As a commercial real estate broker with a focus in apartment investment sales based in Southern California, one of the markets with some of the highest barriers to entry in the nation, multifamily investors have to be more savvy when performing due diligence when identifying submarkets to invest in, especially in consideration of political statues recently implemented to protect renters whose income may have been affected due to COVID. When considering your next acquisition in Los Angeles (or nationwide), here are some of the things that you need to consider first:
BUYING A PROPERTY LOCATED IN A MUNICIPALITY GOVERNED BY RENT CONTROL WITHOUT A STRATEGY TO MAXIMIZE CASHFLOW:
Rent control is a government regulation that controls how much a landlord can increase rent in a given year. In Los Angeles, rent control caps annual rent increases at five percent + a maximum of three percent for inflation. For those buying value add apartments where the existing rents have not been regularly raised to stay aligned with market rents, this can create a long time before the new owner is able to maximize the properties financial viability unless the existing tenants move out, which is unlikely to occur anytime soon unless some financial consideration is provided (see pitfall #7). One notable exception to properties that subject to rent control are those built less than fifteen years ago-they are not subject to rent control.
NOT BEING AWARE OF WHAT THE ARE GUILDLINES REGARDING EVICTION DUE TO NONPAYMENT OF RENT.
In some municipalities, an unlawful detainer (“i.e. eviction) is still possible to obtain, that being said California state statues AB 1482 and AB 3088 severely limit most landlords abilities to evict tenants, and in most instances only able to evict for “just cause” meaning that the tenant has been a nuisance or has threatened the safety of other tenants at the property. Evictions for nonpayment of rent have been significantly limited, especially for those who provide written notice to the owner that their income has been affected due to COVID. If you buy an apartment building and you are not aware of the guidelines regarding eviction, you can find yourself stuck in situation that will take a significant amount of time and money to get out of.
NOT REQUESTING/THROUGHLY REVIEWING ESTOPPEL AGREEMENTS
Estoppel agreements verify 1. The person(s) occupying a given unit are those whose name is on the existing lease. 2. That the amount of rent that the seller of a given property states is accurate and 3. If there is any appliances in the unit that are tenant owned vs. landlord owned. If the new purchaser does not 1. Request as a part of his/her due diligence process and 2. carefully review estoppel agreements prior to the close of escrow, he/she may end up with tenants where they are not aware of the true identify the tenants occupying the property, or tenants paying less rent that what was marketed by the previous owner/broker, and ending up with tenants who take appliances who the new owner believed that they were their property when in fact they belonged to the tenant, which is why requesting and reviewing estoppel agreements are an essential part of the due diligence process.
FAILURE TO HAVE RENT PROJECTIONS THAT ARE IN ALIGNMENT WITH THE MARKET
Relying on a real estate broker’s pro forma for rent projections is a pitfall which will lead a new owner with a false sense of projected returns when marketing vacant units of his/her new acquisition. To obtain an accurate sense of rents in a given market where potential acquisition is located, it is best to utilize apartment data sources such as Rentometer, or Data providers such as Costar or Yardi, to accurately assess a realistic rent projection for vacant units.
NOT BEING AWARE OF A MUNICIPALITY’S REQUIREMENTS FOR PROPERTY INSPECTIONS, SEISMIC RETROFIT (LOS ANGELES COUNTY)
In Los Angeles, seismic retrofitting, is the modification of existing structures to make them more resistant to seismic activity, ground motion or soil failure due to earthquakes. Most apartment buildings more than four units in Los Angeles built prior to 1980 will require to be done at some point. The cost for a seismic retrofit company to perform the service can easily run into the six figures. From the period where the owner of a property receives notice they are given seven years to perform the retrofitting prior to being penalized by the city. As an apartment investor, one needs to verify with the city (not just the owner) that the seismic retrofit has been completed or factor it into their property improvement costs.
NOT RESEARCHING EXISTING BUILDING CODE VIOLATIONS
In residential real estate (condo, single family, multifamily two to four units, there are numerous disclosures that the owner must certify when selling a property. In the commercial (5+ units) space, those disclosures are not an obligation. This is why it is essential for buyers of apartment buildings to check the municipality where the property is located building records, even in instances where those records have to be requested formally and are not easily accessible over the internet. These records will show if the property has existing code violations that are outstanding, then the prospective purchaser will be responsible for curing once buying the property.
NOT BEING AWARE OF ANY REGULATIONS REGARDING CASH FOR KEYS EXCHANGES IN A GIVEN MUNICIPALITY
In high demand rental markets, such as Los Angeles, cash for keys, or tenant buyouts, are a common practice. That being said, a number of submarkets in the Los Angeles area, such as Culver City, have their own guidelines for how tenant buyouts are executed. Furthermore, the amount of cash for keys varies upon the submarket-high rental demand markets such as Santa Monica tenants can command tens of thousands of dollars, sometimes more, to agree to a buyout. This is important to consider if you are planning on buying an apartment building in a high rental demand market, where the rents are below market rent and you are creating a budget to stabilize the property. In addition to construction costs, you may have to factor in a cash for keys budget. Furthermore, you need to verify that your tenant buyout plan follows the guidelines where the property is located.
FOR MIXED USED ASSETS, NOT CONDUCTING DUE DILIGENCE ON THE COMMERCIAL TENANTS.
When acquiring an apartment building with commercial tenants on the ground floor of the property, known as mixed use, it is important to conduct thorough due diligence on the commercial tenants, especially is the commercial tenant income comprises are large portion of the total gross rents. If the tenant is in the process of filing bankruptcy, while you many recover the space, you will not recover the lost rents during the time the tenant was occupying the space. Furthermore, re-tenanting the space can be expensive as many retail tenants are expecting rent concessions and tenant improvement budgets in light of the current pandemic which has caused more spaces to become available.