New California Laws for 2013 Affecting Landlords

Landlord Must Install and Maintain Carbon Monoxide Detection Devices in All Units: In the US, hundreds of people die from carbon monoxide poisoning in their own homes every year. These deaths can be prevented by taking simple measures. In 2010, the California legislature enacted the Carbon Monoxide Poisoning Prevention Act of 2010 to help prevent death and illness resulting from carbon monoxide poisoning. In conjunction with the Act, further legislation was added in Health and Safety Code Section 17926 which states that owners of all rental units with a fossil fuel burning heater or appliance, a fireplace, or an attached garage, must install and maintain carbon monoxide detection devices in the unit. This mandate is effective on July 1, 2011 for existing single-family dwelling units, and on January 1, 2013, for all other existing dwelling units. 

The new law further requires landlords to verify that the carbon monoxide detectors are operable when the tenant takes possession of the unit. Tenants are responsible for notifying the landlord of any problem with the detectors in their unit, and the landlord has the responsibility to correct any reported problems. Ca. Health and Safety Code §§ 13260 and §§ 17926

Landlord May Dispose Abandoned Personal Property Less Than $700: Commencing January 1, 2013, the total resale value of personal property left behind by a tenant after termination of a tenancy that the landlord must sell at a public auction (rather than dispose of or retain for his or her own use), has been increased from $300 to $700, if certain procedures are followed. This law, however, also prohibits a landlord from assessing any storage cost if the tenant reclaims personal property within 2 days of vacating the premises. The statutory notices of Right to Reclaim Abandoned Property have been revised to reflect these changes. Furthermore, a landlord’s notices of termination of tenancy and pre-move out inspection must contain specified language that former tenants may reclaim abandoned personal property left on the premises, subject to certain conditions. Assembly Bill 2303.

Landlord Must Disclose Notice of Default to Prospective Tenants: Starting January 1, 2013, every landlord who offers for rent a residential property containing one-to-four units must disclose in writing to any prospective tenant the receipt of a notice of default that has not been rescinded. This disclosure must be made before executing a lease agreement. If a landlord violates this law, the tenant can elect to void the lease and recover one month’s rent or twice the amount of actual damages, whichever is greater, plus all prepaid rent. If the lease is not voided and the foreclosure sale has not occurred, the tenant may deduct one month’s rent from future amounts owed. The written disclosure notice as provided by statute must be in English, Spanish, Chinese, Tagalog, Vietnamese, and Korean. A property manager will not be held liable for failing to provide the written disclosure notice unless the landlord has given the property manager written instructions to deliver the written disclosure to the tenant. This law will expire on January 1, 2018. Senate Bill 1191.

Tenant Entitled to a 90-Day Notice to Terminate After Foreclosure: Effective January 1, 2013, a month-to-month tenant in possession of a rental housing unit at the time the property is foreclosed must be given a 90-day written notice to terminate under California law. For a fixed-term residential lease, the tenant can generally remain until the end of the lease term, and all rights and obligations under the lease shall survive foreclosure, including the tenant’s obligation to pay rent. However, the landlord can give a 90-day written notice to terminate a fixed-term lease after foreclosure under any of the following four circumstances: (1) the purchaser or successor-in-interest will occupy the property as a primary residence; (2) the tenant is the borrower or the borrower’s child, spouse, or parent; (3) the lease was not the result of an arms’ length transaction; or (4) the lease requires rent that is substantially below fair market rent (except if under rent control or government subsidy). The purchaser or successor-in-interest bears the burden of proving that one of the four exceptions has been met. This law does not apply if a borrower stays in the property as a tenant, subtenant, or occupant, or if the property is subject to just cause rent control. This law will expire on December 31, 2019. This new California law is similar, but not identical, to the 90-day termination notice requirement under the federal Protecting Tenants at Foreclosure Act (12 U.S.C. § 5201, et seq.) (as extended by the Dodd-Frank Wall Street Reform and Consumer Protection Act), which is set to expire on December 31, 2014. Assembly Bill 2610.

When is an owner required to have an on-site manager for residential income property in California?

