How do you feel about giving your tenants part ownership of your apartment building for free? Pretty terrible, right?
If you own a rent controlled building in Los Angeles and don’t raise your rents by the amount allowed by the city each year, you’re effectively giving your tenants a stake in your building for free.
Don’t believe me? Consider this: At any point in time, your apartment building is worth some multiple of the annual rents. (In Silver Lake, right now, it’s around 11-12x annual rents, give or take.) So let’s say a landlord has a unit renting for $1,000 and is allowed by the city to raise the rent by 3% this year.
That unit was worth $1,000 x 12 months x 11 = $132,000. If the landlord raises the rent, it goes from $1,000 to $1,030, making the unit worth $1,030 x 12 months x 11 = $135,960. If the city allows a 3% increase the following year and the landlord follows through, the rent goes up to 1,060.90 and the unit is now worth $140,038 (up $8,038 since the first year).
If the landlords chooses not to raise the rent after year one, he’s opting to forgo:
- The $30 x 12 months = $360 in actual cash; plus
- The $3,960 in potential value gain
But that’s not all (don’t I sound like Billy Mays, RIP?), because he can’t do retroactive raises. Once he fails to raise it one year, he can’t go back and get that increase – it’s gone forever.
If you play this scenario out over 5 years, the landlord who chose to raise his rents by the 3% ends up with a unit worth $153,024 (ah, the magic of compounding!). The other landlord’s unit is still worth $132,000. That’s $21,024 in value the second owner won’t be getting.
So where did that extra $21,024 go? To the tenant! Any buyer of the building who wants to raise the rents to market is going to have to pay the tenant whose rent hasn’t gone up in 5 years to move out. And that tenant is going to demand thousands of dollars. The buyer knows he has to pay the tenant, so he deducts that amount from what he can offer the owner.
So unless you’re cool with giving your tenants money that should have gone to you, do the smart thing and raise your rents when you can!