Category: Income Property

Los Angeles Income Property Utility Cost

When renting Condos and Single Family Homes landlords usually don’t pay for any of the utilities (except for condos, which the Landlord pays the HOA dues which cover some utilities).

For Residential Income Properties (2-4 units) and Apartment buildings (5U+) it’s a different story. Landlords usually pay at least a few of the utilities with these properties. Water + Trash are the most common utilities paid by the landlord since most income properties in Los Angeles are on a Master Water Meter and not separately metered. The cost to install a water submeter is quite prohibitive at about 20K, and water is cheap, so most landlords never bother to upgrade to separate water meters.

Advice from experience:  I recommend to put a stop service request on all utilities that are to be paid by the tenant prior to their move in. That way, you ensure that the utilities are put under the tenant’s name (at least if they want to use them) and you don’t have to pay for them.

Expert Tip: Most public utility companies have a “Landlord Account” you can set up. You should consider setting up a Landlord Account for all your investment properties. The two main utilities to set up landlord accounts in Los Angeles are Electricity and Gas. Landlord accounts save time and effort. When a tenant turns off their utility service, instead of disconnecting the Electricity or Gas, the service is left on and automatically transferred back to your landlord account- so you don’t have to start service again.

One last point I’d like to mention about utilities is that there is a lot of research that shows when a tenant pays their own utilities, they use about 20% less than when the landlord is pays for them. So if you can have the tenant pay for their own utilities that is always best.

Utilities Expenses:

WATER

ELECTRICITY & GAS

TRASH

SEWER

Water

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Fresh Water is one of our planet’s most abundant resources. Los Angeles has low rainfall and has to import about 70% of the water it needs, so water here is more expensive than wetter parts of the country- even if water is cheap (750 Gallons public water is ~$5- a lot cheaper than at the supermarket!).

Most of the income properties in Los Angeles are on a master water meter. I think this is because water is very inexpensive and the cost to install a meter is cost prohibitive ($20,000). Since there are no separate water meters, landlords usually pay water.  

The average person uses 100-120 Gallons of water per day and about 36,000 gallons of water per year. I would estimate about $200-$300 a year per person for water cost. If you have a 2 Bedroom unit, assume 3 occupants 3X$250 = $750 water cost per year. For 1 person in a 1bedroom $250 per year.

Some typical things people use water for: Showers (15-30 Gallons), Cooking (2 Gallons), Laundry (15-30 gallons), Gardening (8.5 Gallons/100sqft), Dishwashers (10 gallons) Bathroom – Toilet and sink (10 Gallons). A Bath is about 36 gallons. Showers are 2 gallons a minute.

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For properties that have extensive landscaping- especially grass, this can really skyrocket the water bill. Figure about $30/year per 100 SQFT of grass.

Los Angeles Water Companies? Beverly Hills Water covers BH and westhollywood??
DWP for LA

Electricity & Gas

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Electricity and Gas are commonly separately metered in Los Angeles- so tenants almost always pay for their own electricity and gas. Landlords for 2-4 units usually don’t have common area electricity (Lights in the front, the parking garage, Laundry room, and hallways) or common area gas charges (shared boiler, or laundry room gas dryers for example) for smaller size buildings. Apartment building owners, on the other hands, will probably have some common area electricity and gas bills for larger properties.

Electricity can be quite expensive @ 12 cents per Kilowatt Hour. The average American houshold spends $1,200 a year on Electricity Bill or about $100/mo. Since people spend about 5x more on electricity than water- this is a much more desirable utility to separately meter- paying the 20k to install a separate meter can recoup investment on a 15 year timeline.

For electricity, I would just like to specifically mention HVAC- which can be a huge power sucker. Especially if the HVAC system is old and functioning with less effectiveness. If the property has common area cooling system that is going to affect utility cost a lot.

Trash

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The City of Los Angeles provides collections services for Residential customers. Residential Service is for properties of (up to how many units?). The city only offers Trash bins, if you need a dumpster you will need to hire a commercial trash company and the cost is much higher (about +3K/mo per dumpter). 

Residential is Le expensive- for Single family dwellings it is $36/month or $432 a year. 

and for Duplexes and Multi-Family Dwellings $24/mo. per unit or  $288 per year per unit.

SEWER

Sewer is one of the little bills  $20/mo or $250 a year.

