Tuesday, June 19, 2007

Manhattan Beach and the Beach Cities: Rents and Income Property

Yesterday there was an article in The Daily Breeze about Keeping an Eye on Rising Rents by Sandy Mazza. The article was focused on Gardena and a rent mediation panel they have established. Sandy had called me about rents in the South Bay and we had a long chat about rising rents and ownership problems. Overall Sandy did a great reporting job.. but there are few things I would like to clarify.. or maybe just expand on a bit.

There has always been a difference of perception between landlords and tenants.. ..tenants always think rents are too high and landlords always think rents are too low.. the truth is somewhere in the middle. Tenants believe landlords rake in tons of money and always want to gouge them by raising rents. Tenants rarely consider what it actually costs to own a property.

So let's start with rents. Rents are very likely going to continue going up for a number of reasons. First rental units are declining and the number of people who want to rent in the South Bay is going up. It's a very tight rental market and quite frankly always has been. A one bedroom unit in Manhattan Beach starts around $1200 in east Manhattan and closer to $1400 -$1700 by the beach. The same is true in Hermosa Beach and South Redondo. Rents in North Redondo and El Segundo are a bit less expensive but overall rents are up in Los Angeles County.

Let's talk about a property I know well that recently sold. The building was in the 100 block of Rosecrans and was on a full lot. The property consisted of 4 one bedroom units and sold for $1,765,000. The rents were $6200 .. 3 units @ $1600 and one at $1400.. If the new owner had a down payment of $550,000 ( slightly over 30%) the payment would be about $9800 per month for mortgage, taxes and insurance. That leaves a negative of $3600 a month. Even if the new owner could raise the rents immediately by $150 per unit that still leaves a negative of $3000 per month. If the new owner chooses to keep the property as a rental it will take a lot of rent increases over a number of years to get to a positive cash flow.

However, I'm willing to bet that the new owner is going to tear the building down and build two new townhomes. Each unit will have unblockable views and sell well over $2.5m each. Guess what... you just lost 4 rental units. If you figure that in the sand section this happens maybe 10-20 times a year and you lose between 1 to 4 rental units each time..you can see that the supply of rental units is declining.. and this has been happening for years.

Welcome to supply and demand.. as more people want to live at the beach and fewer units remain; rents go up on the existing units. Now of course not all of those who buy income property are going to tear them down.. lots of people still buy units at the beach for future appreciation.. but during the holding period.. they will have a negative cash flow for at least 5 -7 years. They will raise rents to cover as much of the negative as possible and so would every renter if they owned the property.

This has always been the scenario at the beach.. I know because I rented a unit in that building on Rosecrans when the owner first bought it back in the dark ages.... and yes he did increase the rents because he had a negative. When the rent was raised to a point where it made more sense for me to buy.. that's what I did. That's when most tenants make a decision to purchase.

I realize that buying a property may not be an option for all renters.. but at the same time they can't expect a landlord to subsidize them either. Even if you own a property for years expenses continue to increase.. taxes go up, insurance goes up, water goes up as does maintenance. Last year I repainted my house.. the cost of a gallon of paint had tripled since I painted 5 years ago as had the price of the painter.

Owning property is not an easy proposition in the best of times and carries risk even in the beach cities. My Dad owned rental properties and he saved money to buy them which meant we didn't go on expensive vacations or have new cars or eat many meals out. I remember a time when he had 10 vacant units. He still had to make the mortgage payments and pay the taxes even though he had no income from those properties.

Most people who own property here are not big companies but Mom and Pop owners like my parents who have saved some money and want to put it somewhere. You can't buy a rental property in Manhattan , Hermosa, Redondo or El Segundo and expect to break even let alone have a positive cash flow. If owners can't make money on an investment they won't invest and neither would anyone else. People who own rental properties are taking a risk.. sometimes a very high risk. Sure they hope to make money in the long run or they wouldn't do it.. but no one knows whether they will have to wait 5 years or 10 to have a profitable investment.

And let's not forget that rents do decrease on occasion. In 2001-2003 rents decreased and there were a lot of vacancies. Interest rates were so low that many tenants became homeowners. People who had recently purchased properties found themselves in a pickle. No one felt sorry for the landlords and offered to increase their rent amount yet most tenants expect landlords to never raise rents even when their expenses increase.

There is a lot of talk and advice to buyers now about renting and not buying until prices come down.. which is fine if you believe that you will really see prices in the beach cities drop 50%.. but most of us who live here know that's not going to happen. So in the meantime what is happening is that people are buying property for other people to rent and rents are rising and tenants will soon complain about how landlords are rent gougers.. without considering that landlords took a risk when tenants wouldn't and put their money on the line when tenants waited for prices to fall.

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