Silver Lake rents and operating margins

Spent some time this morning looking at rents in Silver Lake.

When we started in this business back in 2008, a really nice 1 bed in Silver Lake was around $1500. Today, a similar apartment goes for $2200-2300.

That’s an increase of ~50% in eight years… or around 5-5.5% / year (inclusive of compounding).

But that’s understating the impact for a (non-rent controlled) building owner. Why? Operating leverage.

As an owner of an apartment building, your largest costs are your mortgage (which is a finance cost, as opposed to an operating cost, but let’s not be pedantic) and your property tax. Assuming you have a fixed mortgage, those payments are flat. And your property tax is limited to a 2% annual increase by Prop 13 (otherwise known as CA’s gift to landlords).

Your only variable cost (eg linked directly to revenue) is property management (usually pegged at 5% of rents or thereabouts). The rest of your costs, like gardening and water / sewer, go up, but are the same regardless of what rent the tenants are paying.

The result of the above is that increases in rent disproportionately fall to the bottom line, increasing your margin.

In concrete terms: Say you bought a 4plex in 2008 for $720k cash, which was 10x the $72k rent roll ($1500 / month x 4 apartments x 12 months). Expenses were probably $25k, leaving $47k in NOI (you bought a 6.5% cap!). Assuming your rents are up to $2250, your numbers are now: $108k rent roll, probably $32k in expenses, or $76k in NOI.

That increase in NOI, from $47k to $76k, is ~61%… more than the 50% rents have increased. Not bad, right?