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Los Angeles Income Property – Non Conforming Unit

Sometimes you will see Los Angeles Income Properties listed for sale that advertises having “non-conforming unit(s)”.

1415 Rexford Dr non conforming unit

 

Investors often ask me, what is a non-conforming unit?  Non-Conforming is a very nice way of saying that the rental unit is illegal and that the number of actual rental units for the apartment building is more than the number of permitted units according to the property’s  Certificate of Occupancy.

Take for example the property above, 1415 Rexford Drive. It has only (1) Certificate of Occupancy recorded with the city of Los Angeles and that CofO says it’s a legal 10 unit apartment building.

1415 Rexford Drive certificate of occupancy

1415 Rexford Drive Certificate of Occupancy

The Los Angeles Building Department has quite a few of their permits online. The online records go back to about 1970, so if the year built is before then you can usually find the building permtis online here with that link. If you are dealing with an older property, the Certificate of Occupancy for a property can be obtained the same day in person at the Records Department at one of LABDS office Locations.

Dowtown LABDS Records Counter

Downtown LABDS Records Counter

Be forewarned that pulling permits will take you half a day and there will be a small printing fee.  Also if you go to the downtown location, parking is annoying. The meters are almost always full. If you are ok walking a bit and don’t mind the homeless people that usually are under the bridge, I find the meters under the bridge on W 1st usually have a few available. Or you can pay $10 or $20 buck for parking in the building on Fremont which I do on occasion. If you can wait 3-5 days, it is much easier to order a permit report for $60 online. Another place to check is both the assessor website parcel viewer or the city zoning website.  For Zoning website goto http://www.zimas.lacity.org/ and follow these three steps:

STEP 1: Type in Property Address and Click Go

Zimas Step 1

STEP 2: Click the Assessor Tab

zimas 2

Step 3: Review the Number of Units (this is the number of permitted units the property has)

Zimas 3

With 1415 S Rexford it is pretty easy to spot the non-conforming unit, it is probably the 0Br/1Ba studio unit being rented out for $700/mo. My guess is this building was originally built with a rec room that the owner illegally converted into a studio unit at some point. Non-conforming rental units cannot be registered with LAHD, and you are not allowed to collect rent from them. In addition, if LAHD finds out about the non conforming unit they can require the owner to restore the non conforming unit back to its original use or retroactively permit it, which may or may not be possible with Today’s strict building code (the current owner probably tried to permit the non conforming unit but discovered after visiting the building department that the number of parking spaces required or Max Dwellings units made it impossible to permit).

The Los Angeles Housing Department and the Los Angeles Building Department enforce building codes. They don’t have many resources available for enforcement so they aren’t actively looking for violations. There are two main ways non conforming units are commonly cited- tenant complaints to LAHD and the city of Los Angeles’ SCEP inspections. The city of Los Angeles inspects every registered rental unit every 3 years. You can check if the Los Angeles Building Department has already flagged a non-conforming unit on their website:

Property Activity Reporty

Property Activity Report

https://www.permitla.org

And you can also check the LAHD website to see if they have and code violations on the file:

STEP 1: Click Code EnforcementLAHD Code Enforcement 1

Step 2: Click Prop Info/Complaints

Lahd Code enforcement 2

Step 3: Click Property Profile

LAHD Code Enforcement 3

And you can search by address and review any complaints, violations, and information from there.

Apartment Buildings located in the City of Los Angeles are at especially high risk of having their non-conforming units cited because of SCEP. Someone purchased 1415 Rexford drive for full list price, and put 50% down. With the non conforming rental income included the property produces a minuscule 0.2% cash on cash for $4,000 cash flow on $2,180,000 invested. If you lost the $700/mo from the studio because LAHD demanded you to restore it to a rec room, your cash flow would turn to a negative -$4,000 per year instead. In this instance, since whoever bought this building was probably an institutional investor or a trust, with a 30-year hold plan, they can take a break-even investment like this work and won’t be sensitive to slightly negative cash flow.

