Growing a RE portfolio without displacing low(er) income folks?

19 Replies | Oakland, California

Hi Folks, 

I'm wondering if anyone else out there has pondered this. 

In Oakland, if an owner moves into a property, and that property is 3 units or fewer, then after 2 years of the owner living in one of the units, the property is no longer subject to rent control and all rents can be adjusted to market rate. I am going to be exempt from rent control pretty soon here, so I'm going to be able to raise the rents in my duplex to market rate. Market rate is nearly double what the tenant is paying now, and I suspect the tenant will choose to leave when that happens. 

If I want to invest in real estate, the only strategy I've identified that works for me with my level of income is to buy fully tenant occupied duplexes or triplexes at a small discount, then move into one of the units, live there for 2 years and increase the rents to market rate. Then repeat this process. The only problem is I don't want to leave a trail of displaced families in my wake, as I go on buying more units over time. 

Question: Is there a way that I could transition my existing tenants into a subsidized rent program? For a hypothetical example, let's say my tenants are paying $750/month for a 1 bedroom, and the market rate is $1500/month. Is there any way a program like section 8 could come in, transition my existing tenants to their program and cover the gap between what they pay now and what market rate is? 

I actually like my tenants, they're chill people, they don't bother me and they even pitch in doing yard work. They're great. I just don't want to pay more of my own money towards the mortgage to subsidize their living there. 

@Daniel Gonzalez my comments are going to sound harsh but I promise none of this is personal so keep an open mind...

You can't be serious that your investment strategy is to move into a property and actually live there for 2 years so you can go up on rent? Lets see...take two years out of your life to satisfy some BS leftist law in California just so I can buy an artificially overpriced property? Uh NO, would be my answer.  How about investing somewhere else and making money right from day one? There are hundreds of markets around the country that can provide exponentially better returns than you will find in California AND without the BS rules and regs.  Vote with your $$ and invest somewhere else.

As to your question regarding these "displaced" tenants;   I find it astonishing that your solution is to take people who have been paying an artificially, non-market based low rent (because of failed leftist CA laws) and instead have taxpayers step in to provide a handout  to them? This is why California is bankrupt now and why the state continues to lose population.

How about this solution? You raise their rent and they either figure it out or they move on to somewhere else and they support themselves without my tax dollars? If you genuinely feel bad then take money out of your own pocket and give it to them as charity but lets not further perpetuate the culture of entitlement that pervades much of this country. 

Again, I reiterate none of this is meant as any sleight on you personally just trying to give an alternative view. I hope you make a mint in real estate so good luck.  

Robert,  I can appreciate your perspective on how tax dollars are spent. Me personally,  I'm ok taking on a slightly higher tax burden to allow an older couple to stay in their home. Agree to disagree on that I suppose. 

From an ROI perspective Oakland property has and will continue to appreciate at a rate that is much higher than out of state RE. There's an under supply of housing here, and nimby politics prevent development of housing at a rate that fixes the under supply. Definitely artificial, but unlikely to change soon.

The idea is this:  I might make $1,000/ month buying out of state in cash flow,  but I can deploy the same capital to make $3,000/ month in appreciation here in Oakland over the long term 10 - 20 year time horizon. 

I think the are other markets that appreciate at similar rates,  if not better (Denver and Seattle come to mind), but I can't use low down payment, low interest,  owner occupied financing there, I've gotta put down 20% in those markets. 

That strategy of buying here in Oakland,  owner occupying, waiting for 2 years and repeating will actually get me to $120,000/ year in cash flow (all expenses accounted for) in about 15 or 16 years. 

I wouldn't break any speed record to financial independence,  but I'd definitely get there. 

My understanding is the wait list for sec 8 is a very long time. If you want to save all those tenants in a triplex you probably will have to  pony up the difference yourself rather than dumping them as burden to the taxpayers. You yourself are taking on just a tiny fraction of that sec 8 tax burden since everyone else is paying for it too. 

Don't kid yourself you are doing the noble thing. You are profiting off of raising rents and handing the expense of doing so over to the taxpayers of Ca. The difference is you don't have to look them in the eyes.

