital intensive model and unfortunately could not raise the money that would have been needed for that strategy to have been implemented.

Back to the core business, we ended up with 1.17% vacancy rate which is a strong indicator of rental strength compared with our 6% historical average. This low vacancy was especially impressive given the larger than usual number of turnovers - some of which we initiated to improve the quality of tenants. It was a busy year in that respect. Drilling down into our two geographic areas, our Bay Area vacancy rate was 1.1% with 41.6% turnover. We increased rents on those by 15% on new rent. In Las Vegas we had a 0.76% vacancy rate with 33% turnover and new rents coming in 9% 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. We have been more aggressive raising rents in the Las Vegas market so anticipate having a good ramp for increases.

As stated last year, we have taken over Property Management on all properties over the course of last year.  We have moved to eliminate much of the deferred maintenance and also have eliminated some problem tenants.  In Oakland one of our Section 8 tenants who had been with us for 9 years left.  We were able to do a substantial renovation of the house.  Among the items - new Kitchen cabinets, added a dishwasher, new countertops, new deck, new bath vanity and new tile floor, removed all carpet and restored original wood floor throughout, replaced rotted deck, and re-painted the house.  It was a massive undertaking which our Oakland crew led by the amazing Jamie Cabrera did in 3 short weeks - just in time for us to pass inspection and welcome a new tenant.  

    

    

We had two turnovers in the Shorey House in the middle units which allowed us to significantly raise rents.  Turnover costs were minimal as the "millenial" retro paint job in prior years held up.  

In Las Vegas we incurred major turnover expenses as we upgraded our tenants.  We had an upcoming turnover in our 6 Bedroom property - as the tenants reduced the number of people staying in the house.  We used the opportunity to keep the tenants by having them move into a smaller house where we were having tenant issues.  The transfer did not go as smoothly as we would have liked and as the tenants were slow to leave - and when they left we had to incur significant turnover costs as the tenants had been hard on the property, including eliminating smoking odors.  Lesson learned though to not be so aggressive in filling vacancies especially in less than ideal move-out situations.  Many thanks to Jimmy and Chera for being flexible and getting the job done.  

At the larger property, on the turn, we upgraded the floors with a nice hardwood, replacing the carpet.  

 

 

Earlier, we had an AC unit go out - which required a full replacement.  With the two in early 2018, we are well into replacing the HVAC units - as our 30 year old houses are beyond the 20 year replacement cycle.  

We also replaced tenants at our other pool property .  During the course of the year we made many upgrades to that property including addressing several functional obselence issues.  

So lots of work as we significantly improved our properties and in the course also the quality of tenants.  We are encouraged by the good progress made on that front.  Many thanks to our crews and professionals for the hard work.  

  

Market

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 2017, it will be 9 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 at the end of 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?  Did we think Hillary would win?  We have been bad at forecasting - the prevailing wisdom is that the Trump adminstation will have to borrrow signficantly in a full economy which will compel the Fed to raise rates to put on the brakes.  However, take that 2 cents for what its worth.  What we will do this year is to consider the opportunity cost to both us and our Partners of selling assets and earning a "risk-free" rate.  With interest rates rising it may make more sense to take the cash out and park it in other assets.  We should be able to raise rents in Oakland, Vegas is slower.  We will continue to track operating costs closely - if we aren't hitting our 6.5% goal on invested capital - that will also be an indication that we need to cut back on those properties.  

Market Update 

We reference Case Shiller in each of our updates as we believe that index to be the best indicator of asset prices. as of end of January 2017, SF registered annual gains of 6.3%.  This reflects a slowing down of the growth rate - law of large numbers finally catching up?   Las Vegas registered a 6.2% 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 3.625% 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 100% from purchase price plus rehab costs.  

-  K1s were distributed thanks to our  Accountants for taking care of us thru it all.    

In Summary,

We head into 2017 with several new challanges.  We look forward to being more involved with our Las Vegas properties as we will fully control the management this year.  We also look forward to being more involved with AirBnB / VRBO thru the Squaw property.  From a strategic standpoint, we may decide to make some asset allocation decisions that allow us to reap the rewards of what we have sown these past years.  

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:

 
 
Updated April 29, 2018.   Note that while 2017 was steady, with the rise in interest rates in 2018 - the index is down 8.18%.  The yield is now at 4.8%.  

 

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