Rent Control Is Coming To A City Near You — What That Means For REIT And Real Estate Investors

The average residential rent in America jumped 18% from February 2017 to February 2022, according to a recent study by Pew Research Center. 

The same study found that nearly half of American renters spend one-third of their income on rent, with 23% paying more than half of their income on rent. 

With numbers like that, it can’t come as a surprise that both tenants’ rights groups and government agencies are taking aggressive steps to relieve America’s housing affordability crisis. One of the proposed measures is the introduction, or in some cases a dramatic tightening, of rent-control laws. Benzinga looks at these laws, new proposals up for consideration and what that could mean to real estate investors. 

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What Is Rent Control?

Rent control is a loose term given to laws that regulate how much property owners can rent residential apartments for in a given area. In most cities where rent control exists, the restrictions on how much landlords can ask for rent only apply to occupied units. 

Most rent-control laws were approved in major cities such as New York or Los Angeles in the 1970s when apartment rents began rising faster than tenant incomes. A government agency — usually the housing authority — determines the maximum annual rent increase by tying the increase to an economic indicator such as the consumer price index.

For example, if you are the landlord of a rent-controlled building and you have a tenant who started off paying $1,000 per month, the housing authority might limit you to a maximum annual rent increase of 4%, no matter what the market rate for that apartment is.

By contrast, if you had a vacant unit next door to the one your old tenant was renting for $1,000, and similar units were going for $2,500 across the city, you can only get the market rent on the vacant unit. This is why many laws also restrict the reasons for which a landlord may serve notice to terminate the lease of an existing resident. Governments don’t want landlords circumventing the spirit of rent control by selectively terminating month-to-month leases on tenants paying below-market rents. 

Locations where rent control laws exist include:

• New York City (and 18 other cities in New York state)
• Los Angeles
• San Francisco
• Washington, D.C.
• New Jersey (99 municipalities have rent control laws)

The irony here is that many of those cities have some of the highest residential rents per square foot in the country for renters. This begs the question “Do rent control laws work at all?”

Do Rent-Control Laws Work?

If you asked real estate investment trust (REIT) investors and rental property owners what they think about rent control, you would likely get a lot of negative responses. It’s no secret that an overwhelming majority of them view rent control as an unnatural restraint on their ability to profit from their investments. If you look at rent control in a vacuum, they might have a point. 

While rent control puts caps on their revenue, such restrictions don’t exist on their expenses, such as repairs, property taxes or insurance. The landlord of a four-unit building with all rent-controlled tenants who have been there for decades may not be making enough money to keep up with expenses. The plumber and electrician don’t have to charge rates from 20 years ago just because the building is rent controlled.

From the perspective of many modern tenants, living in a rent-controlled building is the only way they can afford to live in a major American city. This is especially true for retirees and tenants living on fixed incomes. Millions of renters across America are aware that if they move out of their apartments today and tried to re-rent them tomorrow, the asking price would be several times what their previous rent was. 

Rent-control laws have kept many tenants with a roof over their heads. But if you look at the average monthly rents in cities with rent control, you’ll realize the practice doesn’t guarantee housing affordability. 

How Have Landlords Responded To Rent Control?

It’s true that some landlords recruit neighborhood tough guys to intimidate rent-controlled tenants into moving or shut off the heat or hot water in winter, these are extreme examples. Most landlords begrudgingly cooperate with rent-control laws to the best of their ability. 

REITs and institutional landlords have responded to rent control in a variety of ways. First, they try to avoid cities with rent-control laws when targeting investment opportunities. This is the easiest, most straightforward way for landlords to be unencumbered by rent control. That is a big part of why so many REITs and institutional landlords have invested heavily in Sun Belt cities or the outlying suburbs of larger cities.

For example, Los Angeles has rent control, but surrounding areas such as the Inland Empire and Orange County do not. For this reason, Riverside, Orange and San Bernardino counties have seen a lot of multifamily development.

But it’s not practical for landlords and REITs to avoid the nation’s hottest urban rental markets. Most rent-control ordinances have a cutoff date — they only apply to apartment units in buildings constructed before a certain date. In Los Angeles, it’s Oct. 31, 1978 — any apartment building or condo built after that date does not have rent-control restrictions.

When REITs invest in Los Angeles, they either build new projects or invest in properties built after 1979. That’s resulted in rents climbing higher for two reasons. No. 1 is that there is little new construction in the affordable housing sector because it doesn’t make money. No. 2 is that landlords of rent-controlled buildings are incentivized to raise rent as high as possible when their rent-controlled units become vacant.

National Rent-Control Laws Proposed

With housing affordability being such a hot-button issue, it’s no surprise that rent-control laws are being proposed. The difference now is that while most original rent-control laws were local, rent control and tenants’ rights ordinances now are being proposed at the state and national levels.

