24 Things You Need to Know About National City Rent Control

24 Things You Need to Know About National City Rent Control

National City Rent Control

Rent Control may be coming to San Diego County sooner than you think. National City renters recently gathered 3,600 signatures to place the National City Rent Control and Community Stability Ordinance on the November 2018 ballot. The implications that this may have on property owners, renters, and our local economy could be immense. We encourage all property owners to educate themselves on this matter and understand it’s potential consequences. If you would like a full highlighted copy of the ordinance, please leave us a comment below and we’ll be happy to send you a free copy. In addition, I will be hosting an informative lunch and learn on September 18th that will be covering rent control and the recent vacation rental restrictions. Click here for more information and to RSVP.

San Diego Rent Control


24 Things You Need To Know About the Ordinance

  1. All rental properties would be subject to this measure except for single-family homes with granny flats, rooming houses, student housing, and subsidized affordable projects.
  2. All rental rates will be placed back to the date this ordinance was published (March 2018). The rent charged at that time will serve as the base rent for the unit.
  3. The base rent will be allowed to increase by the inflation rate (CPI) of up to 5%, but no more regardless of whether inflation went beyond 5%.
  4. This ordinance does not allow for the standard of vacancy decontrol, where an owner would typically raise rents to market upon a tenant moving out. This means the owner must keep the unit at the current controlled rental rate.
  5. Establishes a 5-member National City Rental Board (NCRB). This Board would have the authority to set and adjust annual rent rate for rental properties.
  6. The Board must be composed of at least 3 tenants currently renting in National City.
  7. The Board would finance its “reasonable and necessary expenses” by charging landlords annual rental housing fees. This would start at $120 per unit and is subject to increase by the Boards discretion. Most rent control boards in California charge between $240-$360 per-year per-unit.
  8. The Board would create a “base rental rate” and units would be assigned a maximum allowable rental rate that the landlord could charge a tenant. The maximum rate could be adjusted higher or lower with the Board’s discretion.
  9. Landlords wanting to increase their maximum allowable rate would have to petition the board for approval.
  10. Contains a Just Cause Provision, which significantly decreases the landlords right to require a tenant to vacate unless under specific circumstances. The landlord must file with the Board justification as to the why the tenant is being evicted.
  11. If the landlord plans to remove the unit from the market, they must notify the Board and provide a minimum of 120 days notice to tenants or 1 year if the tenant is a senior (62+) or disabled. Relocation payments will also apply.
  12. The landlord would have to provide $7,000 to the tenant or $10,000 to a senior/disabled tenant for relocation assistance. This is the 1st year established fees and would be subject to increase per Board review on a yearly basis.
  13. Any significant repairs requiring a temporary-vacation of the unit for more than 30 days are subject to relocation assistance fees.
  14. The evicted tenant possesses a “right of first refusal” and is allowed to take back the property if the owner places it back on the market. The tenant will also be entitled to pay the same rental rate they initially paid. For example, an owner decides to move back into his unit for 5 years, and then suddenly decides to place it back for rent. The owner must then offer it to the prior tenant at the last rental rate they paid.
  15. Any attempt made to recover the unit in violation of the ordinance shall render the landlord liable to the tenant for actual damages, including damages for emotional distress, in a civil action for wrongful eviction.
  16. Landlords and tenants are prohibited from making agreements that contradict any provision in the ordinance. These private agreements would be deemed void.
  17. Ratio Utility Billing (RUB) is prohibited. Rental owners may not charge for utilities unless they are individually metered.
  18. Landlords must petition the rent board for any request to increase the maximum allowed rent.
  19. Hearing examiners may review an owner’s books and records and conduct a building inspection and/or request that the City conduct a building inspection. Tenants may request that a hearing examiner conduct an inspection prior to a hearing.
  20. The City Council, City Manager, and City Attorney will not have any power to oversee, supervise, or approve the Board’s yearly budget.
  21. The Board will be allowed yearly assess and determine if there is a sufficient number of hearing examiners, housing counselors, and legal staff to effectively carry out the ordinance. This would increase the budget and cannot be overseen by City Council.
  22. The landlord’s failure to comply with any of the requirements in the ordinance can result in the tenants right to withhold rent. After the issue has been resolved by the owner, the Board will get to determine how much, if any of the withheld rent, will be owed to the owner.
  23. Any rental owner who demands, accepts, receives or retains any payment in excess of the amount allowed under the Ordinance shall be liable in a civil action to the tenant, including general and special damages and emotional distress. Additionally, the tenant will be entitled to costs and expenses.
  24. An order authorizing rent withholding shall survive the sale of the property and shall be binding upon the successors of the rental owner.

