Learn how rent-history due diligence exposed inflated income before a buyer closed on a Los Angeles rent-controlled building.
A tenant notice revealed a 7% rent increase against the 3% limit described in this acquisition case. That discrepancy raised questions about legal rents, inflated property value, and potential repayment exposure for the buyer.
Advise RE explains why the buyer refused to release contingencies and canceled after the seller rejected proposed protections.
🔎 Before buying multifamily property in Los Angeles RSO:
• Review documented rent increases, not just the current rent roll.
• Verify the legal rent base and the applicable rules for each increase.
• Investigate potential new owner liability for previous landlord illegal rent increases.
• Resolve compliance questions before releasing contingencies.
• Discuss credits, holdbacks, or indemnification with your advisers rather than assuming an as-is purchase resolves the risk.
đź“‹ Chapters
[00:00] Inflated rents can inflate the purchase price
[00:32] The Los Angeles RSO acquisition
[01:02] A 7% increase against the stated 3% limit
[01:41] Rent-history red flags and valuation impact
[02:39] Management could not explain the increase
[03:05] Contingency pressure and proposed protections
[03:30] Canceling the deal
[03:48] Why paperwork matters beyond inspections
[04:15] Protecting the buyer over earning a commission
[04:42] Reviewing rent-increase documentation
[05:13] Buyer advisory for Los Angeles acquisitions
[05:42] Subscribe for more acquisition insights
Buying a Los Angeles rent-controlled property? Contact Advise RE about buyer advisory for your next acquisition.
This case reflects the limits described in the video, not a statement of today’s allowable increase. Applicable rules and liability depend on the facts. Consult qualified legal counsel.
Transcript
[00:00] Alright. How’s this first setup? Raise the rents past what the law allows, price that building based off of these new non-allowed rents, and then hope to God a stupid buyer comes along and believes it. Last month, someone tried to do that on my client, and I’ll explain to you how we caught it and what you can do to protect yourself as well. So if you follow our videos, we’re still following the client from our last video where we talked about the insurance issue that we tackled.
[00:32] In this particular deal, we were looking at a small multifamily project in the city of Los Angeles covered under rent stabilization ordinance. If you’re not familiar with what rent stabilization ordinance is, it’s basically a law that some other cities in the United States have, notably New York and San Francisco and a few others, where basically there is a cap to how much you can raise as a landlord to your tenants for annual rent increases. Usually, they’re very small. They’re designed to be very protective. They’re supposed to keep housing affordable, that’s another issue altogether as to whether or not that actually works.
[01:02] But the point is, at the time of this video, the maximum allowable increase was 3%, and the seller’s property management or the seller himself increased the rent by 7%. If you raise the rent over the legally permissible amount, that raise is going to be void, and you’re gonna have to refund those rents back to that tenant for the illegal raise. Plus, there’ll be things like attorney’s fees and all sorts of other penalties and considerations because typically, local housing does not like it when you violate rent control rules. By the way, local housing doesn’t care who caused the rent increase. The liability follows the building.
[01:41] So if a past landlord illegally increased rents and you came in and bought the property and did everything right by the book afterwards, you as the owner have to pay back all those rents. I should mention that let’s say landlord A who previously owned the building raised rents by 7%, 7%, and 8%, and then you carried on with a 3% increase, let’s say that was legally allowed for the next five or six years subsequently, you have a huge bill to pay back at some point because the base that you charge it on is still higher than you were legally allowed to do so. This can accumulate to be a lot of dollars, not to mention, like I said, the attorney’s fees as well. So when we were digging through the due diligence documents, we noticed that there was a letter sent to the tenants for a 7% rent increase, which definitely triggered a red flag saying, well, how could this even be possible? Every dollar of rent increase over the legally permissible amount was essentially a fake $240 of increased value to the property at cap rate assigned to it.
[02:39] It’s a huge amount of money and it definitely compounds over time. What really raised our eyebrows is when we questioned this, property management said that they’ll be talking to their attorney to justify their position. But that was after they did the rent increases. I would have expected a 7% increase to have already been legally justified prior to that happening with the answer easily available. However, after being told, we’ll look into it, now we knew that there’s a huge problem.
[03:05] While all this is going on, we’re getting pressured to release contingencies. Again, there’s no way we could possibly release contingencies without solving this major issue first. This looks like a financial time bomb waiting to blow up on the buyer’s investment many years down the road. When we countered to address it with some sort of credit, some sort of holdback, perhaps an indemnification of some sort, seller’s only response was take it as is. I’m not giving you a single penny more.
[03:30] And so we had to cancel the deal as well at that point, get all of our money back, and move on. So what can you learn from all this? Yes, physical inspections are important. It’s good to look at a property’s condition and make sure that there aren’t major issues that are gonna wait for you down the road, such bad roof, bad exterior, bad waterproofing. Yes, I get it.
[03:48] Those are all very important things. You can usually price those pretty much right off the bat. However, what’s really gonna cost you a lot of money is all the paper behind the project. Documented rent increases, compliance with the city rules, insurance notifications, insurance requirements. These are the type of things that cost you well into the six figures of judgments and claims, whereas the repairs are generally fairly quantifiable.
[04:15] Again, important, but the big stuff is the paper. So again, I killed my own deal. I made no commission on the project, but I did protect my client, and I know later down the road we’re gonna find a project that is suitable, adequately documented, and doesn’t have these apparent time bombs waiting for them down the road, which would, of course, kill relationships and kill your reputation in the business. So I hope this helps. When you’re looking at a deal, again, the physical inspection is important.
[04:42] Yes, it is important to look at how well the windows and doors sit and all that good stuff, but you’ve gotta look at the paperwork behind it as well. You’ve gotta look at how the rent increases are documented, especially in cities with rent stabilization ordinances. The compliance around that is incredibly cumbersome, and if you fall afoul of it at all whatsoever, the city agencies will come down really hard on you. Their position is that landlords are all evil and that tenants are all good angels with halos on their heads. Again, I have my own opinions on which one’s true and which one’s not.
[05:13] But the point is, as a buyer and investor, you’ve gotta protect yourself against that risk. You should be just a little bit more paranoid in these type of markets than perhaps in more free market kind of situations like in Texas and other states that have a lot less stringent tenant protections in place. So I hope this helps. And if you’re interested in buying property in the city of Los Angeles and you’re looking for buyer advisory, then feel free to reach out to us right here and we’ll be happy to help you with your next acquisition. Thanks so much for watching.
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