One of the contractors I use a lot recently did a rehab of a small apartment building in Silver Lake. He bit a lot of our style, but that’s life.
When I asked him about the project, what he told me shocked me. Apparently, the genius who bought the place paid my contractor to turn it from a triplex into a duplex, thus violating one of the key rules of multifamily real estate in Los Angeles:
Never reduce unit count. Ever.
Now, you can imagine what the guy was thinking, right? I bet the units were small and oddly-shaped. I bet he saw an opportunity to make two nice, big units and thought that would make the building more attractive as a flip. And, he could save the cost of doing another kitchen and bathroom.
Bad move. Here’s why:
- Most apartment buildings in Silver Lake are grandfathered in. You could never build them now, because they don’t have enough parking to comply with modern building codes.
- If you reduce the unit count, you are going to struggle to get that unit back at some point down the line. Most likely, once it’s gone, it’s never coming back.
- In general, the smaller the unit, the higher the price per square foot you get in rents. This is because there is a ton of demand at the low end of the market and decreasing demand as you move up into large and larger units.
- So, given a set amount of square footage, you’re always going to get more rent from three small units than two larger ones. (Incidentally, this is why zoning exists in the first place; otherwise, developers like me would just build very, very tall buildings full of studio apartments.)
- Because apartment buildings are valued as a multiple of their rents, converting from a triplex to a duplex resulted in the owner producing a less valuable building.
Now, you might argue that, in removing a kitchen and bathroom, the owner saved himself $15k in rehab costs or something.
But look at the math. The difference in rent between, say, three studios (3 x $1300 = $3,900 / month) and a 2/1 and a 1/1 ($1800+1500 = $3,300/ month) is $600 / month. Assuming 11x annual rents as a multiple, that’s $600 x 12 months x 11 = $79k in value that he left on the table. It’s safe to say he should have spent the $15k to earn another $64k.
Whoops.