Don’t walk into a rent control trap

Here’s a dangerous trap set for an unsuspecting buyer of an apartment building by a broker:

“Live in one unit and have additional income or use this 2800 s.f. structure as a single family residence.”

Let’s say you want to choose the later option. Can you? Absolutely not. At least, not without paying between $20,000-40,000 in additional cash to the existing tenants, going through some major legal hassles, and permanently impairing the value of the property. But the broker never mentions that in his listing (which I’m not linking to to avoid causing trouble for the other broker and me.)

Why can’t the new buyer do whatever he wants with his property? The 1978 Los Angeles Rent Stabilization Ordinance, otherwise known as rent control.

Over the years, rent control has become a big hairy gorilla of a law with all kinds of special exceptions and exemptions and with a major city department (LAHD) whose main purpose for existing is enforcement.

The good news is, you don’t need to understand all of it. But here’s a little primer for you. As always, caveat emptor (and broker).

  1. Rent control applies to properties in Los Angeles with two or more units built prior to 1978. This means that single family homes and anything built after 1978 are excluded from LA rent control. Note that the property above is a multi-unit building built well before 1978 and therefore is covered.
  2. Vacant units may be rented at whatever a new tenant will pay. There are some exceptions having to do with how the unit became vacant, but, basically, if a tenant moves out, you can try to rent the unit for whatever price you want.
  3. Once a tenant moves in, you can only raise the rent by an amount determined by the city each year. By law, this will be between 3-8% (recently, it’s been 3%). If you don’t raise the rent in one year, you can’t go back and raise it retroactively – you either use your annual increase or you lose it.
  4. Can’t evict a tenant unless he fails to pay rent. There are some exceptions to this rule, but, almost always, if they pay rent on-time, they stay. In the case of the building above, to turn the thing into a single family dwelling, you’d have to use the Ellis Act and would end up paying the existing tenants tens of thousands of dollars to leave, plus never be able to rent out the apartments ever again (which would permanently decrease its value).

When I explain these rules to people, their first inclination is to try to figure out ways around the Ordinance. And, to be honest, there are still a few tiny loopholes. But the loopholes disappear or get narrower every year. So, unless you’re a pro, don’t waste your time: if the tenant is there, he’s almost definitely staying.

One more thing: Rent control isn’t all bad. I have my problems with it, there’s no doubt. But you have to remember that 1. It does help some pretty poor people avoid being homeless (albeit in possibly the least efficient manner possible), and 2. It creates arbitrage opportunities for smart investors who buy rent-controlled properties, pay tenants to move out, rehab the buildings and increase the rents.