CHICAGO–Here are two truths about the recent movement of states toward rent control: Yes, it’s a trend, and no, it’s not the end of the world as we know it.
So says John Sebree, senior vice president and national director of Marcus & Millichap’s National Multi Housing Group, in the wake of California’s new rent control regulations. He senses a trend in that, “Prior to 2019, rent control in the United States was only on a municipal basis, and only a few cities–Manhattan; Washington, DC; and a handful of municipalities around Los Angeles and San Francisco, CA–had it.”
But virtually overnight, what was once a municipal issue became a state consideration when Oregon passed its own rent regs late last year, with California and New York following suit this year. “And now several of the presidential candidates are floating the idea of national rent control.” (Sebree explains that California’s new regs, while going into effect next year, are retroactive to March of 2019.)
Marcus & Millichap has released a research paper and hosted a webcast (now available on demand) on the subject, and together with insights from Sebree himself, the market can begin to make sense of the new dynamics of investing in multifamily real estate. The upshot of both is that rent control creates a tale of two markets, one for workforce housing and one for investors, and it’s clearly the potential renters who stand to lose the most.
“We’re dealing with a housing crisis in this country,” Sebree tells GlobeSt.com, “especially for working-class families. Over the past few years, household growth has increased demand at a much greater rate than the supply of total new units brought online–both single and multifamily. So demand exceeds supply. The problem is that rent control doesn’t increase the supply or spur new development. In fact, most economists state new construction will be stymied by the existence of rent control.”
Caps on rents, he explains, limit the values that can justify new construction, making it harder to pencil out. Plus, despite California’s stipulation that rents revert to market rate once the resident relocates, rent control diminishes a tenant’s incentive to do so. “When the kids grow and move out, the family would traditionally downsize,” argues Sebree. “But if their rent is low, why would they want to?” And that’s a decision that impacts the next generation of workforce residents.
There are solutions to the issue, the Marcus executive notes, but those take a coming together of dissonant voices: Owners and municipality decision-makers.
“We need to increase the supply of rental units for middle-income families,” he says. “The National Multifamily Housing Council completed a study in 2018 that revealed 35 percent of the costs of building an apartment building are soft costs–expenses such as application, zoning and environmental fees you have to pay even before you buy your first building materials. In this sort of environment, the only projects that make sense exist in the higher tranches–Class A projects.”
Dialog needs to take place, he says, with compromise on both sides. If a municipality can adjust fees and guidelines on density, the developer can more easily include a percentage of workforce housing units in the development, says Sebree. “Right now, you’ve got one side of the equation with a hardline stance on rent control,” he says. “Our position is that rent control not only fails to solve that issue, but it will make the problem worse.”
So what, then, is Sebree’s advice for investors of multifamily in general? “Any time new regulations are implemented, no matter the industry,” he says, “the first response is that the world has come to an end. But it hasn’t. Owners simply need to understand how to operate within those new regulations. Investors have been buying and selling multifamily properties in rent-control markets for many years. Some of the rules have changed, but the fundamentals remain very strong.”
One small part of that is the understanding that rent control doesn’t mean rent freezes. Sebree explains that rent increases in most markets are tied to the consumer price index, plus an established percentage increase so that rental increases will continue.
“The metrics might change,” he continues, “but the industry will continue to do very well. Right now, this is all very new, and no one can say for certain that this or that will be the state of the market next year. We all have to educate ourselves and understand how new rent controls will affect values. The rules have changed a little, but the opportunity for sound investment returns still exist.”