Here is what the California Code of Regulations Title 25, Section 42 of the California State Housing Law says on the topic:

§ 42. Caretaker (25 CCR § 42)

A manager, janitor, housekeeper, or other responsible person shall reside upon the premises and shall have charge of every apartment house in which there are 16 or more apartments, and of every hotel in which there are 12 or more guest rooms, in the event that the owner of an apartment house or hotel does not reside upon said premises. Only one caretaker would be required for all structures under one ownership and on one contiguous parcel of land. If the owner does not reside upon the premises of any apartment house in which there are more than four but less than 16 apartments, a notice stating the owner's name and address, or the name and address of the owner's agent in charge of the apartment house, shall be posted in a conspicuous place on the premises.

Keep Rents at Market Level

Keeping rents at market level is critical to maintaining the value of your investment. The rent collected in a multi-residential income property largely determines the value of the property. When the time comes to sell your income property, prospective buyers are going to assess the purchase price against its income and operating expenses.

As a real estate agent, I can show prospective buyers data regarding the potential rental income, but nothing speaks louder than the actual rental income being collected. Having tenants that are paying market level rents are a valuable asset when selling a residential income property.

A landlord who allows his rent to slip substantially below market is allowing his property to deteriorate just as surely as one who lets the roof deteriorate or the floors rot.  This implies that raising the rent as needed to market levels is as important a part of maintenance as fixing roof leaks or unplugging toilets. 

I highly recommended that you renew leases, or at least rent rates, annually and adjust your rents accordingly to maintain tenants that are paying market level rents.  Advise new tenants that you review rents once a year and adjust according to market levels. This obviates huge increases due to years of neglect. While tenants hate rent increases, small increases that come on the yearly anniversary of their tenancy are more tolerable.

By tying rent increases to the anniversary of their tenancy you also tend avoid raising the rents to all your tenants at the same time, risking multiple vacancies or multiple upset tenants. You also avoid the perception that the rent increase is somehow linked to some maintenance or repairs that you are doing for the tenant or the overall property.  

If you have been neglecting your rents and need to make substantial increases, think about giving them in installments.  In other words, if you need to increase the rent $200 on a given unit, consider raising it $100 in February and another $100 in May.  Notify the tenant of the second rent increase at the same time as the first increase so the tenant can plan accordingly.

Under California Law there is currently no maximum limit for rent increases. However there are regulations that must be followed.

1. If the tenants have leases, the leases carry over to your new ownership. The rent cannot be increased during the terms of the lease unless the lease provides for rent increases
2.  
3. If the rent increase or cumulative rent increases are greater than 10% of the lowest rent during the past 12 months, you must give a minimum of a 60 day notice.
4.  
5. If the rent increase or cumulative rent increases are 10% or less than the lowest rent during the past 12 months, you must give a minimum of a 30 day notice.

For specific details on advance notice requirements please refer to the California Landlord Tenant Guide which can be found on the California Department of Consumer Affairs web site at www.dca.ca.gov.

Local rent control ordinances may also limit rent increases, or impose additional requirements on landlords. If your investment property is in an area with rent control, check with your local rent control board to find out what additional restrictions apply.

Why use an LLC to Own Income Property?

Whether you own one, or many income properties, owning them personally can be a major liability. There is an inherent risk of liability with property ownership. Should an accident occur, you might lose not only the property itself, but all of your other personal assets (including other properties, your home, bank accounts, vehicles, stock, etc). Although insurance can limit your potential exposure, why be exposed at all? 

Many real estate investors create a Limited Liability Company (LLC) to protect their personal assets from possible litigation associated with their income property.  If the property is held in your personal name, a successful claimant will be able to attach your personal assets to satisfy the judgment. By contrast, if the property is held in a California limited liability company, the LLC may be liable. A successful claimant will be limited to only attach the assets of the LLC and your personal assets will remain protected.

Although it may be possible to protect multiple income properties from one another by establishing a separate LLC for each property, LLCs with the same officers and directors may be considered fraudulent. It would be most prudent to discuss your options with a qualified attorney.

A California real estate LLC can also provide significant tax advantages as well as estate planning benefits. For more information on these topics you will need to consult with a tax accountant or tax attorney.

Creating your limited liability company is fairly straight forward. You will register your LLC with the California Secretary of State. There are many attorneys that offer LLC services.

The limited liability company (LLC) has become a favorite vehicle for owners of income-producing real estate seeking to easily and inexpensively establish a level of personal liability protection from claims from tenants and outsiders.

Can you prohibit your tenants from smoking in your rental units?

Effective January 1, 2012, California Civil Code 1947.5 provides that a landlord has the right to prohibit the smoking of tobacco products in all or part of a residential property. This right applies to new tenants who enter into leases after January 1, 2012.  