Keep in mind that all your profits as an investor in multifamily apartment buildings come with your last 10% of occupancy after all the expenses, debt service, and maintenance are paid off. Losing the income from a non-conforming could change an income property investment from a great deal to a bad one. There is no guarantee that two years after you own the building, your regular SCEP inspection occurs and the LA city Housing Department inspector tells you that you cannot rent the non-conforming unit. Now the cash flow for the non-conforming unit is gone and in addition you will need to pay the tenant living there relocation assistance of $10,000 to $20,000 and construction expense. Without the non conforming unit income, you either won’t be getting the return you wanted or you might even become negative cash flow!

I discount non-conforming units to no value.

token no cash value

Non-Conforming Unit cash flow is like Token Money but this isn’t the arcade or a car wash at a gas station….

The County of Los Angeles is a bit different because they do not have SCEP inspections, so its a bit easier to get away with a non-conforming unit. I still don’t recommend you rely on income from a nonconforming unit that can be taken away to base your purchase decision on- the safest and most conservative way to value non-conforming unit income is to assume zero income.

Have you been cited for having a non-conforming unit by the city and need advice? Try:

Aaron Cooke
17940 Ventura Blvd Unit B
Encino, CA 91316

O. (213) 373-4513

C. (818) 923-3664

Standleystructural.com 

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Gross Rent Multiplier [GRM]

Let’s suppose you are searching for a real estate investment, and you are reviewing a large number of los angeles income properties. In this list there are all kinds of different investment properties for sale- single family rental houses, duplexes, triplexes, quadraplex, 5 plexes and so on. How do you make sense of the information to quickly sort through the properties that are overpriced and once you have the list narrowed down, compare these different investment property types?

Which is the best investment?

 

Price $5,890,000 32 units

Price $5,890,000 32 units

Price $1,795,000 2 units

Price $1,795,000 2 units

 

Price $1,550,000 4 units

Price $1,550,000 4 units

 

Price $875,000 2 units

Price $875,000 2 units

The Gross Rent Multiplier (GRM) is a quick and easy tool that investors can use to review and compare different investment properties. 

grm equation

All you need is two numbers- the price and the gross income. GRM is the simple ratio of Price divided by Gross Income.

The LOWER THE GRM, the BETTER the investment.

Example Calculation: If the sales price of an Income property is $200,000 and the monthly total rent is $1,600- the annual gross rent is $1,600x 12 = $19,200. Divide $200,000/ $19,200 = GRM = 10.4

Here are the Results:

3036 S Hoover has a GOI of 584,000. 5890/584= 10.08

3036 S Hoover has a GOI of 584,000. 5890/584= 10.08

 

174 S Orange Dr has a GOI of 90K. 1795/90= 19.94

174 S Orange Dr has a GOI of 90K. 1795/90= 19.94

9842 Vidor Dr has a GOI 69600. 1550/69.6=22.27

9842 Vidor Dr has a GOI 69600. 1550/69.6=22.27

 

860 N Las Palmas has a GOI of 60K. 875/60= 14.58

860 N Las Palmas has a GOI of 60K. 875/60= 14.58

Were you surprised that Vidor had a worse GRM than Orange Dr? Clearly 4 units for less in a better area is the better investment. However Vidor has all four tenants at WAY BELOW market rent, and so the income for the building is not good. This illustrates the challenge with using GRM, because price per square foot kicks in even if the rents are very low- because of building replacement cost value. Additionally, although below market tenants cannot be evicted except for the 12 legal reasons under rent control, an owner may offer the tenants a buy out amount via a voluntary vacancy agreement- just because the rents are low, doesn’t mean they have to stay that way- even if the building is rent controlled.

GRM doesn’t factor expenses (like Cap rates does), nor vacancy reserve– it assumes 100% occupancy. GRM is too simple to make a final investment decision based on. GRM is useful for quickly sorting and comparing.

Properties in prime A+ locations have higher GRMs than properties in less desirable locations. Duplex, triplex and 4plex tend to have higher GRM’s than 5 unit+ multifamily property, because owner users compete with investors and drive up the prices to comparable single family house cost. GRMs are going to be lower in the USC neighborhood where the 32 unit buiding Hoover is located versus the Beverly Hills Adjacent Neighborhood Vidor is located in.

For investors a GRM of 12 will probably cash flow break even. A GRM of 10 or below will probably cash flow positive. GRM over 18 is not feasible as a straight investment, the most I would consider paying is GRM 15, when the property is located in the most prime Los Angeles areas.

