Investing in an Apartment Building

If you are new to investing in apartment buildings, you must consider several interlocking factors to see if the investment is worthwhile. As a prospective buyer, you first must consider the net operating income (NOI), which estimates the property's income and expenses. Brokers typically estimate the NOI, which may differ from the current owner’s financial statements.

If you purchase the property, your NOI will depend on how you run the apartment building. For example, will you manage the apartments or hire a manager? For minor repairs, will you do the repairs or hire a contractor? If you are planning to make building improvements, will you be raising the rent?

All of these considerations impact your revenue and expenses, which impact your NOI. The NOI divided by the current market value of the building gives you the capitalization rate. If the capitalization rate is lower than your desired rate, consider offering a lower price for the building to increase the capitalization rate.

Property taxes are another factor to consider. Generally, taxes make up a large portion of the expense, and local governments have different computing property taxes. Seek advice from a property tax expert who knows the local tax computation and its effect on sales. Property tax changes may eliminate all of the gains you have projected for the investment.

Before you buy, you must get an assessment of the physical state of the building. Do not be too concerned about minor issues in the inspection report, such as a leaking faucet, because these issues are a part of regular maintenance. Your primary concerns should be components such as windows, plumbing, electrical systems, heating, cooling, and roofing. Local contractors who specialize in these areas can provide estimates during the due diligence period before the sale can be closed. These inspections help you determine whether a component is adequate or requires attention.

For components that require repairs, make sure you have sufficient expenses allocated in the repair and maintenance item in your NOI statement to cover the costs. If the requirements are short-term or needed within five years, they have to be budgeted as one-time expenses. It is also true for other major items that are difficult to predict.

As these are capital or fixed asset expenditures and not operating expenses, you will not record the full amount as a yearly occurring expense in your NOI. Instead, add a line item in operating expenses called reserves. The figure is the estimate of all major short-term building requirements spread over time and expensed annually. You can determine the amount of money to put aside for these components. Hard-to-project expenses include fixtures, furniture, tenants suddenly leaving and taking your appliances. You will need to replace them.

Lastly, consider the location. Keep in mind that a good location for another type of real estate may not apply to an apartment building. Ideal apartment locations offer transportation accessibility and proximity to shopping, schools, and major employment centers. An apartment building unique to the area due to local government rules and regulations, such as the prohibition of new apartment construction, can be a valuable investment since it offers buyers a sought-after location.

Tenants under California Law

To avoid costly procedures like eviction or tenant turnover, landlords perform due diligence on prospective tenants. Nevertheless, even with solid verification processes in place, landlords will still encounter issues with tenants that are severe enough to require legal action. Often, problems arise when tenants break the terms of a lease agreement.

Failure to pay rent is a common reason for eviction. This includes missed and late rent payments. Landlords have leeway in how to deal with this issue.

Major life changes such as illness or job loss can impact a tenant’s financial situation. Landlords can allow a short grace period or create a payment plan to keep their tenants housed. If late or nonpayment is habitual, most states give the landlord the right to evict.

Misuse of the property is also considered a rental contract violation and grounds to terminate the lease. Tenants who sublet rooms without notifying the landlord or perform business activities without the proper permits risk losing the right to reside in the unit. Furthermore, those who endanger the well-being of other tenants through engaging in criminal behavior or violence can be immediately removed from the premises.

In California, landlords must provide a valid reason to seek a termination of the lease. Depending on the cause, tenants may be served with one of three types of notice:

1. In the case of back rent, landlords can serve a three-day notice to pay. This notice can be filed once the rent is one day past due, and must be handed to the tenant in person. If the tenant does not pay the rent within 72 hours, the landlord may begin the court process for eviction.

2. Tenants who violate other terms of the lease agreement, such as having animals in a unit that prohibits pets, may be served with a three-day notice to cure. This gives the tenant three days to resolve the issue at hand or face eviction.

3. Lease violations related to criminal conduct, subletting, or extreme property damage are grounds for a three-day unconditional quit notice. In these cases, the tenant has no recourse and will face eviction within three days.

Even after receiving an eviction notice, a tenant may refuse to leave or remedy the violation. The landlord must then go through the court system to remove the tenant. Alternative methods such as harassment, intimidation, or shutting off essential utilities are illegal and cannot be used to remove a tenant, even after eviction.

After the tenant has been served with a court complaint, he or she has five days to respond. At the end of this period, if the tenant has not responded, the landlord can request a default judgment. If the tenant still fails to appear before the court, the landlord can receive assistance from the local sheriff to remove the tenant from the property. From start to finish, an eviction can take more than six weeks.

The process of removing tenants is time-consuming and expensive. In addition to months of missed rent and court costs, landlords may face financial losses due to property damage. While some of this can be recouped from the tenant’s security deposit, the best way to deal with problem tenants is to avoid renting to them in the first place. When conducting a background check, landlords should reach out to references who can vouch for the applicant's conduct, including previous landlords, roommates, and neighbors.

Los Angeles Real Estate Growth

Taylor Goldblatt is a Beverly Hills real estate executive who focuses on luxury apartment complex properties with significant upside potential. Having successfully purchased properties and increased their marketability and value, Taylor Goldblatt maintains a close watch on Southern California property trends.

As revealed in a California Association of Realtors Forecast report, the impact of the pandemic on a red-hot Los Angeles real estate market was temporary, with rebounds starting as early as mid-2020. This set the stage for an explosive December, in which residential sales rose by double digits across all major regions. The $709,500 median sales price across Los Angeles County represented 10.6 percent growth year-on-year. Factors cited in this uptrend included families seeking more spacious living quarters as they worked from home and a continuation of interest rates near a record low.

The high-end markets were particularly active, with numerous properties generating over-asking bids and multiple offers. Hot markets included Malibu, Hollywood Hills, Beverly Hills, Bel-Air, and Pacific Palisades. One key differentiator in today’s market, as noted in a Forbes article is that buyers are now extremely discerning and forgoing the ostentatious for a carefully curated, understated approach that emphasizes inherent value.

When it comes to rental property, there were challenges related to the coronavirus pandemic, but the Orange County Register reporting a rent boost of 1.2 percent in February 2021. This represents the first increase since June 2019 across a region spanning Los Angeles and Orange counties. This was described as reflecting an economic landscape that is gradually returning to normal.