Existing Rents turn a Great Deal into a Bad Deal

Buying & Selling Real Estate
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Existing Rents turn a Great Deal into a Bad Deal

Daniel DiChiro
Developer · CA · Member since 2021 · 19 posts · 8 votes

Hello BP Community,

This is an interesting scenario and I would love to hear your feedback. At first glance this 4-plex in Oakland, CA would appear to be a steal for $750,000! It is in relatively good area near downtown and is fully functional. 3 of the units are already occupied and the 4th is newly renovated, making it the perfect house hack opportunity... sounds too good to be true, right?

Well I reached out to the selling agent to understand how this seemingly fictitious deal could be real? Turns out the building is rent stabilized (no surprise for CA) and the existing renters have been in there for so long that the existing rents are well below market (~1/2). As a result, the tremendous deal analysis I originally ran with market rent values, actually turns out to be a terrible negative cash flow deal!

So what's up fellow investors? The asking price is so low it seems irresponsible to pass up on this deal, but the existing rents make it a deal breaker. Are there any other considerations to make? Have you experienced this situation and if so, what did you do?

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Ethan Plaza
New to Real Estate · Oakland, CA · Member since 2020 · 6 posts · 6 votes
5y

Hi Daniel, I used to live in Oakland and while I don't know the people who live in that quadplex. My guess is they won't be leaving anytime soon, regardless of who the new owner is. They know they're paying well below market rates, and they know they don't want to be paying current market rates. If what they're paying is less than 1/2 of market, I'm assuming they've been living there at least 10 years. And probably will still be living there in 10 years.

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  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    5y

    I don't have experience with rent controlled markets but how does any of this affect future tenants? If you purchase the property and get existing tenants to sign new leases (some will move out), when they do wouldn't you bring the new tenants up market rate? Seems like a logically answer to this problem. 

    Each unit is treated differently. I wouldn't necessarily pass on this deal. I would also think long term and consider the condition of the structure before making an offer.  

    1Reply
  • Daniel DiChiro
    OP
    Developer · CA · Member since 2021 · 19 posts · 8 votes
    5y

    Good point @Jaron Walling. I need to do more research to understand the rent stabilization laws in California, but the way I understand it is the existing renters can maintain their existing rent price so long as they reside in the unit. I do not know how change in ownership plays into that, but I believe new rent prices could only be imposed once the existing tenants move out and new renters move in. Once that happens, rent stabilization mandates that the rent prices only increase by a nominal amount every year - this means I might end up in another similar situation a few years down the road...

    As I think through this, it seems like rent stabilization can be a major disadvantage for REI. Does it exist in Indiana?

    0Reply
  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    5y

    @Daniel DiChiro No rent stabilization laws in my state. No thanks. 

    1Reply
  • Forrest Williams
    Real Estate Agent · Chicagoland · Member since 2018 · 314 posts · 199 votes
    5y

    I don't know a lot about rent stabilization, but my instinct is stay away. When I look at fully occupied places, if the existing rents can't cover the mortgage, I move on. Those people have most likely lived in those apartments for years. Do you want to be the guy that comes in and evicts everyone from their homes? I know they don't technically own it, but in their eyes they may as well. Better off finding a different place. 

    Not to mention, if you can't get higher rents because of the laws, you're looking at a big loss. Theoretically the numbers may look good, but that will change when you put it into practice.

    2Reply
  • Ethan Plaza
    New to Real Estate · Oakland, CA · Member since 2020 · 6 posts · 6 votes
    5y

    Hi Daniel, I used to live in Oakland and while I don't know the people who live in that quadplex. My guess is they won't be leaving anytime soon, regardless of who the new owner is. They know they're paying well below market rates, and they know they don't want to be paying current market rates. If what they're paying is less than 1/2 of market, I'm assuming they've been living there at least 10 years. And probably will still be living there in 10 years.

    2Reply
  • Daniel DiChiro
    OP
    Developer · CA · Member since 2021 · 19 posts · 8 votes
    5y

    Thank you all for your insight. I found this information on the following page: link

    "In 1980, the Oakland City Council adopted the Rent Adjustment Program Ordinance, which uses the annual Consumer Price Index (CPI) to set maximum yearly rent increases and allows rent adjustments for claims of decreases in housing services. On February 1, 2017, Measure JJ (Renters Upgrade Act) became law, which introduced the following tenant protective measures:

    • Landlords must obtain Rent Board approval before imposing a rent increase higher than the annual permitted increase.
    • Protection for just cause evictions was extended to units built prior to December 31, 1995.
    • Landlords or individuals assisting a landlord who endeavors to recover or recover possession of a rental unit without just cause may face a civil penalty of three times damages and attorney’s fees, including a trebling of damages for a mental and emotional injury if the landlord acted in knowing violation or reckless disregard of the rent ordinance.
    • Anyone who engages in one or more of sixteen enumerated actions or omissions against a tenant in bad faith may be subject to a civil penalty of three times damages and attorney’s fees, including a trebling of damages for a mental and emotional injury if the wrongdoer acted in knowing violation or reckless disregard of the rent ordinance."
    0Reply
  • Lynnette E.
    Rental Property Investor · TN · Member since 2018 · 2k+ posts · 2k+ votes
    5y
    Originally posted by @Jaron Walling:

    I don't have experience with rent controlled markets but how does any of this affect future tenants? If you purchase the property and get existing tenants to sign new leases (some will move out), when they do wouldn't you bring the new tenants up market rate? Seems like a logically answer to this problem. 

    Each unit is treated differently. I wouldn't necessarily pass on this deal. I would also think long term and consider the condition of the structure before making an offer.  

    If their rent is now at half price, they will never move out, ever.  Why move and have to start over at full price rent?

    1Reply
  • Darius Ogloza
    Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
    5y

    Yeah, rent control, death and taxes are forever.      

    0Reply
  • Steve K.
    Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes
    5y

    @Daniel DiChiro if you’re planning to move in to the vacant unit, that may make the building exempt from rent control laws. From a quick google search: “Other properties exempt from rent control include owner-occupied buildings with no more than three or four units (depending on local regulation)...” Check your local regulations but I believe the rules are usually much different for owner-occupied, 4 units and under. Could be a great move if you can get the building at a steep discount, occupy a unit and bring the other units up to market rent. Definitely look into the local regulations more and of course the building condition, but this could be a great opportunity as most investors will not want to owner-occupy. If you could double the rent in a few years, it’s reasonable to expect the value of the building to go up significantly in a relatively short time.

    2Reply
  • Daniel DiChiro
    OP
    Developer · CA · Member since 2021 · 19 posts · 8 votes
    5y

    Incredible! Thank you, @Steve K. I definitely need to educate myself better on rent control laws. This could be a game changer.

    1Reply
  • Nicholas L.Pro Member
    Flipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes
    5y

    @Daniel DiChiro if it truly were a steal, it would not sit on the MLS for two weeks.

    1Reply
  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    5y

    I agree with @Forrest Williams to stay away. If this property is listed on the MLS for more than a week without offers something is holding it back. It's either the price, rent regulations, or direction of the market due to COVID, etc. Maybe it's DEAL as an owner occupied like Steven said, but once you move out you're subject to stricter rules. I never thought of the existing tenants refusing to leave so it's bad to assume they would.

    1Reply
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