Santa Monica 10 unit DEAL !!?

10 Replies

Why would anyone want to purchase a rent-controlled Santa Monica apt building?

Consider this deal…

10 unit building, built ~ 1950, class C, in a prime Santa Monica location !

Under rent control !

Huge upside in rents (assuming you can actually get current tenants to leave) !

Decades of deferred maintenance !

Well, we are getting unsolicited offers to purchase said building at a GRM of ~ 21.

cap rate ~ 3% !!

Seems like a good time to sell… perhaps we are nearing peak pricing for the area...

Ay thoughts?

Scott, whats the income. What are the expenses? Do you have any P&L's on the place?

We are fortunate to not have any mortgages on the property as well as very low property taxes as property has been in family for decades. Current income is ~ $180k/ yr,  total expenses (self-managed) ~ $45k/ yr....

With those numbers, if someone were to purchase the building with 30% down and correcting  for property tax adjustment, they would be easily be in the red to the tune of $7000/ month. Despite that, people seem more than willing to purchase property in 'prime' Santa Monica....

@Scott Malkin  

Someone has a plan for the building, whether they can successfully execute on it or not, that is the question.  Santa Monica is extremely strong, where demand is so high that many investors (institutional etc) feel very safe putting their money to work.  

I met a large multi-family investor in California earlier in the year on a flight.  His company has been around for a long time, upwards of 6,000 units owned in California.  We were talking cap rates and most of his current acquisitions were in the 4's.  They still funded each deal separately with high net worth investors.  I was asking him how he set up his pref returns etc.  And although the preferred returns were lower they always achieved strong double digit returns upon sale.  Demand was always there for strong appreciation.  

Are we coming to a peak in the cycle, I would say yes, at a 3 cap it's hard to make income producing real estate work.  I would probably sell...

Location. Location. Location. 

Appreciation! Appreciation! Appreciation!

2 words x3

It would be a great time to sell or better yet, utilize the equity in that building to purchase more units!

@Scott Malkin  

Seems like you have a nice property!

I usually call out the buyer/broker and ensure that they realize that they are buying into a cash flow negative deal to make sure they are serious before proceeding.  I did with a property I recently sold in LA, I simply spoke to the buyer and bank and said "you know you are buying a cash flow negative deal right?" and see how they respond.

Usually, they are banking on appreciation or cash flow down the line or sometimes they are in an exchange and would simply buy into a cash flow negative deal rather than pay the large capital gain taxes.

Don't forget that if you sell your property, that you may would need to pay capital gains unless you can find an exchange which is very difficult in this market.  It's a double edge sword - get a nice price for your building but either buy another expensive property or bite the bullet on the capital gains.

Best of luck!

Scott Malkin,

I live in NYC, so I'm familiar with a lot of the issues you're dealing with.

Do you have any interest in redeveloping the property yourself?  Have you tried to play the game to get your regulated renters out?   IIRC, if you can get the current renter out in SM, you can rerent for whatever you can get.

Sight unseen, my tactic would be to get the renters out, then redevelop the property for condos.  I have a feeling that's what your potential buyers are planning, which is why cap rate seems to be a non issue for them.

Something you should calculate it the final value of the property maximally redeveloped, and work backwards from there to determine valuation.

You are indeed correct- one can charge market rent once a tenant leaves. Getting a tenant out is easier said than done. They know they have a good deal and know their rights. You can legally force one tenant to leave if you move into the unit; however, you would need to pay them a relocation fee of ~ $10k, you can only ask the tenant who has moved in most recently (as opposed to one who has lived there for many, many years and paying the lowest rent), you would have to live there for 2 yrs and if you moved out sooner or happened to have another vacancy, you would have to offer the available unit first to the tenant you just paid to leave.... Of course you can do 'cash for keys' but that will likely cost several tens of thousands for it to be worthwhile to the tenant paying far below Santa Monica market rent. 

You can also use the Ellis Act to go out of business but would need to pay each unit an $8300 to $19,950 (depending on # of bedrooms, if tenant is a senior or disabled) relocation fee and cannot rent the units for another 5 years, I believe. Getting condo permits in Santa Monica is quite difficult these days, so I've heard....

@Michael Wolffs   I'm reading your comment and saying to myself yep, yep, yep!  That is exactly the game played in San francsico. Sometimes you get lucky with cooperative tenants. I usually go the buy out route.  That, and A LOT Of patience!

I'm curious, is this angle mostly a Manhattan thing or is it also worthwhile in Brooklyn and other areas of NYC?  How hard is it to condo convert in NYC?

@Scott Malkin what is the process to condo convert in Santa Monica? Is there some lottery or process involved? Are there any TIC sales going on as an alternative to condos?

TICs are big in SF.  It's much easier to convert 2 unit bldgs in SF if both units are owner occupied. 3-4 units had a lottery option...but the "wait" list got ridiculous, 12+ years. So they offered all us lottery people an "expedited" program, where we pay an "impact" fee of up to $20,000 per unit to have the privilege of condo converting. And, the lottery is in a deep freeze for at least 12 years, and will be even more restrictive in the future! I jumped on this and just finished my conversion of a 3 unit property in a hot area (Mission district.) I just got one unit appraised at $770,000, so I guess buying the whole building for $650,000 9 years ago (inspite of bldg condition being a total POS) was a wise move :). And thanks to SF's crazy restrictions I can expect future values of condos to remain rosy. Thanks again genius city politicians.  Keep those artificial restrictions coming!

Amit, 

The rules are the same anywhere in NYC.  It's just the numbers that change, location to location.  Brooklyn has become very hot.  So a LL who has rent regulated tenant will play the game the same way as in Manhattan.  

In some of the less desirable areas of the boroughs, the market rent can be less than the regulated rent, so there is less pressure.  But that becoming much less usual.  Some big corporate LL, private equity firms, etc., have been buying up big properties in the outer boroughs, and trying to squeeze out the regulated tenants.  This has been causing some big fights that have gone political.

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