Being In Los Angeles
A High-Beta Wealth City
Last week I wrote, I think I can love this city. A week into a month of working from a second home in the winter, I am convinced I do — despite days of unusually low 50 degrees and pouring rain. There is a lot of beauty here — in the form of mountains and coastal landscapes, architecture from all periods, and vegetation that’s pristinely wild in some places and hyper- groomed in others. The air is filled with tropical smells, the sky can be an endless blue, and the people are as friendly as anywhere else in the country. There is delicious food too, and I am a picky eater who is generally convinced that most food in the US is crap.
People move or stay here for the beauty of the city and its lifestyle. But that requires money, lots of money. This city is all about money. West Hollywood to the Pacific Ocean — along Sunset Boulevard — is a giant bubble, and I am curious to understand the socio-economic dimensions of this. The less glamorous rest of the town is also about money, but in different ways — thinking about money all the time (or the lack of thereof), as opposed to thinking about nothing but money all the time.
Within the 9.8mn inhabitants of L.A. County, there is a small community of ~16,000 people with a taxable annual income of more than $1mn — the privileged 0.1%, not the plebeian 1%. By my quick calculations, a family of five and a $5mn entry-level house in the bubble will need a gross income of at least $1.6mn, based on a 37% top federal income tax rate (34% effective rate) and a 13.3% top state income tax rate (10.4% effective rate):
Chances are that husband and wife are generating similar incomes — lawyers are often married to other lawyers and the same goes for doctors — which makes it a whole lot easier to stomach the bills. I am talking about taxable income, and if you are salaried W2 employee, you don’t have much wiggle room to optimize your taxes.
But you may be a real estate developer, in which case you probably have zero taxable income and positive cash-flow. The reason is depreciation — a quirk in most tax laws, which recognizes losses on the value of total assets and not just the equity. The more debt, the higher the assets, the more losses can get deducted.
A highly simplified example:
- One develops a property with $1mn in equity and $9mn in loans
- The property generates depreciation and interest cost of $1mn per year
- It rents out for $600k per year and is cash-flow positive after interest
- The income is a negative $400k
The trick is to leave any gains in the property that hopefully appreciates in value (California has an onerous state capital gains tax of 15–20%), take out the accrued gains in the form of loans which can be used as equity for new developments, and gradually people build a shaky pyramid of wealth. This is aptly called high beta wealth, because the equity may be wiped out or multiply by many factors if the underlying asset’s value moves up or down by just a bit.
Annual living expenses of $900k to keep up with the Joneses (not even close to keeping up with the Kardashians) seems like a steep price to pay, and it’s no guarantee for happiness. But certain groups have an advantage, and they own and spend a lot of money:
- Celebrities of any kind — TV personalities, producers, actors, musicians
- Successful entrepreneurs, active or retired (Jeff Bezos lives here in Bel-Air)
- Senior partners at top law firms ($5mn — $10mn in annual income)
- Private equity, where most income is capital gains
- Successful doctors (or doctor couples) with their own practice, ideally in plastic surgery
- Rich heirs with trust money
- Rich divorcees
- People who don’t have any income by design — they turn themselves into a corporation and take loans from the company. That brings its own complications, but nothing that’s impossible to overcome with the support of good advisors
- Part-time residents who only live here 182 days of the year. The rest of the time, they will go to their houses in Montana, Wyoming or even Texas. Places with political ideals which they may not share, but the absence of state income taxes alleviates the pain. Or they divide their time between Chicago and L.A., both high tax cities, but the primary residence is in Sioux Falls, where they only have to spend two weeks of the year (enough punishment).
Someone with an inclination for redistribution might say, let’s take it all away and spread it among the less privileged members of the population. Let’s redistribute liquid assets of $5mn per rich person and 50% of the annual net income of $900k: that would provide $8,000 one-time and about $100 per month to everyone in the county — probably not worth the predictable upheaval.
On the positive side of concentrated and extreme wealth, the Getty Center in Brentwood with a view of the Pacific Ocean stands out — although Jean Paul Getty Sr. was an unpleasant old miser. The Getty foundation’s initial endowment of $660mn has grown to $8.6bn, and the Getty Center — never seen by Getty, who died in 1976 — opened in 1997 to the public, entrance is free. It houses some of the most significant artefacts from over 2,000 years of history and attracts 2mn visitors per year.
My true heroes in this environment are the people who make all of this work — the construction workers, the cleaners, the gardeners, the agricultural workers or the many people in hospitality. Our two cleaning ladies — mother and daughter — arrive by bus from the North, it takes them 2 hours of driving and thirty minutes of walking, and they are the friendliest people. They deserve every dime they make, and it probably feeds a family at home. Both speak very little English, but I am able to bridge some gaps with my broken Spanish. So many workers in this town are Hispanic, and our society would cease to function if they were not here. Their presence invites an awful lot of hypocrisy in this country, and we should have no tolerance for that.
