Why you can’t just compare LA and Santa Monica cap rates
Spent some time over the past few days looking at properties in Santa Monica and West Los Angeles for investors. As I looked at buildings in both places, I started to realize that you can’t really compare them easily. Why?
Theoretically, you should be able to. After all, a cap rate is a cap rate, right? If you buy a 4% cap in Santa Monica all cash, you’re getting 4% on your money. If you buy a 4% cap in West LA, you’re getting 4% on your money. So what’s the difference?
The difference is in the rent control regimes and how they affect rent growth.
In LA, the Rent Stabilization Ordinance sets the annual rent increase at between 3-8% every year. So even in a bad year for landlords, you get a 3% increase from your rent-controlled tenants.
Contrast that with Santa Monica, where the insane are running the asylum. In 2002, for example, Santa Monica granted landlords a whopping $11 increase. Not 11%. $11. Didn’t matter if your tenant was paying $200 or $2000. You got $11.
What is the practical implication of the difference in rent control regimes? To find out, I ran the numbers to compare a tenant who signed a lease for $1000 / month in LA in 2000 with one who did the same thing in Santa Monica. I looked at all the allowable rent increases for each year between 2000 and today and tallied up the results.
Here’s a graph showing the rents our sample tenants paid over the period 2000-2012:
The Santa Monica tenant is now, in 2012, paying $1,332.31. The LA tenant is paying $1,481.80. That’s a difference of $149.50 / month. Don’t think that’s a lot? Over on the West Side, properties are trading at 14x annual rent. That $149.50 is therefore worth $149.50 x 12 months x 14 = $25,116! On a 10 unit building, that’s a quarter of a million dollars difference in value.
When I look at those numbers, I feel like I would want a discount versus West LA to tempt me into buying in Santa Monica. But the market actually seems to charge a premium for Santa Monica properties. So, I’m out. If you ask, I’ll help you buy there. But I wouldn’t do it with my own money.