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Single Family Home Investment

Buying a single family home as an investment is the starting point for many real estate investors. Unfortunately, in Los Angeles, most single family homes don’t debt cover when being considered as an investment. The cardinal rule of real estate investing is: cash flow break-even or cash flow positive.

Homes have no correlation between their prices and the amount of income they produce. Therefore, it is common to see houses with 18-20 GRM and 2.5% cap rates or worse.

If the single family home doesn’t cash flow positive, you will have to come out of pocket each month to hold the property. When you lose money each month- that is a bad investment.

The only reason I can think of that an investor would be willing to do this is in the hopes appreciation will increase the value of the property greater than holding cost (4%/yr) + cost of sale (7-8%) expenses.

Single Family homes have a greater vacancy loss risk than multifamily properties because they only have one tenant. If you have a vacancy you will be losing 100% of your gross income every month the house is empty.

Single family houses are more management intensive than multifamily properties because they have multiple roofs, lawns, locations… etc. They don’t scale well.

A perk of single family homes is that utilities are separately metered. If a single family home can be purchased for a 11.5 GRM or less, and a Cap rate of 5% or more- they could make financial sense.

 

Let’s consider a real world example:

 

hancock Park Bungalow

2Br/2Ba Hancock Park Bungalow worth $800,000 and rents for $3,600. Property is purchased with 20% down at an interest rate of 4.38%. The Vacancy reserve is increased from the normal 3-5% to 15% ($6,500 or two months vacancy) because of the high vacancy loss risk. If you were to manage the property yourself, the property would negative cash flow $1,500/mo. (or $18,000 annually).

Hancock Park Bungalow example

What does the purchase price of this bungalow have to be to break even? The answer is $480,000!

Hancock Park Bungalow example 2

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Rental Property Expenses

When reviewing a deal it is important to properly estimate the operating expenses of the income property- if you underestimate the expenses you may pay way too much for the building, or the building might negative cash flow!

A good rule of thumb for operating expenses is 40% of Gross Income. Having property management versus no property management will change the expenses by 5%-8% and is one of the bigger expenses. I would be very suspicious of 20% or less operating expense buildings- chances are they are leaving somethings out.

There are 3 different sets of numbers for Operating expenses: the seller’s numbers, the listing brokers numbers, and the buyer’s numbers.

The seller’s numbers will be understated (I have never seen an accurate seller accounting!). The seller has incentive to report lower expenses because this will raise the net operating income of the building and increase the cap rate/ price. The seller may tell you that they didn’t spend money on property management or that they spent very little over the past year on maintenance. Some expenses may be missing altogether from their accounting, such as pest control or reserves.

Verify all operating expenses during the due diligence period.

Listing Brokers play ‘with the numbers’ to make the property look like a better investment. They may use “Market” Rents instead of actual rents, current annual property tax instead of the property tax based on the new purchase price, or understate expenses or omit expenses.

Buyers, do your homework.

Operating Expenses do not include Capital Improvements and Mortgage.

Operating Expense Catagories:

Taxes

-Insurance

-Utilities

Trash

-Pest Control

-Gardner

Vacancy Reserve

-Property Management (On site & Off site)

-Routine Maintanence

-Reserves

-Sewage

Registration

-Cleaning Service (if Applicable)

-Pool Service (if Applicable)

-Elevator Service (if Applicable)

-Sprinkler Systems (if Applicable)

-Phone Service (if Applicable)

-Intercom Service (if Applicable)

-Payroll (if Applicable)

 

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How to write a Letter of Intent

Writing an Income Property offer depends on whether the building is commercial (+4 units) or residential (2-4 units).

Residential Offers are written on California Association of Realtor, Residential Income Property Purchase Agreement (RIPA).

A complete offer will include (click on link to review the CAR form):

1. Residential Income Property Purchase Agreement and Joint Escrow Instructions

2. (Optional) Wood Destroying Pest Inspection and Allocation of Cost Addendum

3. Proof of Funds

4. Preapproval Letter (if financed)

For commercial offers, negotiations start with a “Letter of Intent” or LOI for short.

LOI pic

An LOI is a one page piece of paper that outlines the basic terms of the agreement, mainly price. If an agreement is reached then a contract will be negotiated and drafted.

*If you plan to take title as an LLC a copy of your Articles of Organization will also be needed.

 

 

 

 

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