These are just the main highlights of the proposed ordinance. I strongly encourage you to read through the entire ordinance and familiarize yourself with it. If you would like a copy of the full ordinance, I would be happy to send you one. Just let me know if the comments below.


Stay posted for more updates on Rent Control in National City. If you haven’t checked out my earlier blog post on the proposed San Diego Rent Control efforts, click here to read more. I hope to see you at my upcoming lunch & learn on rent control and vacation rentals. This will be a great chance to get your questions answered and to hear more about this issue.

What Now?

If you a property owner and have concern over how this could affect your investments, my team and I would be happy to help. We have a wealth of experience in the multi-family industry and provide our clients with unmatched expertise. Give us a call today at (858) 356-5973 or click here to send us an email.


Curtis Gabhart and Gabhart Investments, Inc – 2018 All Rights Reserved
The information presented in this article represents the opinions of the author and does not necessarily reflect the opinions of Gabhart Investments, Inc. The material contained in articles that appear on gabhartinvestments.com is not intended to provide legal, tax or other professional advice or to substitute for the proper professional advice and/or commercial real estate due diligence. We urge you to consult a licensed real estate broker, attorney, tax professional or other appropriate professionals before taking any action in regard to matters discussed in any article or posting. The posting of an article and of any link back to the author and/or the author’s company does not constitute an endorsement or recommendation of the author’s products or services.
Don’t Take Cap Rates at Face Value When Buying Your Next Multi-Family Building

Don’t Take Cap Rates at Face Value When Buying Your Next Multi-Family Building

The Quick Facts

  • Cap rates on properties can be misleading without proper expense reports
  • Many small to mid-sized multi-family buildings don’t have accurate expenses records
  • By only looking at cap rates can cause you to lose out on potential good deals
  • It is imperative to do your due diligence and analyze the expenses
  • Pairing yourself with proper representation (commercial broker) can make a huge difference
  • Learning standard expense multipliers can save you a lot of time and money

 

So, you’re looking to purchase your next multi-family building. You’ve selected a few perspective properties, gathered the financial reports, and are trying to decide which is the best investment. How do you know which one is the best deal? Many investors would run straight to comparing capitalization rates (AKA cap rates).

While this is a good start, I’d argue that you should be cautious when comparing cap rates. It is crucial never to take a cap rate at face value and always conduct proper due diligence and seek appropriate representation. Not only could you overpay for a property, but you could also miss out on some great deals. The answer to this dilemma lies in the expenses.

First, I will explain why cap rates can be inaccurate due to inaccurate expenses and then offer a more accurate and efficient alternative.

If you’re unfamiliar with cap rates, get caught up to speed by checking out my earlier blog post on cap rates. 

Be sure to make it down to the end of this post for my PowerPoint presentation on “Don’t Take Cap Rates at Face Value”. I’ve included some valuable and practical examples of the topics discussed in this post. 

CAP Rates

To understand cap rates better, it is best to take a look at a crucial component, the net operating income (NOI).

Net Operating Income on commercial properties

To arrive at the net operating income, we must subtract gross operating income from operating expenses; but what if the operating expenses are misreported? That can have a drastic effect on the final calculation of a cap rate.

Most small to mid-sized apartments available on the market don’t have actual expense reports or profit and loss statements from the owners.

This could happen because the owner is:

  • Unorganized
  • Hiding expenses
  • Doing repairs themselves and not factoring in things like labor costs
  • Miscategorizing capital expenses as maintenance expenses
  • Keeping incomplete expense reports or in some cases, no reports at all.