If you are truly going to do the right thing as you say you might well be paying the difference for 2 tenants and every 2 years for 3  tenants after that . If each tenant has an 8 year wait good luck on supporting them all. It might be years before they can even get on a wait list.

Not sure how you got your numbers, but I sold A bay area rental a few years ago. 

In 2 years time it went up $90K and would have collected  $45,600 in rent for a total of $135,600 profit. 

I bought out of state and those properties went up $172K and collected over $76K in rent

for a total of $248,000 profit.

I'd say my out of state kicked the California return's butt.

@Kevin fair point about not needing to look CA tax payers in the eye. Serious point,  but it made me laugh when you put it that way. Lol!

I'm here to learn, and it sounds like you are where I want to be. 

Some questions for you: 

1. What state(s) are you investing in to get those results? 

2. Are you investing out of your home state? 

3. How'd you do it in 3 years?

I won't say what state I'm in, but will say it's in the Midwest there are a lot of states in the Midwest and south thathave this opportunity. Just do you research and homework and actually invest time and money into flying to those areas.

I'm in Georgia now but except for my principal residence own no real estate here. It's not that there aren't opportunities here, it's just that my out of state properties have a manager so I basically am retired. If I buy here I will be tempted to self mange which means I am on call again.

I mostly bought foreclosures at a discount. Once repairs and rehab done the value goes up to market value. For example, let's say you buy a house for 35k, put 15k into getting it rent ready. You are into it for 50 k. Appraised values in the hood run about 75k so in a month you've made 25k. I 1031 exchanged the California property to 6 out of state homes. The cash flow from those 6 well exceeded the one California house.

Now you could do the brrrrr thing or whatever they call it. On two of my houses I cash out refinanced them and they still flow positive albeit only a few hundred a month, but I got out all my money invested in those houses and a few thousand extra on top. Then took the proceeds to buy two more rentals cash.

@Daniel Gonzalez  "Me personally, I'm ok taking on a slightly higher tax burden to allow an older couple to stay in their home."

The thing you fail to realize Daniel is that while you may be fine taking on a higher tax burden to help people out;  others, (including me) are not and since the section 8 program is federally funded we all take on the financial burden for your altruism. Just food for thought.

Secondly I get where you think you are going to see overall appreciation but remember two things: cashflow and appreciation aren't the same thing and never buy property when you're exit strategy is strictly appreciation because you can't bank on that. 

Hi Daniel,

I can appreciate where you are coming from with this desire to help your tenants. At the end of the day you need to decide what it is you are doing with your properties (business or charity). There is nothing wrong with either but it is important to be clear on your goal as otherwise you will likely fail at both.

We purchase distressed properties and fix them up (improved cash flow & forced appreciation). All renovated units get priced at current market rent. We have made one exception for a long term tenant who’s unit we have not renovated. Though we do periodically move his rent up so that it is at least close to market rent. My personal belief is that keeping your tenant’s rent artificially low is actually hurting rather than helping them. At some point they are going to have to pay market rent and if they have been sheltered from that reality of what it actually costs to live in an area there are only a couple possible outcomes and they are all bad for the tenant.

I don't think it is correct to presume that taxpayers pay more if someone creates a new Section 8 property. HUD has a budget and they operate within it, regardless of the number of properties or tenants in the program. That is why there is a waiting list. Don't feel like you should or shouldn't utilize Section 8 based on taxpayer impact. I think of it as a way to get my own tax dollars back!

You might be able to keep your tenants by gradually increasing their rents, say $100 - $200/month per year.  That means you delay your own gratification, but you also keep your tenants.  This might work well if you can wrap it into a long term lease with them.  You may be able to avoid a vacancy which will be one of your largest costs if you raise rents and displace your tenants.

Your tenants can apply for Section 8.  If they qualify, you and your tenants can apply to turn your lease into a Section 8 subsidized lease.  Your tenants may have to wait a few years in line, but that might be your long term solution.  Also, look for grants for housing assistance to the elderly or other relevant demographics.

@Daniel Gonzalez

I can definitely see where you are coming from, my wife and I went to see this duplex with two incredible older tenants paying undermarket rent, we ended up walking away from it as we don't have the stomach to owner-move in and kick out either one of them..

