29 Units. $290/SF. Built in 2013. A 6% Cap. Why I’m Keeping This Comp.

What matters

1. Newer Construction Does Not Stay Exempt From AB 1482 Forever.  This property was built in 2013 and is currently exempt from California’s statewide rent cap. But the exemption lasts only 15 years and operates on a rolling basis. Depending on the exact certificate-of-occupancy date, this building should become subject to AB 1482 around 2028. The lesson: when buying newer multifamily, investors need to underwrite not only today’s regulations—but the regulations that will apply during their hold period.
2. A “6% Cap” Depends on the Expense RatioThe reported cap rate is based on a 30.4% expense ratio, before vacancy and replacement reserves. That may be achievable because every unit—including water—is separately metered. But several expenses, including repairs, insurance, elevator service and reserves, appear lean.  The new owners should put up 100k and fix deferred maintenance to lower the headaches and lower future costs. After normalizing those costs, the economic cap rate may be closer to 5.7%.  Although there is rent upside in this building and the new owners will get to 6% fairly soon.  
3. Average Rent Can Hide the Real Story.  The ten three-bedroom apartments show an average rent of only $2,557. But one 1,295-square-foot unit rents for $1,200 because it is occupied by the on-site manager. Excluding that apartment, the remaining nine three-bedrooms average approximately $2,707.  In addition, the underwriting should actually show that unit as $2995 and factor a manager expense.  A new owner should consider changing the management agreement to lower their costs. The offering memorandum does not disclose any affordable units.  I a assuming based on the date it was built that there are no affordable units in the building.   The lesson for me: unit-type averages can be misleading. Always review the individual rent roll before deciding how much upside actually exists.  Always look at the manager rent and see if you find a value add play there. 
4. Price Per Square Foot Can Matter More Than Price Per Unit.  At $327,586 per unit, the building may not initially look cheap for Lake Balboa. But the apartments are unusually large, the property has 53 parking spaces, and the buyer paid only $290 per square foot for a building completed in 2013. The lesson: price per door can penalize buildings with larger units. Price per square foot often provides a better comparison to replacement cost and the physical asset being purchased.