Starting a Large Renovation on 5 Unit Oakland Apartment

5 Replies

Investment Info:

Large multi-family (5+ units) buy & hold investment in Oakland.

Purchase price: $640,000
Cash invested: $640,000

5 Unit Apartment in Oakland California. Purchased at a sheriffs auction for $640,000. Oakland has very strict rent control and tenant rights laws, with more proposals introduced all the time. We are just about to start a major renovation on the building.

What made you interested in investing in this type of deal?

If a good deal comes a long, you have to jump on it. Although the city of Oakland is making it very hard on landlords to do business in the city. If another apartment deal came along, I would have to be incredible for us to buy it.

How did you find this deal and how did you negotiate it?

We had a friend that told us their apartment was going to go up for auction due to family issues. Sheriffs auctions are not publicized like foreclosure auctions, so there was only 2 other bidders.

How did you finance this deal?

Cash

How did you add value to the deal?

There is one vacant studio on the bottom floor. The previous owner added 2 additional un-permitted units in the basement making a total of seven units. The additional units were ripped out which caused a lot of issues, but it showed that we could put rooms down there, so we are converting the studio into a 2-3 bedroom apartment. We have to move fast on the vacant studio because Oakland has a vacancy tax of about $5,000 per vacant unit coming soon. We are also looking into sub-metering the water

Lessons learned? Challenges?

Working with tenants will be a challenge. We have to pay them to relocate and then when the renovation is complete they get 1st right to rent their previous units, for the same rent.

Nice! Are you compensating the tenants to *temporarily* relocate while renovations take place, or permanently with a full buyout? If the former, what is your plan to recoup renovation costs if they decide to come back at their previous rent amount. Capex passthrough? Is there a possibility of legalizing the previous two non conforming units rather than using that space to enlarge the legal units?

@K T. good questions... I'm still learning all this so please let me know if you see any discrepancies. Any advice is greatly appreciated.

When we bought it, we planned to do a "Substantial renovation" which means if the renovation costs are 51% or higher to the full replacement cost of the building, we could take it off rent control. Unfortunately, the the city of Oakland has removed that option.

Are you compensating the tenants to *temporarily* relocate while renovations take place, or permanently with a full buyout?

As soon as we get the permits, we will have our lawyer take care of this. I have asked the tenants if they are open for a buyout. Some said yes and some said no. They are paying around 50% of current market rates. The previous landlord never raised their rents, so I have been banking them over the last 2 years. They are still very low. The relocation costs are around $8000-9000 per unit. I believe they are responsible to find new housing and they are responsible for all moving expenses. We will negotiate buyouts at the time they get the relocation notice. Our buyout will be 1 year at market rate for their unit, so they can live for free for a year. If they plan to come back, we will do minimal renovation in their units.

I think if they get paid the temporary relocation payment, and sign another lease, it will most likely be a for a year. If we finish in 6 months and offer the unit back to them, they will not be in a position to take it. That might be a way to avoid the high buyout payments

Capex passthrough?

Yes, we can recoup 70% of the renovation costs over the depreciation period. If my math is correct. Let's estimate the renovation cost is $300,000/27.5 years = $10,900 per year. 10,900*70% = $7,630.00 increase in rent per year. About $160 increase per month for each of the existing tenants. I've heard the city is stringent on renovation recoup costs, especially if most of the renovation costs are going to towards to increase a unit they do not live in.

Is there a possibility of legalizing the previous two non conforming units rather than using that space to enlarge the legal units?

No. Talked to the building department, no way to rezone. If we were to put in new units, they would have to be up to code in regards to amount of natural light in units, parking, ceiling height, etc… But since we are connecting to the existing studio, all that is taken care for. For example, natural light will be in a issue in the basement, but the studio conforms to that code, a separate unit would not conform. Does that make sense?

@Matt Dunlap Not sure how I missed the notification of your reply. 

All makes sense.

A couple of other things to keep in mind that I discovered. If you've already been doing banked increases you may run up against this -- In Oakland, rent for any unit can't be increased more than 30% in any 5 year period. So if you pursue the capex passthrough (which you need to petition the rent board to get approved for) on top of the banked increases you've already done, you may bump up against that 30% ceiling. If that's the case, the capex improvement passthrough would be decreased $-wise by extending to a greater number of depreciated years so as not to exceed that 30% ceiling. The full buyout option seems the better one to give you certainty if you plan to invest in renovations.

Good you have a lawyer to help with this. There are strict notification/disclosure and filing requirement for buyouts in Oakland, with specific time periods. Definitely read up on that. Fried and Williams in Oakland is a great landlord attorney I've worked with, if you need a reco.

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