Forced Appreciation Strategies
Revenue collected on rental property investments is the lifeforce that drives the asset. When rents are below market, the lifeforce the encompasses the financial stability of the property becomes compromised. Obviously, every property incur expenses that eat away at the scheduled gross income, some of which are tied to inflationary treads subject to increases such as utilities, trash collection, and property taxes. When an investor, broker, or accountant puts together a statement of return on their investment as we do for our clients, it is prepared with the intent of determining how the asset is performing from a financial prospective. Even if the investor is not considering selling the investment, cash flow and the return on the amount originally invested need to be assessed because it is just good business to find ways to off-set any increase in the cost of expenses. This can be achieved by finding ways to add income to the existing property revenue and surely by increasing the rents on an annual basis by the percentages allowed by local or state law.
Throughout my many years in the rental property industry, I have heard many reasons why landlord don’t raise the rents. ‘I don’t want to lose good tenants by raising the rents.’ ‘I don’t want to get the unit ready for another tenant.’ ‘I could lose months of income with a vacant unit.’ ‘My tenants are good people and I like them. They are on a fixed income and they really can’t afford any increase of the rent.’ ‘I paid cash for my apartment and it is worth twice the amount I paid for it so I really don’t need the additional rent.’ These and many other reasons for not raising the rent are nice ways of saying ‘my tenants should not have to pay market rate for the most important expense of their household.’ But every other consumer purchase that occurs on the open market for everything from a can of soda to a new car is sold based on what the market would bear or market value. A retailer could not stay in business very long if they sold items based on what a consumer could or could not afford to pay. So why would you not raise your rents on the basis of what a tenant could or could not afford?
AB 3088 was extended to SB-91 which has now been extended to September 30th by AB 832. Local moratoriums in areas like Los Angeles have an indefinite time frame unless the state of emergency is lifted by the mayor and falls in line with expiration of AB 832. The COVID-19 crisis has made things more difficult for landlords, especially here in California because some tenants have used the rent/eviction moratorium to stop paying rent, not because they have been affected by the Pandemic but because they see an opportunity to use money for things like vacations, expensive cars, clothes etc.
Rental property owners must find ways to increase cash flow through forced appreciation by either increasing rents, adding income, or reducing expenses. Prior to implementation of AB 1482 (statewide rent control) that became effective in 2019, landlords with properties in some areas were refusing to raising rents to market. Let’s look at an eight unit building in Gardena with four 3-bedroom – 2 bath units and four 2-bedroom – 1 bath units. The proforma rents are $216,000.00 but current rented at 20% below market. This reduces the SGI by more than $43,000.00 per year! No matter how nice your tenants are or how much you want to help them or fear losing them, would you want to risk taking $43,000.00 out of the mouths of your own children?
There are some ways to add revenue to rental properties depending upon the size and configuration of the premises. If the building has a recreation room large enough, it can be rented out for community gatherings and meetings. Some owners have added vending machines onsite to increase revenue. There have been some landlords in more affluent areas who have offered weekly dog grooming and waterless car-detailing as paid services. Unassigned parking spaces can be rented and additional storage facilities can be installed and rented out at larger buildings. Then there are always programs like R.U.B.S. to reduce expenses by allocating the cost of master metered utilities to tenants without installing or setting up submeters.
Despite AB 832, properties in jurisdictions subject only to statewide rent control can raise the rents on tenants right now by 8.6 % (5 % plus CPI of 3.6%). Dwellings not subject to statewide rent control such as: single family homes, properties in Common Interest Developments, and duplexes where the owner resides in one of the units can raise the rents to as much as the market will bear. Exceptions would be those owners who failed to provide notification of the exemption to the tenants or properties where title is held by a corporation, REIT or an LLC where one of the members is part of a corporation.
In the example of the Gardena property, the landlord could recoup almost $15,000.00 per year by raising the rents by the amount legally allowed! Rental property owners must have the mindset to treat their rental properties like a any other business and run the investments as such. If you can raise the rents, DO SO TODAY! And be sure to provide proper notification. If you need assistance with any non-legal/tax-related rental property matter, be sure to give our office a call.
Blog by M. A. Williams(DRE Lic#01468935)