For existing tenants, a new smoking restriction constitutes a change in terms of tenancy and must be made in compliance with all state and local laws. For specific details read civil code 1947.5

When I purchase a residential income property how much can I raise the rent?

It is not all that uncommon to purchase a residential income property where the current tenants are paying below market value rents. As the new landlord, how much can you legally raise the rent?

Under California Law there is currently no maximum limit for rent increases. However there are regulations that must be followed.

1. If the tenants have leases, the leases carry over to your new ownership. The rent cannot be increased during the terms of the lease unless the lease provides for rent increases
2. If the rent increase or cumulative rent increases are greater than 10% of the lowest rent during the past 12 months, you must give a minimum of a 60 day notice.
3. If the rent increase or cumulative rent increases are 10% or less than the lowest rent during the past 12 months, you must give a minimum of a 30 day notice.

For specific details on advance notice requirements please refer to the California Landlord Tenant Guide which can be found on the California Department of Consumer Affairs web site at www.dca.ca.gov.

Local rent control ordinances may also limit rent increases, or impose additional requirements on landlords. If your investment property is in an area with rent control, check with your local rent control board to find out what additional restrictions apply.

Having tenants that are paying market value rents are a valuable asset when selling a residential income property. It is highly recommended that you renew leases annually and adjust your rents accordingly to maintain tenants that are paying market value rents.

Evaluating Multi Residential Income Properties with GRM and CAP Rate

When evaluating multi residential income properties that are for sale, in order to decide how much to offer or, to compare two unlike properties, among other things, investors will look at two financial numbers, the Gross Rent Multiplier (GRM) and the Capitalization Rate (CAP).  By calculating these two values, it may for example, help you decide how well priced a duplex in a high rent area compares to a fourplex with lower per unit rents.

GRM = Purchase Price/Annual Gross Income

The GRM is the purchase price divided by the annual gross income. The result gives you the number of years it takes for the gross income to make up the purchase price. The nice thing about this calculation is only minimal financial information about the property is needed and it can quickly tell you if the asking price is out of line with other  properties you are considering. It is important to be consistent with what you use for gross income when comparing properties.  I prefer to use my own estimated market value rents as opposed to current tenant rents. You can use the maximum potential rent or make an allowance for some vacancies. I also prefer to include the income from coin-op laundry machines.

The downside of the GRM calculation is that ignores operating expenses. So while two properties may appear to be of equal value based on a GRM calculation, you may find one has significantly more operating expenses than the other. For example, with the duplex each tenant pays their own utilities, where in the fourplex you find there are not separate water meters, so water is paid by the landlord. The CAP rate looks at both income and expenses.  Once you can obtain expense information on your potential purchase you can then make this calculation.

CAP% = Annual Net Income/Purchase Price * 100

The CAP rate is the annual net income divided by the purchase price, usually expressed as a percentage. If one ignores the tax advantage of rental income and appreciation of property values, then you can consider the CAP rate as the return on your investment.

The annual net income is the gross income you used in the GRM calculation minus all annual operating expenses. Common operating expenses paid by you, the landlord, may include:

·         Property taxes

·         Insurance

·         Garbage service

·         Landscaping services

·         Water and Sewer

·         Gas and Electric

·         Maintenance and Repairs

·         Property Management fee

·         Vacancy factor (if not included in the gross rent calculation)

If you borrow money to make the purchase you will have a mortgage payment. This expense is not considered an operation expense (it’s the cost of borrowing capital) and not included in the calculation. 

Example: Purchase Price = $900,000 Gross Income = $65,000       Net Income = $45,000

GRM = $900,000/$65,000 = 13.85         CAP% = $45,000/$900,000 * 100 = 5%

When comparing properties, a smaller GRM is better and a larger CAP rate is better. Often these values will be provided to you by the listing broker or on the MLS. However, it is important to understand how these values were derived. I have found that often a vacancy factor was not included, property taxes were based on the seller’s rate and maintenance and repair costs were understated. It is best to get as much information as possible from the seller, and then make your own adjustments and calculations.

Vacancy Rate in Silicon Valley Expected to be Below 3%, a Level not Seen Since the Dot-com Boom

As reported by the San Jose Mercury News on April 17, 2012
http://www.mercurynews.com/business/ci_20410464/bay-area-rent-renters-expensive-squeeze-tight-market

With depreciation, your rental income profit could be tax free!