Other times it can also be the broker’s fault because they don’t ask for the expense reports from the owner.

A failure to have actual expenses can lead to you, the potential buyer, to purchase an over-priced deal or worse, walk away from a great deal.

Here are some ways it can be inaccurate

San Diego Painter Mr Magoo

I’d like to introduce Mr. Magoo, a carpenter, and the owner of a small apartment building that has recently been put on the market. He’s seen a couple of Martha Stewart shows and thinks he’s quite the handyman, so he decides to do all maintenance and repairs himself. He’s made some questionable decisions like when he mixed several leftover paint cans to paint the exterior of the building, or when he patched a leaky roof with plywood. He’s also read online about property management and decides he can manage the building himself.

By doing this, Mr. Magoo has been able to save thousands of dollars on labor and maintenance expenses. He’s able to avoid placing these line items on his expense report, which makes his NOI appear higher than it is.

So, one day you’re on LoopNet or Costar looking for commercial property and stumble upon his building and decide to give him a call. When you speak to Mr. Magoo, he tells you it is an excellent building with little expenses. He claims that maintenance and repairs only cost him 5% of total expenses, which is drastically different from another owner who may assign 25% of their total expenses towards maintenance and repairs.

After doing some math on the given expenses, let’s say you calculate the cap rate of his property to be 6%. You think this looks like a great deal and are considering making an offer.

This can pose a severe problem if you, the potential buyer, take his expenses at face value without conducting any due diligence.

If you were to look into the expenses on Mr. Magoo’s property, you would find his cap rate is inaccurate unless you plan to hire yourself to be the painter and the property manager. The reason his cap rate appears to be high is that he was not accounting for the labor or market costs of maintenance. Unless you’re making less money than a property manager or painter at your current job, you should hire professionals. You’re going to save more money by paying them to do these services, and a lender will always add these expenses to their underwriting criteria. Your job should be running the operations, finding more properties, or continuing your career that pays you more than painting or managing your property. So, in this scenario, the cap rate is useless because Mr. Magoo’s expenses do not represent what you, the new owner, would be paying.

Without digging into his expenses, you might end up paying far more for a property that doesn’t produce anywhere near the stated NOI.

Now I’d like to demonstrate how over-reporting maintenance expenses can drive you away from potential deals.      

Let’s say you stumble upon a 6-unit apartment building that has everything you are looking for in a multi-family property. The only issue is that it has an alarmingly low cap rate of 3.5% and very high expenses. Many inexperienced investors or brokers may walk away from this deal without even digging into the expenses.

Upon further investigation, you discover the current owner has been overstating expenses because they don’t know how to accurately spread out repair costs over the life of the repair. When looking at the report, you see that there were two consecutive years of significant electrical upgrades that cost about $30,000 per year. This adds up to $60,000 in total expenses for new electrical that was meant to last 50 years. The owner should have spread out that $60,000 expenses over the life of the electrical rather than doing it up front. An experienced broker would be able to spot this and reallocate the expenses to the property area. After correcting the error, you will see that the cap rate will go up and expenses will go down.

As you can see, by the owner not understanding how to report expenses accurately, the property seems to be a bad deal. You may have walked away from a great opportunity had you not conducted a little due diligence.

Property Taxes

Another way cap rates can be misreported is through property taxes. The property taxes for multi-family apartment buildings in San Diego is 1.2% of the purchase price of the building. Where many inexperienced brokers can make mistakes is by basing their cap rate calculation off the old property taxes which is not accurate of what the new owner will be paying. Here’s an example:

Let’s say you have a property that the current owner bought for $1,000,000 over ten years ago.

Old commercial real estate investment

Currently, the owner would be paying $12,000 a year in property taxes. The property is then listed on the market for $2,000,000. Instead of calculating the new property taxes, which would be $24,000 per year, the broker decides to use the same $12,000 that the current owner is paying.

New owner for commercial property

What results is that the expenses will be reported at less than what they actually will be. This has the unfavorable result of artificially increasing the cap rate. When the new owner acquires the property, they will not be receiving that same income as their property taxes will be based on the new purchase price.

