The Negative Impacts Of Rent Control For Real Estate Investors

[Kyle Mccaw]

Recent rent control laws in California, New York, and another states reflect challenging times for real estate investors. Efforts to protect low-income residents in fast growing cities have led to the passage of a raft of pro-tenant laws. Rent control, restrictions on background checks, and higher thresholds for eviction make it harder than ever to make money in real estate. Here is how new rent control laws impact real estate investing.

Fewer Units Can Be Rented For Market Rates

One of the notable negative impacts of rent control laws is that a significant numbers of units are not rented at market rates. When rent control laws go into effect, tenants often respond by staying in their units for as long as possible. In many cities, rent control laws mandate that existing tenants cannot have their rent increased by more than 2.5% per year. That means that in some buildings a significant number of tenants are not paying market rates. Depending on the city, some landlords may receive only a fraction of the rental income that would normally be expected.

That makes it difficult to earn a profit renting properties or when properties are eventually sold. I’ve found that in certain jurisdictions, there is little a landlord can do to evict tenants that have been abusing rent control laws. For example, one New York City resident has lived in the same rent-controlled apartment for decades and paid $28 a month. That’s decades of lost rental income that could have been used to make improvements and attract new tenants. Rent control laws effectively “lock” units for years.

Greater Difficulty Recouping The Cost Of Maintenance And Repairs

Maintaining residential real estate properties requires periodic maintenance. Some of that maintenance is routine and necessary to provide an appropriate standard of living. The cost of more significant renovations can in part be passed on to residents and used as leverage to raise rents. Renovations can take the form of furnished common areas, a rooftop deck, or other amenities. Recent rent control laws dramatically impact the financial analysis behind such renovations. In many cases, landlords have found that renovations, or anything beyond basic maintenance, no longer make financial sense.

That has recently been the case in New York City. The Stuytown complex in the East Village is a professionally managed property home to 30,000 residents. In July 2019, Stuytown management prepared a series of renovations and improvements to the grounds. Following New York’s new rent control laws, Stuytown announced that it was halting all planned improvements. The fact that Stuytown management may not be able to rent a significant portion of its 11,000 at market rate makes improvements a serious financial risk.

Lower Valuations For Rental Properties

There are a number of ways to value rental properties. One of the simplest to understand is the Gross Rent Multiplier (GRM) approach. The GRM approach values a rental property in terms of the amount of rent an owner can collect each year. If a seller is asking for $750,000 for the property and the combined annual rent of all units is $150,000, the GRM is 5x. It's important to note that the GRM does not take into account taxes, interest, or any required maintenance. This approach allows for easy comparison of gross rent multiples among different properties.

A large number of rent-controlled units in a particular building will mean that there are fewer units that can be rented for market rates. Over time, the Gross Rent for the building will be lower than it would be if the owner could charge market rates. Let’s say that the building that collected $150,000 in Gross Rent now collects $100,000. In order to offer a competitive valuation compared to the previous scenario, the seller would now offer the same building for $500,000, a 33% price cut. Rent control can significantly hurt property sellers over time and buyers will have less flexibility to develop their new property.

Added Regulatory Hurdles

Rent controls have been passed in major cities amid a wave of pro-tenant legislation. Some cities like Portland have mandated that landlords must reserve units for below market rate rentals. Other cities like Los Angeles have passed laws prohibiting no-fault evictions. These laws have made being a landlord in some of the largest American cities far more difficult. In some cases, cities have specifically targeted landlords who have challenged new legislation.

This follows a larger trend of pro-tenant legislation that penalizes landlords. This is especially true in cities such as San Francisco and New York, where landlords have faced targeted activist campaigns. In some cases, attempts to improve properties have been met with significant backlash. Ultimately, being a landlord and making a profit has become increasingly difficult in certain states. Purchasing property in Texas or other states that are more pro-landlord can reducing the risk of activism that hurts my bottom line.

Major cities have become increasingly unfriendly to landlords and that is unlikely to change in the coming years. Landlords and real estate investors need to navigate new laws that prevent them from charging market rate or evicting tenants. Political uncertainty also makes it more difficult to effectively value rental properties. Fortunately, the challenges of operating in the California or New York real estate market don’t apply nationwide. Consider investing in Dallas Fort Worth. Real estate investors like us deserve the chance to focus on our properties instead of the state house.

[Kyle Mccaw]

@Andrew Postell I mentioned this in our recent meet-up.

[Jose Matuk]

Great info @Kyle Mccaw, thanks! I’m in the DFW area, is there a way to make sure those laws won’t affect us here, or better said, how to know if they’re planning to control it and what to do to avoid it?

[Anthony Rosa]

Those families paying $28 per month will live in that unit for generations. They put phone bills & other address documents in their children name to show residency and it juts keeps getting passed on forever.  Rightfully so, landlords try cracking down on non-residents taking over the unit but the tenant claims harassment and the courts are so tenant friendly its ridiculous! 