The objective behind owning residential income property is usually to make a profit. The property itself will typically appreciate over time, providing a nice profit down the road when you decide to sell. In the mean time we are striving for a positive cash flow from the rental income. That is, realizing a profit after all expenses are paid. 

  

Rental income is taxed as ordinary income; however, you will offset much of this income with your expenses related to owning and managing the property. Deductions include your true out-of-pocket expenses such as mortgage interest payments, property taxes, maintenance and repair costs, utilities, advertising for renters and professional property management fees. What’s left is your profit, taxable income.

But wait! There is a phantom expense allowed by the IRS. It’s called depreciation. Like any piece of capital equipment for a business, the IRS recognizes that your property, excluding the land, depreciates as it gets worn out over time. Basically (at the time of this writing) they say take the fair market value of your residential income property (excluding the land value) at the time it became a rental property, divide it by 27.5 and that amount of money can be deducted against your income each year for 27.5 years.

For example, if after deducting the value of the land, your income property is worth $550,000, you divide that by 27.5 and get a $20,000 annual deduction against your rental income. Have you owned your income property more than 27.5 years? Then it’s time to exchange it into a new property using the IRS 1031 Tax Deferred Exchange rules (see my March 19, 2012 post) and keep on going for another 27.5 years.

This is general information regarding residential income property tax advantages. Always check out all tax issues thoroughly with a tax accounting professional before making any real estate investment decision. 

Did you know that conforming loan limits are higher on multi-residential properties?

The Office of Federal Housing Enterprise Oversight (OFHEO) set the criteria on what constitutes a conforming loan limit. Lenders offer the lowest interest rates on conforming loans because they can be later sold to Fannie Mae or Freddie Mac. At the time of this writing the FHA loan limit in California is $625,000 for single family and condominium home. Loans above this amount are referred to as jumbo loans and have a higher interest rate. However, small multi-residential properties have higher limits. The FHA loan limit, at the time of this writing, for duplexes is $800,775, for triplexes is $967,950 and for four-plexes is $1,202,925.

If you are thinking about purchasing a multi-residential income property and would like to discuss loan options, I will be happy to refer you to a knowledgeable and trustworthy mortgage consultant. 

What is a 1031 Exchange?

One of the benefits about investing in residential income property over the stock market is section 1031 of the Internal Revenue Code, otherwise known as a 1031 tax deferred exchange.  When you sell a stock investment in order to purchase a different stock investment, for example you sell your old Apple stock in order to purchase some new Facebook stock, you will pay the appropriate capital gains tax on any profit you made from Apple and the remaining proceeds can go towards your Facebook investment.

When investing in real estate, if done according to the 1031 tax code, you may sell one real estate investment in order to purchase a different real estate investment without paying income tax on the profit you made from the sale. The taxes from the sale can be deferred sale after sale, until you do a non 1031 exchange sale, or when the property goes into your estate. You have numerous exchange options. You can sell one property to buy another, sell one to buy several or sell several to buy one. You can mix residential, commercial and land properties. So if you wanted to expand your rental income you could sell your condo to buy a duplex, or sell two duplexes you own to buy an small apartment building.

However, to qualify for  the 1031 tax deferred exchange you must strictly follow the rules which include  very specific buying and selling time periods and how funds must be transferred. You should always consult with your tax consultant regarding the specifics of the tax code and, use a knowledgeable real estate agent to help you navigate through the exchange transaction. More information can be found on my web site at http://tommartinswebsite.com/1031Exchange.

Housing Crisis to End in 2012 as Banks Loosen Credit Standards

DSnews.com  - Housing Crisis to End in 2012 as Banks Loosen Credit Standards

Do you own a residential income property with 5 or more units?

The Renter’s Right to Recycle Act (AB 818) was authored by Assemblyman Bob Blumenfield and signed into law by Governor Jerry Brown in September 2011. 

The law mandates that owners of multifamily dwellings, defined as a residential property that consist of 5 or more living units, provide adequate areas for collecting and loading recyclable materials and arrange for recycling services for their tenants.

Although the law is mandatory, it does have a provision for properties to receive a waiver, if the property meets certain qualifications that make it impossible to recycle within the property.  According to Assemblyman Blumenfield, if no recycling plan can be agreed upon for a certain apartment building, it can be exempted from the law --- if the building's inability to institute recycling is certified by the recycling companies.

