Rear-View Mirror Ramifications of Rent Control

SAN FRANCISCO—Last year, California joined Maryland, New Jersey, Oregon and New York as the only states with some form of rent control. While the rent control law protects roughly 8 million residents who live in rental homes and apartments from tenants from being evicted without cause, there are issues that resulted from this legislation.

In this exclusive, David Harrington, executive vice president and national director of multifamily for Matthews Real Estate Investment Services, offered insights on how the rent control law affects the value of properties that were previously not subject to any rent control law and what owners can do to maximize value in their properties.

GlobeSt.com: How does the rent control law affect the value of properties that were previously not subject to any rent control law?

Harrington: If an owner has maintained rents at a market rate, the property will maintain current value.  However, many owners have allowed rents to remain at lower levels and have not kept rents up with the market. We routinely see assets that were previously not subject to rent control have current rent levels that are 25% to 50% below market rates. In some cases, we see rents more than 50% below market. Before rent control, a new investor would have a much shorter horizon to capture the rent upside potential and thus were much more willing to pay a seller for part of that upside today in the purchase price. Given the new rent control laws, the timeline in which to move rents to market levels has stretched considerably in situations where the current owner has allowed rents to remain low. Therefore, an investor is forced to build in additional capital costs to generate unit turnover and delay rent increase projections, both of which will have a negative impact on the value of the asset.

GlobeSt.com: What can owners do moving forward to maximize value in their properties?

Harrington: An owner needs to implement a business plan to focus on those tenants who are currently below market rents. For many long-term owners, their long-term tenants are typically far below market rents. In order to maximize value in a rent-control environment, it is critical to implement vigilant management of a property. This means lawfully evicting tenants when rent is not paid on time or if there are blatant violations of the lease terms. Long-term owners have often given lower paying units a break on the date rent is paid or other lease violations. This tolerant approach has typically been enacted in order to keep unit turnover to a minimum, which is exactly what has led to tenants with rents significantly below today’s market rates. Additionally, an owner must consistently increase rents by the maximum allowable increase on an annual basis. Finally, as units turn, owners should take the necessary steps to upgrade unit interiors that will allow them to capture a top of the market rent.

GlobeSt.com: Are you seeing owners move their capital out of California and if so, what are some of the most popular alternatives for real estate investments?

Harrington: Absolutely. We are seeing apartment owners relocate capital to less regulated states as well as other investment product types. Investors are inclined to move their money to urban markets with growing populations that are less likely to have rent controls in the near future. Phoenix and Las Vegas have been popular destinations lately and rightfully so, as these two metros have seen the highest rent growth in the country over the last 12 months. Additionally, markets such as Dallas and Atlanta are receiving continued interest due to the population growth and strong employment fundamentals over a sustained period of time. We are also seeing investors exchange into single tenant net-leased properties which offer owners less hands-on management and are not subject to the same state regulations.

GlobeSt.com: Does rent control cause more harm than good to the renters these laws are drafted to protect?

Harrington: Ultimately yes, because we frequently hear from landlords who were not regularly raising rents that they will now be increasing rents every year and for the maximum allowable amount. We also have heard that owners have less incentive to consider upgrades to their assets now that rents are restricted, and they have a reduced ability to recoup the costs of capital improvements.