In many major markets across the country, rent control is either in full force or being considered to regulate asking rents. Landlords are increasingly being pinched with new legislation that is in the tenants’ favor and creates a higher risk for ownership.
As a broker specializing in Santa Monica and prime Westside Los Angeles markets, the rising interest rate environment and overall economic uncertainty have generated an elevated interest in value-add apartment assets. With closing cap rates typically hovering in the 3 percent range throughout key Los Angeles markets, investors are averse to acquiring an asset at market rents as it means they are losing money right out of the gate.
Many of these coveted value-add opportunities involve rent-controlled assets units, and they present an added but not unsurmountable challenge. Below I have provided three successful strategies apartment owners can employ to elevate value over the short and long term.
I have marketed some assets with rents more than 50 percent below market value. Of course, a landlord can always gradually increase rents every year, but this approach doesn’t pencil well with property expenditures and inflation likely being more than the allotted rent raise. Some owners choose a different approach. For example, I had client who acquired a well-located property in Santa Monica who bought out six of the eight tenants. He compensated them no less than $80,000 to vacate the one-bedroom units. In other cases, I have seen up to $150,000 buyouts. The investor views this buyout strategy as a long-term way to create value, where over time, the rents would recoup the buyout amount.
A popular strategy for creating additional income is via fee-based offerings. This can include storage space rental and parking rental. This can be offered to the existing tenants or non-tenants in need of the space. In areas like Santa Monica with a dense population base, there is usually an outsized demand for both storage and parking.
Many rent-controlled units are very outdated. The very nature of rent control discourages landlords from making cosmetic improvements to units as there is no return on the investment. A landlord can certainly, however, negotiate with a tenant for specific improvements for an agreed-upon additional monthly amount. For example, remove the popcorn ceiling, upgrade flooring, and install an in-unit washer/dryer could be an additional $150-$300 per month in rent. An entire renovation is also possible if the tenant is willing to agree to the higher monthly rental rate. An amendment to the current lease would be signed and the new rent rate would be registered with the city.
While rent-controlled assets continue to experience new hurdles for owners, well-located properties are still proving to be strong investments. Getting creative with ways to add value contribute to a solid return on investment especially for those who are informed and patient.
Kimberly Stepp is principal, Stepp Commercial.