The multifamily sector of real estate, especially in Los Angeles, has experienced a sharp increase in prices over the last couple of years, primarily due to the demand from new investors and lower inventory. Many of these new investors have been first time investors looking for alternative investments outside of the volatile stock market. Some are just tired of not having any significant return from having their money in either the bank or in bonds. As new investors, many have not planned for some potentially significant pitfalls from investing in multifamily.

1. Rent Controlled Apartment Buildings

One of the major pitfalls of investing in Los Angeles multifamily is of course rent control.  With the majority of the apartment buildings in Los Angeles falling under rent control, most investors do have a general understanding of what they might expect. For instance, they are unable to raise rents or unable to renew a rental agreement after the lease expiration. They also have to deal with biannual inspections and, of course, government mandated maximum rent increases. Unfortunately, many investors do not consider the possible long term effects of rent control.

One of the biggest issues I see on the horizon is the cost of water. With almost every municipality issuing water rate increases, this will dramatically affect the bottom line of multifamily investors. The anticipated increase for every household is expected to be between $30-$50/month, not including any common area watering needs. The majority of buildings are on a master meter system. With this system, most landlords pay for 100% of the water costs. The cost to sub-meter each unit in a building can be as high as $2,500 per unit, as well as a monthly cost to monitor and send out invoices. Due to current rent control laws, this cost cannot be passed along to a tenant, nor can any increase in the water rates. This will have a tremendous negative impact in the bottom line of any investment.

3. Earthquake Retrofitting

Another issue is mandatory earthquake retrofitting. The city of Los Angeles recently passed a law about how much a landlord can recoup for mandatory retrofitting, and many other municipalities are considering similar laws.Earthquake retrofitting can cost upwards of $130,000 for wood frame, “soft story” buildings, and millions of dollars for concrete buildings. Landlords have up to 7 years to complete the mandatory retrofitting and all of the costs are supposed to be shared up to 50% by the tenants. In reality, the maximum percentage is almost never attained, because a landlord can only recoup these costs by raising the rent a maximum of $38 per month for a 10 year period. Also, this rent increase would go towards offsetting any interest on a loan a landlord would need to get to pay for the retrofitting.