Get it through your head: The land is important!
Too many buyers don’t understand that the land component of a property is potentially it’s most important aspect. Why? Well, buildings all fall down in the long run. But land is unchanging and often has potential.
What do I mean by potential? Well, in the absense of government regulations, you can always build a lot more structure on a given parcel of land. Buy a single family house, knock it down and building a fourplex. What stops you from doing that in LA? Zoning.
Zoning is a form of governmental regulation that determines what can be built, where.
LA’s zoning code is particularly terrible, since it was designed for a city of detached, single family homes, making it extremely difficult and expensive to develop apartments or condos, which are the kind of denser development the city desperately needs to combat sprawl and traffic. OK, lecture over.
For the purposes of the apartment investor, here’s what you need to know about the relevant types of LA zoning:
- R1 – This is residential home zoning, but an apartment building in an R1 zone is allowed to continue to operate because it’s grandfathered in. In a way, it’s the best scenario, because you know no one can build any more apartments to compete with you.
- R2 – Slightly denser than R1. You can building one dwelling unit per 2,500 sq ft of land. So if you have a 5,000 sq ft lot, you can build two units (provided you meet the other requirements)
- RD1.5 – One unit per 1,500 sq ft of land
- RD2 – One unit per 2,000 sq ft
- R3 – This is where things get interesting. One unit per 800 sq ft
- R4 – One unit per 400 sq ft
- C1 – Commercial zoning; but can be treated as R3 if you want to build apartments or condos
- C2-5; CM – Treated as R4
- MR1 – M3 – Treated as R4
Why does all of this matter? Because a property’s value is to some extent determined by its potential. Say you’re looking at two otherwise identical single family homes on 6,000 sq ft lots in Echo Park:
- Property A is zoned R2. To find out how many units you could build there, divide 6,000 / 2,500 = 2 (the city always rounds down). So you could build two units.
- Property B is zoned R3. So divide 6,000 / 800 = 7 units.
Right now, apartment developers can afford to pay you around $50,000 per unit for well-situated land to develop. So the land underneath Property B is worth $350,000 by itself (ignoring the value of the home). By this measure, Property A’s land value is obviously only $100,000.
So identical pieces of property can have vastly different values due to their zoning. And that’s why you pay attention to boring zoning codes.
Legalese: I’m not an architect or a land-use attorney, so this is not architectural or legal advice.