@Robert Gilstrap

And I don't know anyone is feeling the same way, I think subsidized housing is the less of two evil over rent control, for both tenant and landlord..

And in the ideal world, everyone gets more tax return when less people apply for section 8. I guess I blame the game but not the players..

@Daniel Gonzalez You don't have to move out of state to avoid rent control.  We don't have it here in Sacramento and our market rents have shot up 50%+ (property values too) in the last three years.  It's pretty "purple" here too so I don't know that we will see a change on rent control.  Granted I'd rather be lucky than good...the bay area exodus has really driven up the market here in the valley since we bought our first property.  Consider looking at under valued 5+ unit buildings in stockton or sacramento, fix what's making them under perform and bump up the rents.  There are a TON of incompetent "mom and pop" landlords out here and with a 5+ unit property the value of the building is directly related to rents (ie more rents = more equity to purchase the next property).  Plus, moving every two years must be a pain.

As far as getting your tenants on federal assistance this is a hard thing to do.  The wait lists are long, it's easy to fall off and just because you bump the rents doesn't mean they will qualify for assistance on their own merits.  It's a nice thought but could always accept section 8 tenants coming in?  Oakland is gentrifying and rent control or liberal politics (like 'em or hate 'em) won't stop that's just a matter who's making the money.

I hear what the out of state crowd is saying, but (caution - incoming anecdotal evidence) my buddy has bought other people's midwest fix and flips with no chance for forced appreciation (in fact the building depreciates over time as housing values remain flat factoring inflation), Lower Cap rate and greater risk than I experienced house hacking.  I'd argue that as more jobs become automated areas that depend on blue collar paychecks will only get worse for property values, rents, vacancy, vandalism, etc.  You live in one of the most profitable states in the country with far and away the largest GDP and one of the highest housing costs (behind HI and NY) with white collar educated professionals able and willing to pay rent.  For reference they can't build housing at $750k a door fast enough to keep up with demand!  My buddy buying in the midwest has seen returns, but he would have been better off in the stock market (granted it's been a great few years).  To clarify...not that the area he invested in is garbage, but the investments he's proud of have objectively under performed, and when you're that far away sweat equity is off the table.  Now if you're investing to be hands off that changes things a bit, but you seem to be doing owner occupied units so I'm betting you are putting in some elbow grease.  

I'm always looking for new strategies/philosophies on investing, but I would venture to guess most of the people bagging on CA real estate have never owned any.

Apologies for wandering off the topic of this thread but..

@Andrew Jones , I completely agree with your thinking above...If you were looking for 5+ units in Sacramento, what neighborhoods would you be focusing on?

Have you got a pulse on what is going on regarding the current attempt to repeal Costa Hawkins which if successful would open up the door for Sacramento to legislate rent controls. Can you see rent controls happening if continued migration from SF Bay area to Sacramento makes rents too unaffordable for Sacramento tenants?

@Andrew Jones

You paint the entire Midwest with a wide brush, a common mistake I see from investors who refuse to believe there are areas with appreciation and strong economies there.

The whole Midwest is not a dying rust belt town.

@David S. It really depends on what your budget is.  If sky is the limit I'd focus on downtown/midtown...really anything on the grid.  If you're on a budget I'd consider the old part of Elk Grove or Oak park (for our purposes Oak Park = Oakland...nice downtown, near the grid, but still a long way to go).

Not familiar with Costa Hawkins, but Sac Business Journal and other local publications interview county decision makers who, at least publicly, say rent control is not a likely option.  It could happen long term, but the issue isn't pricing as much as it is lack of housing.  There was a long period where no new affordable housing (at least not on a significant scale) has been built.  The mayor mentioned wanting to add 7,500 new affordable units over the next X years (keeps changing) and wants investor feedback on how to make that happen.  Infill projects are big right now.

@Anthony Gayden per my original statement: "To clarify...not that the area he invested in is garbage, but the investments he's proud of have objectively under performed, and when you're that far away sweat equity is off the table."  I am not wrapping up the entire midwest, but you need to know the area to make a smart purchase.  My friend did not.  I do not care enough to learn about the midwest to make a smart move out there...part of the appeal of real estate to me is the hands on control of the investment.  Out of state investing is less appealing to me personally than using the securities license I got and let collect dust (or better yet, buy another duplex here in Sacramento with an 8.76 cap rate).

yeah,  I have to agree. Single family home owners want costa Hawkins rent control exemptions on single family homes. 