Furthermore, this could cause you to pay more for the property than it’s worth. Take a look at the following spreadsheets.

Old vs New commercial real estate investment

The difference between the old and new property taxes comes out to be $12,000. If we value the $12,000 difference at 5% cap rate ($12,000/.05) we get a value of $240,000. Now, let’s say the property requires a 25% down payment. If you were to pay the original asking price of $2,000,000 assuming the old property taxes, your down payment would be $500,000 ($200,000 * .25). If, however, you took into consideration the reduced value given the updated property taxes, you would see the offer price comes down to $1,760,000 ($2,000,000 – 240,000). This makes your 25% down payment $440,000. That’s a $60,000 savings by accurately accounting the property taxes.

This is why it is crucial to pair yourself up with proper representation. An experienced commercial broker would realize this and account for it in the offer.

The pay between experienced commercial brokers and new ones is not far off, so why not pair up with one who is experienced?

So now that I’ve demonstrated some ways that cap rates can be inaccurate let’s look at a better alternative.

Standard Expense Multipliers

With properties that may not have accurate expense reports (especially small to mid-sized apartment buildings), I recommend that you use standard expense multipliers to learn the price per square foot. This puts you in a much better position to understand a properties performance and overall value. I have found the Institute of Real Estate Management (IREM) Apartment Expense Multiplier sheet to be extremely valuable when determining baseline expenses.

Operating expenses for commercial real estate

When used appropriately, this will allow you put a better estimate on what your actual expenses may look like on a price per square foot basis.

This will allow you to compare the owner’s expense report versus your estimate. Any significant discrepancies could be a red flag that requires further investigating. These calculations will save you a lot of time and potential money spent.

If you’re trying to look through 180 listings, you can’t underwrite every deal promptly. Instead, what you can do is quickly look at each deal and say, “okay, this is a $170,000 unit. It’s a 14 times GRM.  If you put about a 40% expense on it, it is going to be in the 4% cap range”. Using this approach is going to make it much quicker for you to go down the line of properties.  Also, sometimes you’re going to find very similar buildings. If you saw something that sold for a particular gross rate multiplier, that may be a better way to sort through properties quickly. It will become easier to make apples to apple comparisons because those rents that they listed are usually accurate as long as they’re not pro forma rents.

So, when do you use Cap Rates?

Well, the larger the property or, the more organized an owner is, the more likely it’s going to be accurate. Also, the more respectable and experienced the broker is, the more likely it’s going to be a precise number. If the pay difference between an experienced and new broker isn’t far off,  why not pair yourself with an experienced broker?

Rarely, when you get down to it, will expenses be precisely what any owner says.  The question becomes; how far off is it?  So, my first piece of advice is to try to deal with people who are reputable and looking at the numbers. If everything you see in the market is at a 5% cap rate, and all of a sudden you find a property with a 7% cap rate – you should think to yourself, “that’s suspicious, why is it still on the market?”. Another example is if you see two comparable buildings with similar rents but drastically different cap rates; this could indicate something is off.

If you’re looking at larger properties or ones run by management companies, the numbers are more likely to be accurate because the owner is going to be able to print out a profit and loss statement. However, another problem arises.

What you could find is that the owner wants to write off as much money as they can on the property. Besides depreciation, they can achieve write-offs through two main ways.

  1. First is by doing maintenance and writing it off the in the year you did the work. This could be things like fixing your toilet or patching the roof.
  2. The second is capital improvements. Capital improvements typically have a long life but can range from one year to several years. A roof, for example, is a capital improvement because even though I paid $10,000 for it today, that write-off might be over the ten-year life of the roof. Because of this, I’m only able to write off $1000 per year against my income.  Although this is the case, a seller may say, “no, that’s still maintenance, so I’m going to write off the entire $10,000 this year”, even though it’s very questionable if not outright fraudulent to do so – but it still happens more than you’d think. A good broker would be able to spot this right away and reallocate it to the proper area of the financial statement. This would change your overall NOI.

