Planning for capital improvements, such as renovations, additions and infrastructure upgrades, at multifamily properties can be complex for any investor. But properties with rent regulations can bring extra challenges. Real estate owners and managers share five tips to keep in mind when preparing to make improvements at rent-stabilized units.
Brooke Richartz, Managing Director and Senior Regional Sales Manager for Commercial Term Lending at JPMorgan Chase, says clients with rent-stabilized multifamily properties in New York are spending on projects that can save money down the line, like solar panel systems.
In addition to reducing operating costs, these projects can help owners comply with energy efficiency and greenhouse gas emissions requirements, such as New York’s Local Law 97.
“Part of it is to operate more efficiently from a cost perspective, but they can also see, from a sustainability standpoint, that’s the direction they need to head in,” Richartz says.
Green investments like solar panels might also be eligible for subsidies that can help offset the cost. There’s a federal tax credit for solar panel systems for 26% of the cost of projects that start construction by the end of 2022 and are placed in service before 2026. In New York City, solar energy systems might be eligible for a four-year real estate tax abatement program.
“We were trying to nurse it along, trying to accumulate more money before we spent money on a new roof, and it ended up costing more,” he says.
Humberto Lopes, founder of H.L. Dynasty Real Estate, owns multifamily and commercial properties in Brooklyn and Staten Island. He says he’s less likely to purchase a building requiring significant renovation since a 2019 New York law tightened limits on rent increases linked to capital improvements. But Lopes won’t skimp on necessary investments in his existing properties.
When owners fail to fix problems, a “domino effect” can lead to even bigger, costlier issues, Lopes says.
“In the long run, it’s cheaper to fix it,” he says. “I don’t jeopardize my building. It’s a big investment.”
It’s easy to justify spending on improvements critical to keeping a building in good condition. However, figuring out when to spend on optional upgrades requires carefully analyzing how long it will take to recover the costs, says Kari Negri, founder and CEO of SKY Properties, a property management business in Los Angeles’ Toluca Lake neighborhood.
She recommends looking for budget-friendly approaches to sprucing up properties, like stripping and repainting cabinets instead of replacing them, swapping in trendier hardware or adding a smart thermostat.
For any project, “there’s expensive and inexpensive ways to do it,” she says.
Jones decided to upgrade the entry system at his San Francisco properties as renters started getting more packages during the pandemic. The new system makes it easier for residents to use the phone to let guests or people delivering packages enter.
His buildings are fully occupied, but “I didn’t want it to hamper our ability to rent going forward,” he says.
It’s smart for any property owner to plan ahead and save for renovation expenses, but it’s especially important when regulations limit rent increases.
Cities with rent regulations like New York, San Francisco and Los Angeles let owners of rent-stabilized properties request approval to pass on the cost of capital improvements through temporary rent increases, but there can be limits.
The state of New York, for instance, passed a law in 2019 with stricter rules for passing on the cost of improvements. A fact sheet from the state’s Division of Homes and Community Renewal explains rent increases for major building-wide capital improvements, like new boilers, windows or roofs, are limited to 2% each year. For investments in individual apartments, owners can seek up to three increases in a 15-year period, and the total cost of improvements eligible for rent increases is limited to $15,000.
At properties Negri manages in Los Angeles, she sets aside money each month to cover the estimated cost of future expenses, like a new roof, by the time they’re required.
“When you have buildings under rent control, it’s all about planning,” she says.
Retrofits were mandatory at two buildings under a San Francisco ordinance that requires strengthening soft-story buildings that have an open area, like space for parking, on the first floor, says Azar, who along with co-owning and helping manage his family’s portfolio is a broker-associate at Compass Commercial and principal at Bay Area Home Offers.
They decided to make similar improvements at two other soft-story residential buildings where the retrofit wasn’t required and turned the first-floor garage spaces into commercial spaces: a tattoo parlor and a nail salon. Azar says he was able to pass the full cost of the mandatory retrofits on to renters as capital improvement passthroughs over a 20-year period, along with half the cost of the voluntary retrofit work.
Between the income and value added to the building, “it certainly offset the initial cost of doing the work,” he says.