Improving and Repositioning Your Income Property
As a rental property owner, you have many options for how to treat your investment. The most aggressive investors will continue to buy and sell, but if you would rather stick to what you have, and you’re willing to spend some cash, improving the property you own is incredibly smart.
Why improve my property?
In Los Angeles, rent control is a fundamental part of the real estate business. In brief, rent control means that a tenant can stay in his apartment forever, as long as he pays rent on time and doesn’t break the law on the premises. In turn, you’re allowed to raise the rent 3% per year.
However, raising the rent 3% per year doesn’t come close to the rate at which market rents increase. For example, an average 1-bedroom in Echo Park has raised in value from $1100 to $1600/month in the last three years. If a lucky tenant moved in three years ago, his landlord would only be making $1,202 on that unit today by increasing rent 3% per year.
How do you beat this scenario? You need cash.
(How do I get cash if I don’t have it? Refinance, sell and buy a new property, or sell other assets.)
Before I explain how to beat rent control, I need to show you how much value you gain by doing it.
Take scenario Echo Park. In your fourplex, you earn the following rents on two 2-bed / 1-bath units & two 1-bed / 1-bath units:
2/1 = $1775
2/1 = $1182
1/1 = $1098
1/1 = $1595
The current value of your Echo Park fourplex with these rents is approximately $1,015,000 at about 15 GRM (gross rent multiple, or 15 X yearly gross rent). If you absolutely maximized the value of this property, you could raise the value to $1,475,000. (A maximized income property in Echo Park can sell for up to 14 GRM.)
While this scenario leaves lots of room for improvement, let’s focus on the biggest problems: the 2/1 at $1182 and the 1/1 at $1098.
You need to increase the rent, and to do that, you need new tenants. The current tenants don’t want to leave, so the only way to change their mind legally is by offering them cash. There is no standard rule for this, but I know lots of owners who have negotiated with their tenants to move out for a lump sum. When you calculate your property’s value based on GRM, you can quickly determine what value you’re adding to the property by raising the rent, and therefore figure out a reasonable offer to your tenants. You need a Voluntary Vacancy Agreement from a lawyer to do this the right way.
Once your tenants move out, you need to know how to improve the unit. This means hiring a contractor. Sometimes you just need to clean, but more likely you’ll want to modernize the bathrooms, floors, fixtures and appliances in order to fully maximize rents (you don’t want another tenant moving in below market). That’s what I did on my property in Boyle Heights and I exceeded my expectations in new monthly rent, breaking records for the neighborhood.
So let’s work the numbers here:
You paid the tenants of the two most problematic units $10k each to vacate (this number varies). You paid $60k each to renovate the units, and $20k to improve the exterior and some deferred sewage issues. You’re all in for $160,000 and you increased rents to $2,595 and $1,795. So how much did you increase your property value? Approximately $350,000 (at 14GRM).
You paid $160,000 for $350,000 in value.
If this seems overwhelming, please feel free to tap into my experience at david@adaptiverealty.com or 310-801-000.