So, when working with cap rates where you get income/expense reports, it is imperative to take a look and identify which numbers are actual maintenance and which ones are capital improvements. You also need to see if they’re moving their maintenance into capital improvements. Sellers often do this so they can report more income in the year that they sell, which gives them a higher sale value. Doing your due diligence here can save you a lot of time and money.

Here’s a great example of a multi-family apartment building in San Diego that I bought a while back. The property had a very low cap rate, which typically means that it’s not producing a lot of income. Many investors would walk away right there without digging into the financials. However, after we got into the property, we realized the expenses were misallocated, and the CAP rate turned out to be higher than it was initially stated. We were able to turn a healthy profit on the building by not taking the CAP rate at face value right away.

The moral of the story is be careful when you rely on the CAP rates of small to mid-sized properties.

  1. Learn your expenses
  2. Learn the price per square foot
  3. Learn the market rents in the area so you can apply those metrics to buildings you are analyzing
  4. Take a look at who is listing the property. Is it somebody who has experience? Are they missing a lot of financial numbers?
  5. Do they have expenses listed out, or do they just give you a bottom line number?
  6. Do they have a marketing package? Are they seeming overly aggressive with what they’re proposing?

Sometimes the best deal you buy are the properties that were not marketed correctly. These can often be opportunities for you get a lower price if you conduct the necessary due diligence.

Please leave in the comments below any thoughts you have on cap rates and valuing a property or any stories you may have run into…

Curtis Gabhart, CCIM

Edited by: Blake Imperl

Disclaimer: I’d like to point out that none of the content in this article is absolute. It’s just food for thought and is based on my numerous years of experience dealing with commercial real estate.

These are just some things you may want to think about when analyzing commercial properties. It isn’t always advantageous to rely heavily on CAP rates when looking at properties where you don’t know their actual expenses. This post was designed to offer an alternative for when you’re looking at dozens of properties and trying to find the best deal available.

Additional Education

Please take a look at my PowerPoint Presentation from my recent class on “Don’t Take Cap Rates at Face Value”. I teach monthly commercial real estate classes on a variety of topics from due diligence to getting started in commercial real estate and everything in between. If you’re interested in finding out more about my classes, please visit my Eventbrite Page where you can find the complete list of upcoming classes. 

Looking for some more tips on buying multi-family properties?  Click here to check out my multi-family inspection tips!

Want to get more return on your investment? Here’s a great article on how to increase your buildings’ property value fast by investing in a new paint job. 

How to Value Commercial Real Estate 101 Slideshare – This crash course will take you through the basics of valuing commercial real estate. It has over 106,000 views so far!

Balancing Act with Agents – Easy yet Selective

Held an interview today for recruiting someone to take charge of the marketing at Commercial Real Estate Association, went pretty well. Then I went to Shasta and took out all the construction guys for a sushi lunch. The guys look like they are going to have a late night.

Then I went over to two properties that an agent needed to get offers for. One was on a hilltop in Chula Vista with an asking price of $175,000. After looking at it as it was really chopped up, messy, no garage, had building violations and even had a $9,000 fine that the seller wanted the buyer to pay I felt $100,000 was a more likely figure.

However when one doesn’t have any information on the property before going to look at it, it can be tricky to give a realistic estimate. So there really should be a qualifying system so that while agents will always choose you to call first when they have a property, you aren’t running all day wasting time looking at properties. As you make it easier for agents to call you this system becomes all the more important once you start getting 5 -10 property review request each day. Eventually one can also train others to look at the properties… I might pick up one of the guys working on the construction job at Shasta.

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Printing Money with a Real Estate Brokerage License

Printing Money with a Real Estate Brokerage License

How do most people start investing in real estate? They save money, they borrow from friends & family and they risk taking credit. Or they try sophisticated techniques like no money down deals which even the experienced real estate investor often has difficulty in succeeding with.

Therefore, they start investing with friends and families money without experience and are not going to be rewarded for their time and efforts until their first deal closes to buy then sells for a profit. Or they may try to bird dog, which is finding and tieing a property with their own money many times, then trying to flip it to another investor. This, technically, could need a real estate license anyway if not done correctly and on the other hand, if the investor doesn’t buy the property you are stuck.

