Is Prop 10 California’s Black Swan Event?

Prop 10 is being described as the biggest threat to the multifamily investment market. The proposition is on the California State ballot in November, and would repeal Costa Hawkins and potentially expand rent control. The proposition is a community response to the rapid increase in rental rates throughout California, but it has multifamily investors and owners severely concerned. In a recent investor sentiment survey from Real Capital Markets, which was overwhelmingly positive, the proposition was among the greatest concerns for investors.

“Prop 10 is probably the greatest threat to multifamily investments, because by giving municipalities the ability to control rental rates, it severely restricts the potential for the high levels of NOI that multifamily investors covet,” Steve Shanahan, executive managing director at Real Capital Markets. “Some investors that were interviewed are more concerned about the passage of Prop 10 than they are about further interest rate hikes.”

Prop 10 isn’t the only concern on investors’ minds. Interest rates are rising inevitably, and it could cause a decrease in investment activity. “Depending on the situation, further interest rate hikes might cause investors to rethink their strategies and approaches to acquisitions,” says Shanahan. “That’s not to say they will forgo their multifamily investing in California; it simply means that they’ll need strategies on how to overcome the increase in debt service payments or be willing to accept a lower yield on their investment.”

Multifamily investors are especially concerned if interest rates rise above rental rates. Many investors have been able to purchase homes without relying on rising rental rates—even though rates have increased significantly—but that would change as interest rates rise. “Many believe that if interest rate increases remain below increases in rental rates the impact will be negligible,” explains Shanahan. “If the reverse is true, it could be “problematic” as one source told us.”

However, many investors are not concerned about rising interest rates, especially considering that they are still at historical lows. The current interest rate environment has supported more value-add investment activity. “Some believe that the current interest rate environment may be more beneficial to those seeking value-add investments,” adds Shanahan. “The idea is that owners would have more flexibility in the capital they invest in upgrades, as it relates to how much they can raise rents.” While Prop 10 and rising interest rates are concerns for investors, the positive outlook from Real Capital Markets investor sentiment report shows that investors plan to remain active despite these challenges.