Prop 13, insurance and operating expenses on a California small apartment building

Proposition 13 and reassessment

Proposition 13 limits annual increases in a property’s assessed value while the same owner holds it. When the property changes hands, the county generally reassesses it to market value, which is usually close to the purchase price. A long-held building can therefore carry a tax bill far below what a new owner will pay.

This is the most common mistake in small apartment purchase math. The listing shows the seller’s tax bill. The lender uses yours. Before you make an offer, estimate the new tax from the purchase price and the local tax rate, and add any special district charges.

Supplemental bills and special district taxes

After a purchase, the county issues a supplemental assessment for the difference between the old and new assessed values for the rest of the fiscal year. The supplemental bill is separate from the regular bill and usually arrives months after closing. It is not normally paid through an escrow account, so set the money aside.

Many parcels also carry special district charges: Community Facilities District (Mello-Roos) taxes, lighting and landscaping districts, school or library parcel taxes, and similar assessments. These appear on the tax bill and lenders include them in the payment. Pull the actual bill for the parcel rather than relying on a listing estimate.

Insurance on older California buildings

Insurance has become one of the hardest expenses to predict in California. Carriers look closely at building age, construction type, roof condition, electrical panels, plumbing, wildfire exposure and distance to the coast. Some owners have had to combine a policy from the state’s residual-market plan with a separate policy for the rest of the coverage.

Lenders require hazard coverage and include the premium in the payment. Some also require liability coverage at set limits, flood coverage in mapped flood zones, or loss-of-rents coverage. Earthquake coverage is usually optional for the borrower, but check the lender’s requirements. A quote in hand early in the process is the only reliable number.

Owner-paid utilities and RUBS

Many older 5-10 unit buildings are master-metered for water and sewer, and some for gas, so the owner pays. Trash service and common-area electricity are usually owner-paid as well. These costs do not appear in the simple DSCR test, which compares rent with principal, interest, taxes, insurance and association dues. They do appear in net operating income, which some lenders test as a second measure.

Some owners bill utilities back to tenants through a ratio utility billing system, often called RUBS. Lenders generally count that income only if the leases support it, local rules allow it and the payments show up in collections. Billing practices for existing tenants must follow the lease and local law.

Repairs, management and vacancy

Lenders that test net operating income usually include a repairs and maintenance figure, a management fee even if you self-manage, and a vacancy and credit loss allowance. Some use the building’s actual history; others use their own minimums. Older buildings tend to have higher repair costs, and underwriters know it.

Do not present an operating statement that looks unrealistically lean. An underwriter who sees expenses far below what a building of that age and setup normally costs will substitute their own figures, and the loan will be sized on those.

Putting the expense line together

Before you rely on any coverage figure, build the expense line from these pieces.

• Property tax estimated at your purchase price, plus every special district charge.
• A reserve for the supplemental bill after a purchase.
• A written insurance quote for this building and the coverage the lender requires.
• Owner-paid utilities from the actual bills.
• Repairs, management and vacancy allowances at realistic levels.
• Association dues if the building is part of an association, which is unusual for apartment buildings.

Then run the simple ratio in the calculator and estimate net operating income separately. If both work, the building is ready for a lender.

Frequently asked questions