President Joe Biden recently rolled out a renters’ bill of rights. The broad strokes of the proposal include:

• Specific direction to the Federal Housing Finance Agency (FHFA) to examine the feasibility of nationwide rent control and/or limits on rent increases on multifamily residential properties
• Empowering the Federal Trade Commission (FTC) and Consumer Financial Protection Bureau (CFPB) to investigate unfair tactics landlords use to deny rental applications or move tenants out of units strictly for the purposes of increasing rents
• Giving tenants the right to organize

What The Federal Proposals Mean For REIT Investors

For REIT investors, the worst-case scenario of these laws is that profits will be reduced. Rental rates for commercial properties are an important part of the property’s overall value. Whenever a potential cap on rent increases occurs, you are looking at a cap on the long-term appreciation of your asset(s), which means you’ll make less money.

Biden’s proposal threatens profitability for REIT investors. Because REITs’ preferred tactics to avoid rent control are new construction or acquiring buildings not included in local rent control ordinances, national regulation on rent increases will make those strategies obsolete.

It’s likely that REITs and landlords will marshal a strong lobbying and legal response to any nationally proposed rent-control regulations. At a minimum, they will fight it in federal court on the grounds that such regulations restrict free trade, and there is no shortage of federal judges who would agree with them. But those same judges may also be inclined to allow state-level regulations to exist.

Giving tenants the right to organize also may be more difficult for REITS and landlords to deal with. Almost all rent-control laws were born out of tenants organizing at the local level. If tenants have a right to organize in every city, it’s likely they will propose similar rules and have success doing it.

City and state politicians are usually more attuned — and attentive — to the wishes of their constituents than senators and congressional representatives. If tenants have the right to organize nationwide, it’s likely they will devise more restrictive versions of rent control or tenant protections. They also will have the votes to elect local officials who will enact the restrictions they propose.

A Preview Of New Rules In Los Angeles

Los Angeles is one of the most expensive real estate markets in the country. Despite having strong rent-control laws, Los Angeles is one of the most expensive real estate markets in the country. The problem isn’t just landlords — the average home in the L.A. area costs about $1 million.

This leaves many tenants perpetually trapped on a hamster wheel that they can’t afford to buy, but the rent goes up faster than their wages. As a result, tenants in Los Angeles have proposed an even further tightening of the city’s existing rent control. In late January, the City Council unanimously passed a new renter’s protection bill, which includes:

• Landlords who increase rents by more than 10% (or 5% plus the inflation rate) would be required to offer tenants financial relocation assistance if they can’t afford the new rents. According to some estimates, this relocation assistance could be around $1,411 per tenant.
• Prohibiting landlords from evicting tenants for delinquent amounts that do not exceed one month’s rent. If tenants pay half a month’s rent, they can’t be evicted unless the following month if they fail to pay the full amount owed.
• Extending the time tenants have to cure lease violations, such as having a pet or unauthorized resident. Currently, a landlord can initiate an eviction on a noncompliant tenant by serving a three-day notice to cure the breach or face eviction. The new law will extend that period to 30 days.

The new restrictions will apply to all multifamily properties in Los Angeles — not just the ones covered by the city’s original rent-control laws. Gov. Gavin Newsome signed a rent-control bill regulating rent increases throughout the state, with Los Angeles capped at an annual 8.3% increase and San Francisco capped at 9%.

California’s statewide rent-control laws are set to expire 10 years from when they went into effect in late 2019. But it’s difficult to imagine the political will (or the votes) existing to scrap these laws if the housing affordability crisis hasn’t eased by then. It might be tempting to look at California’s legislation and think, “That will never get enough support to pass in state X.”

But every state has more tenants than landlords, and telling voters you’re going to help lower their rents is a strong platform for any politician to run on. As more people leave New York City, L.A. and other large cities to move to more affordable states, the population surge in those locations will drive rents upward in those markets, and it won’t be long before tenants begin demanding relief.

Oregon, which used to be a preferred destination for people leaving California, recently approved a 7% statewide rent cap. If you’re a REIT or even a small real estate investor looking at a duplex or fourplex, rent control could be coming to a city near you.

Multifamily Residential Real Estate Is Still A Solid Investment Sector

All this talk of national rent control or landlords paying relocation assistance may sound ominous for landlords and real estate investors, but the reality is they are a victim of their own success. Property values and rents have grown faster than most renters’ incomes for a while, and when that happens, voters will demand regulations and rent restrictions.

It’s unlikely that rents will significantly retreat from their current levels. Although most landlords would protest the idea of an annual cap on rent increases, most of them would turn cartwheels if they could maintain occupancy and get annual rent increases of 7% to 9%. Even though rent-control laws may be sweeping the country, REITs and residential real estate are still great ways to build wealth.

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