Whereas if you had a real estate license you could enjoy the following benefits:-

Lock MoneyLock the property, not your money.

Instead of using your money to make a down payment and lock the property, use your license and lock the property by getting a listing on it. That way you can tie up any number of properties and will never be limited by the amount of funds that are at your disposal. You can use the listings to sell to anyone who may be suited for that investment. Also, your listings are generally 6-12 months that means you have 6-12 months to sell the thing and are not pushed to sell for undue consideration.

Gain wisdom, not knowledge.

You may have read dozens of books in investing in real estate. You may have even attended a couple of courses and now you think you are ready to part with your precious money? Think again. Just as you wouldn’t run off to Las Vegas and marry someone after a few email exchanged but would date them for some time, similarly you shouldn’t invest in real estate without some live experience either. If you have a license you will typically wok through five to thirty deals a year. You will gain practical and live experience of the mechanics of negotiating and the purchase of a property. You will have access to MLS and will also start building relationships with other real estate brokers and agents. The only aspect you will not be directly exposed to is the actual operations and management of the property. However, you can gain insight in that too if you want just by asking your buyers how their properties are doing, if there is something you can help them with etc. That way not only do you build your relationships, but you also gain valuable insight without having to have paid for it through your own mistakes.

Build a network of assets, not buy a chain of properties.

If you have a real estate license you can gain access to innumerable people. You can start developing and maintaining relationships with all of them. If you nurture them then each of these contacts can become an invaluable asset. Some will bring leads of properties, others of buyers. Some will help you save money while others will allow you to make money. All these assets can be created without any significant monetary investment. While on the other hand, to build a chain of properties requires a significant amount of funds to be invested, and while we may wish otherwise, that’s often not possible.

Learn from the Masters, but maintain more accurate information than they do! Learn Master

With your real estate license you will have the opportunity to work with and learn from the most sophisticated investors. These are the best type of people to work with as they know exactly what they want, therefore you will learn to look for what they have learnt to look for. However, you will be the one on the phone calling sellers and buyers every day and you will actually be helping others make deals. Therefore you will have a better handle on the price and other metrics of the properties that you specialize in than they do, even if they are a full time real estate investor. This way you can actually gain the best of both worlds.

Follow your interests, not your burdens.

It is common knowledge that one will do something much better if they are passionate about it. Similarly with a real estate license you can select and start working in any niche that interests you. So if you feel retail is right for you, then work on brokering retail property. If you feel multi family is the way to go, then go ahead! Start talking to appropriate buyers and sellers and understand the advantages and disadvantages of working in that segment. You will also start being introduced to other specialists who work in your niche so you will come across appraisers, contractors, lawyers and a wide assortment of other professionals who are knowledgeable about your niche. These are people who you can immediately choose to work with when you decide to invest in your own properties.

On the other hand when you started out in real estate, you may have bought an industrial property. However it is possible that you quickly find that the industrial segment isn’t for you so now you have to wait the process of disposing of that property and again finding another property that is in the segment that you wish to work in. This not only makes you lose time, but also lose interest, and therefore eventually, lose the opportunities. Also after all it is better to lose a commission than to lose your credit.

Choose how far you want to go, not how far you can go.

Real estate is such a vast market that irrespective of the niche that you decide to work in, the opportunities within that niche are so many and deep, that if you are persistent and systematic, you will certainly build wealth beyond your expectations. Of course it is important that you do set specific goals and these may be specified in terms of an annual amount of positive cash flow say $100,000, or in the value of wealth built at the end of a period, say $30 million in assets.

Get started when you want, not have to wait to build resources.

If you are trying to enter the real estate business then you will need to wait to build a certain amount of capital before you can get started. Whereas if you take the real estate brokerage route, there is nothing you need to wait for.

What! you’re still here reading? Shouldn’t you be at the Department of Real Estate?

For a copy of the actual article that was featured in the San Diego Daily Transcript click here to go to the download page and download the article.

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