The Renter’s Right to Recycle Act takes effect in 2012.

How much security deposit can I collect on my residential income property?

Under California law the security deposit cannot exceed the amount equal to two months’ rent for an unfurnished unit and three months’ rent for a furnished unit.  If the tenant has a water bed, the security deposit can be increased in the amount equivalent to a half months’ rent.

The security deposit may be called last month's rent, security deposit, pet deposit, key fee, or cleaning fee. The security deposit may be a combination, for example, of the last month's rent plus a specific amount for security. No matter what these payments or fees are called, the law considers them all, as well as any other deposit or charge, to be part of the security deposit.

The only exception that the law allows is an application screening fee. The landlord may require a tenant to pay an application screening fee to cover the cost of obtaining information about the tenant, such as checking references and obtaining a credit report.

A California lease or rental agreement cannot say that a security deposit is nonrefundable. This means that when the tenancy ends, the landlord must return to the tenant any payment that is a security deposit, unless the landlord properly uses the deposit for a lawful purpose. Unpaid rent, damage to the rental unit beyond normal wear and tear, or cleaning a unit that was not left as clean as when the tenant moved in, are the most common lawful purposes for retaining a portion or all of a tenant’s security deposit.

Mountain View, CA – a good location for your residential income property

While most communities throughout Silicon Valley have a solid track record for the residential income property investor, I believe Mountain View is now positioned to grow in property appreciation, as wells as rental rates, above average for the area.  The city of Mountain View and the school districts of Mountain View have made tremendous strides over the past 10 years or so, which have created a highly desirable community in which to live.

• Downtown Mountain View is vibrant with many restaurants, shops and night life. Check it out: Mountain View Downtown Guide.
• You can hop on the light rail to see a Sharks game in San Jose or take Caltrain to watch a Giants game in San Francisco.
• Home of many large employers including Google, Microsoft, Intuit, LinkedIn and Symantec that invest in the community and with employees desiring to live near work.  Read this: Google gives to local schools in 2011.
•  Most significant to the community is the continued growth in the school test scores. The Academic Performance Index (API) score for most schools is now in the 800 range with several exceeding into the 900 range. If you drill down in these reports you will find that many of the schools have subgroups of students in the 900 range, a good indicator that the education being delivered is on par with the surrounding communities like Los Altos and Palo Alto.  Take a look:  API scores for Mountain View-Whisman Elementary School District.

The property values and rents in a community are determined by the demand to live in that community. In Mountain View the schools, employers, transportation facilities and local businesses have melded together to create a community that will be in high demand, a good location for your residential income property. Contact me to explore properties for sale in Mountain View.

Buying a Multi-residential Income Property

Buying a multi residential income property such as a duplex, triplex or fourplex is a different process than buying a single family home or condo. One of the major assets of these types of properties could be the renters that occupy the units. It is most desirable to purchase an income property that is currently occupied with quality tenants, paying current market value rents. This means that your new investment will be generating income to you the day you close escrow. The seller and the listing broker will want the selling process to have a minimal impact on these tenants. In some cases the tenants may not be aware that the property is up for sale.

Unlike purchasing a home that you will live in, viewing the interior of the income property is secondary and commonly takes place after there is an agreement to the purchase price and terms. In other words it is typical that you will need to make an offer based on what the seller has disclosed about the condition of the property, but subject to, or contingent upon, a later in-depth inspection of the property.

Instead you will first be examining the seller’s disclosures regarding income, operating expenses and the maintenance history of the income property. You will be looking at your potential return on investment and cash flow factors. You will also be using these factors when comparing one income property to another. Two measurements that are commonly used for comparing income properties are the capitalization (cap) rate and the gross rent multiplier (GRM).  I’ll explain these a little later.

Upon careful examination of the financial factors you will come to a conclusion as to the maximum purchase price that makes business sense to you. With that knowledge, you are ready to make an offer and begin the negation process with the seller. If an acceptable agreement is reached you and the seller will have a purchase contract that is contingent upon your physical inspection(s) of the income property.

At this point you may and should hire professionals to inspect the various aspects of the property including foundation, roof, plumbing, electrical, heating, appliances, termites, water damage and so on. After the inspections you may choose to proceed with the purchase, terminate the purchase, request the seller to make repairs or renegotiate the purchase price.