Repealing costa Hawkins went up for vote, but repeal was voted down recently. I don't think it's going to pass because of SFH owners interests in the exemption.

 @Andrew Jones I agree that staying on the grid is important. I look for areas that are improving which are close to high cost rent areas.  Not sure I agree with the Elk Grove and Oak Park assessment. Those are very hot areas. I just sold a duplex in Oak Park with small studios on each side for well over $350k. I had 4 offers on it and it went above asking. If you haven't looked at Oak Park values lately you might be shocked. It's a good area and more of a long term play. Cash flow may lower in the beginning and the upside of the area is certainly there. I like West Sacramento too. 

 @Andrew Jones I agree that staying on the grid is important. I look for areas that are improving which are close to high cost rent areas.  Not sure I agree with the Elk Grove and Oak Park assessment. Those are very hot areas. I just sold a duplex in Oak Park with small studios on each side for well over $350k. I had 4 offers on it and it went above asking. If you haven't looked at Oak Park values lately you might be shocked. It's a good area and more of a long term play. Cash flow may lower in the beginning and the upside of the area is certainly there. I like West Sacramento too. 

@Andrew Jones

Well I'm not sure If I am the one considered bagging on Ca real estate- I don't see anyone else here doing it so it must be me. I would say that the person claiming people bagging on Ca real estate , that is me, have  actually have owned Ca real estate. Probably more than a lot of posters here, I can tell you I  played the appreciation game and it's a long slow process usually. Not to mention unless you have a big window to hold, you may get to experience it going down in value

I owned 2 houses in Pleasanton years ago. Paid $600K each and put down $200K. They ran a negative $10K minimum cash flow each year. Rent covered mortgage, but taxes, insurance, maintanence, vacancy An owner would cover. I did sell them, but had I held them just taking a rough guess it took 14 years for them to each hit $925K. Great appreciation, but for several years they went down in value. So over 14 years each one went up $325K. There's the appreciation play. A terrific gain , 23K a year, but you had to wait 14 years for it to happen. But wait, let's take off the yearly loss. Up until a few years ago when rents took off and you can break even, you would still lose 10K a year or more for 11 years for a total of $110K negative. Now your appreciation is down to $205K. That's still a good chunk, but kind of a hairy ride for a bit waiting for appreciation.

Now if you bought those  3 years ago when I started buying out of state for cash flow you could have paid $750 to 800K and made 125K to $175K appreciation, but you still would have run a small negative cash flow over 3 years probably say  about 20 to 25k for the 3 years.

So all in all in the hottest appreciation market in the last 3 years you'd make a net of $150K or so with that California real estate putting down about $250K down payment.

In my case the last 3 years with my out of state property I got from $250K  a total of  $135K of forced appreciation and  rental income of 105k. 

That's California appreciation $150k vs out of state $245K from a $250K investement. The difference will be higher if I leverage out of state like the Ca property is leveraged. Right now doing the BRRRR thing I am pulling out all my money I put in plus some extra on the cash out refi, still flowing positive, and still have a 30% equity position on the property

I'm not saying Ca isn't a good bet. It is for most people. If they can wait for a long period. The last few years have been out of the norm. Someone buying today may not see the appreciation over the next 3 years matching the last.

I'm just saying I've owned both so I can tell you pros and cons and pretty much invalidate what the guy who is saying that people posting here never owned Ca real estate.

@Daniel - Have you considered ways to see a return on your property without increasing rent on your tenants, and maybe in a way that benefits them as well?

- If you split the building into condos or TIC and offered them your tenants, could they comfortably purchase their unit and let you see a return that interests you?

-- What if you owner financed?

- Is there room and zoning allowance to build more on the lot? (Look at some of the mini-lot developments in Oakland recently. I find these pretty interesting!)

- Are there other amenities you can monetize on the property? Parking? Laundry? Storage? Allowed commercial uses?