[Neal Collins]

@Kyle Mccaw Nice overview. With the type of rental control measures you're talking about where rental rates are locked in, what happens is that tenants locked in at low rates stay longer and the landlord is prevented from increasing rent any, if at all. The decrease in the supply does still play an impact on the greater market in that the rental rates of the remaining supply is artificially increased above what a true market rate would be. 

I don't have any direct experience in these markets, but my assumption would be that properties are still traded at very low cap rates simply because of the potential upside that will come when a unit does eventually turnover.

Oregon was the first state in the country to pass a state-wide rent control ordinance. It's very different from the rent control measures that we often think of al la New York City. It's better described as an anti-gouging rent control. Landlords are still able to increase rent at a certain percentage per year with a formula of 7% plus CPI, which this year that number comes out to be 9.9%.

Gone are the days of a landlord being able to buy a multifamily, kick all the tenants out within 30 days, rehab, and then stabilize without having to induce minor brain damage and pay out of the nose for relocation fees. 

That's why I say if you're going to play in those kinds of markets professionally then either sharpen your sword to get better at your craft or go find a different market.

[Kyle Mccaw]

@Neal Collins @Anthony Rosa thank you for your comments. Yes the government does make it difficult to be a landlord at times. There still places that value landlords. Unfortunately those places are becoming fewer by the day.

[Kyle Mccaw]

@Jose Matuk 
Fortunately, in general DFW is a great market.

Overall local municipalities are easy to work with. Most cities have a rental registration process. But they are reasonable and are there to protect the public.

Only two cities stand out as less desirable landlord markets. 1) Mesquite, TX has made it very clear they do not welcome landlords. I have many stories to go along with that statement. But this is not the place to vent about that. 2)The City of Dallas has made some decisions that have not been in the best interest for landlords. Their registration program may have good intentions but the people in positions of authority are completely incompetent. The City of Dallas DA is completely off his rocker. Ever since he decided to not prosecute crimes under $750 the criminals have basically just been emboldened. Dallas PD is understaffed, underfunded and completely demoralized. This has had a negative impact on the basic enforcement of law and order in the city.

[Theresa Harris]

It depends on the type of rent control.  Capping the max amount of increase per year simply means many landlords will increase the rent every year.  I don't see how you can allow a lease to transfer between generations-all the more reason to have clear wording that all the adults living in the unit must be on the lease.  Vancouver, BC limits how much you can increase the rent for the same tenant, yet rents there (and housing prices) have sky rocketed.

[Mary M.]

I find it interesting when folks toss in the towel so easily.   Making money in real estate in a game for the long view. It is not a get rich quick scheme.  So if the new laws are preventing the instability that happens when an entire community of people are evicted, well then, so be it. 

The issues i have with the laws such as we have in Oregon are that those landlords who were nice and didnt raise rents are the ones that will be hurt the most. Altho, with the ability to raise rents annualy by basically 10% they should be able to get up to market rents in a few years.  

My prediction is that landlords will fare very well as they now have a motivation to raise rents aggresively each year - This along with the doing away with the SF zoning will be a boon for those of us “dumb enough” to keep investing in tenant friendly states ;) 

[Mary M.]

Btw i had to fact check the 28/mo NYC apartment. As usual there is more to the story - a lot more. https://www.cnn.com/2018/05/14...

[Anthony Rosa]

Originally posted by @Kyle Mccaw:

@Neal Collins @Anthony Rosa thank you for your comments. Yes the government does make it difficult to be a landlord at times. There still places that value landlords. Unfortunately those places are becoming fewer by the day.

What i don't get is there nobody that will fight for the homeowner who, for whatever reason, cant pay for the house anymore. Thats it, credit shot, out on the street and you're done for a while. Meanwhile, a landlord tries to raise the rent, even at 1%  to cover fuel costs, and everyone screams and organizes rallies to defend the tenants & call landlords evil.  Lots of these tenants had opportunities to buy their co-op apartment when it was affordable but chose not to.  If they bought them when they were able to they would be wealthy today. and singing a different song.  Look, there is good and bad everywhere but when you have a tenant paying $500 and the exact unit downstairs is renting for 5K there is no reason the landlord should not be able to bump it to $550.  How about the building with amenities that tenants pay for..The lower income tenants in a class A building scream murder because they cant afford the pool and gym fees cost and feel entitled to use the facilities for free..Then, when the building says "Okay, you pay $500/month and use the facilities for free we want you to enter from the door on the side of the building...you could imagine what they once again scream and retain the best attorney."

[Andrew Postell]

@Kyle Mccaw thanks for posting this. Great to hear your perspective on this (and the other comments too).  Thanks!