Cash for keys deal worth it?

Question

Hi all,

Would love your thoughts on this.  The Building is in Los Angeles, CA. Subject to rent control.

TLDR: Own an apartment building. Should I spend around $28,000 to get an additional $550 a month in rent (conservatively) by doing a cash for keys deal? The $28,000 includes all costs associated with paying the tenant to leave as well as the cost to renovate the unit so it can command market rent.

Detailed Version: I have a 4 unit apartment building in Los Angeles. The building is subject to rent control. I inherited all the tenants when I bought the building. One of my units has a long term tenant who pays below market rent.

The below-market tenant is an ok tenant - They are a bit messy but pay their rent on time and to my knowledge, don't really cause any problems.

If I did a cash for keys deal with the existing tenant and renovated the unit, I think market rent for a good, creditworthy tenant would conservatively be $550 /month higher than current rent.

Including the attorneys fees, paying the tenant, vacancy during renovation and cost of renovation, the project will cost between $28,000-30,000.

I do have the cash on hand, it generates maybe 1% at the moment as I have a fair amount of liquid cash sitting in the bank.

It would take about 4.54 years to recoup, basically a 2.2% CAP on the $30,000 investment. Not that exciting but more than it is currently generating (and of course not factoring that rent will still increase each year).

I plan to hold onto the property, but, comparable buildings in my area trade at around a 5 CAP. So from a value-add standpoint, the $30,000 investment could add $132,000 in value at a 5 CAP.

Would appreciate any thoughts. I'm not blown away by the numbers but they are not terrible so I am conflicted.

Thank you!

Alex J. · Answer

the biggest point not brot up was when you increase the rents you increase your value.  So that 30k could easily be made in equity appreciation. Plus you might be able to increase your cost basis though don't quote me im not a cpa

Think of this...30k might bring up 550 a month but If you refi cash out on new valuation it's likely to be higher valuation on rents and you can pull 100k and still be covered by your new renter value and use the 100k on another project or deal

Wes Brand · Answer

I'd cash for keys 'em, you're getting them out now while market is relatively close to the rent they're paying.

Rent control means the longer you wait the more expensive it is to get them out...if they're paying 1k/mo and market is 1.5k/mo you might be able to convince them to leave. If they're paying 1.5k from the 2% rent increases while market has risen to 3.5k there's no way you're getting them out. (note: this depends on the exact structure of your rent control -- if your rent control allows sizable increases disregard)

Kevin Crosson · Answer

Hey Kevin, this is a personal decision, but if it were me, I don't think I'd bother because the strategy is to hold for the foreseeable future. Remember, whichever new tenant you put in will be locked in under rent control as well at the new rate, so in 5-10 years that rate will be relatively low as well. From a broker's standpoint, the most desirable scenario for buyers in LA (at least right now with inventory so tight) is to have units vacant on purchase. So, I would wait until whenever I decided to sell, then deliver the unit vacant.

Interested to see what others have to say! I'm betting you'll get mixed responses.

Account Closed · Answer

@Kevin Crosson You'd recoup the money in 4.5 years - if nothing goes wrong with the new tenant, and doesn't move out.  I think that's too long to wait to recoup that money, and for an unknown.  If the current tenant was horrible, then sure, kick them out and go for it.  But, it sounds like this tenant is worth keeping.

I'm wondering if there might be a better way to invest that $28,000.

Adam Phebus · Answer

@Kevin Z. 22% ROI on $30k from rent and/or nearly 23% from the increased value at a 5 cap, sounds like cash for keys is a no brainer. I can't think of many places in LA where you could make $30k work so hard for you. Once the new tenant is in at the higher rate, could you also refinance to extract capital for other investments?

Kevin Z. · Answer

Hi,

Thank you all for the replies.  All good points!

@Greg S. - Under rent control laws in Los Angeles, the only way I can motivate the tenant to leave is to offer to pay them to voluntarily leave.  No cause eviction is illegal under LA rent control.

I certainly can put in a new tenant without upgrading but I would not be able to lease the apartment at significantly higher rent.  Given that once a tenant is in, they are there basically as long as they want to be and rent can only be increased by around 2% a year it is wise to get the new rent as high as possible.

Thank you again,

Kevin

Thomas S. · Answer

If the property is still worth buying with the tenant in place I would go ahead and buy as is. I would then simply motivate him to leave at some future data and bring in a new tenant at market rate. Assuming you are allowed to bring new tenant to market without having to up grade the unit.

If it is not necessary why bother spending the money to renovate just replace the tenant.

Kevin Z. · Answer

Thank you for all the replies!  Chris - busted me - I'll take all the advice I can get!

I should edit my original post or at least have those smarter than I check my math because I stated 2.2% CAP on the $30k investment but I believe it is actually 22% ($6,600/30,000 = .22).

Kevin: Interesting insight.  So you have found that vacant units w/ market gross scheduled incomes are doing better than occupied units at or close to market rents in place?  Have you found any differences between 1-4 and 5 and above units?  I imagine higher actual NOI favors the 5+ properties w/ commercial underwriting?  And yes, lots of mixed responses from people I have spoken to!

Sue & Tracy:  The tenant is ok.  They do pay on time, they could do a lot better at taking care of the apartment and I have had a few minor issues with them.  Certainly could be a lot worse.  I guess it is just weighing out if losing the $30,000 in liquidity would set me back significantly on getting the next property or if getting better in place cash flow from the current property will help me on the finance side enough to offset the $30k?

Thank you all again,

Kevin

Cash for keys deal worth it?

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