Pasadena Multi-Family: Where are CAP Rates Headed?

On November 8, 2022 the citizens of Pasadena, CA passed Measure H which amended the City Charter and established the Rental Housing Board. The Rental Housing Board has decreed that as of October 2023 rental rates for residences in the City of Pasadena may be raised no more than 2.75% of the existing rent for the upcoming year.

Property owners must make business decisions based on a variety of factors, including profitability. It is a truism that risk equals reward, which is to say that the higher the risk of losing capital, the higher the expected reward should be in order to justify that risk. As of September 14, 2023 the rate of return on a very low risk 10 Year Treasury Bill was 4.75%. Keep that in mind as we look at what a multi-family investment might yield.

CAP Rate is determined by dividing the Net Operating Income (NOI) by the sales price. Conversely an asking price for a property can be estimated by dividing a target CAP Rate into the NOI. Let’s look at a hypothetical 8 unit apartment with all 2 bedroom two bath units, built in the 1980’s. We are going to assume no amenities in the building and the asking rent is $2995 per month per unit. Expenses are also estimated and the building is separately metered for gas, electric and water.

We have assumed a purchase price of $3,500,000 which yields a CAP rate of 5.41%. Pretty good, but think about our cash on cash return. Free cash flow of $38,879.20 on a cash down payment of $1,500,000 is a yield of 2.6%! And remember we can buy a 10 year Treasury at 4.75%, which entails extremely low risk and no headaches!

Yes there are tax advantages to owning real estate, but with severe limitations on rental growth and inflation running higher than it has been (but still well below historic highs) the likelihood of multi-family property values increasing the way we have seen in the past ten years seems doubtful at best.

Yet there is hope! There is a case before the Supreme Court this October that may decide whether rent control is a form of an uncompensated “taking” of property by the government in violation of the 5th Amendment (Community Housing Improvement Program vs City of New York). The Supreme Court had previously ruled in Pennell vs. City of San Jose that rent control is not unlimited and that landlords can expect a “reasonable” return on their investment.

In sum, I am afraid that we will see multi-family transactions in Pasadena with higher CAP rates, which is great for buyers, but not as great for current property owners.

If you are interested in more information or to discuss your property’s value, please contact me @ (626) 818-7546 or rick@cbi-commercial .com