Intentionally Leave Property Vacant Due to Rent Control?

Question

@Mindy Jensen and I were interviewing someone today for an episode of the BiggerPockets Money Show and the guy owns a condo in San Francisco (used to live there, now lives in Nashville, bought the place in SFO in 2009). The property is worth $1.4-$1.6M as a condo. Mortgage balance is about $600K and the rent (pre-covid) was $5,300. The current rent (for 1 of the 3 bedrooms) is $2,400. Mortgage payment is about $4,000.

The owner does not want to rent it out... because of COVID. He feels that the market is soft right now and that if he finds a tenant, he will not be able to raise rents back to the previous level for many, many years because of the rent control. Apparently many other landlords are in similar positions.

Literally, rather than rent the place out (or sell it... some comps are sitting on the market for months and months, AND he feels that the market is likely to bounce back), he believes, and I think he is reasonable in his belief, that it is best for him to simply "bleed" the $2,000 per month cash flow loss covering the spread between current rent and mortgage/HOA + maintenance/CAPEX and wait for clarity to emerge.

What an unintended consequence of rent control! Anyone else find themselves in a similar position? It seems that rent control can in some cases prevent investment in rehabbing/improving properties in good times (because folks can't come in, create vacancy in occupied units, and remodel whole structures), and might contribute to an increase in vacancy in downturns, which is something I had never considered as a possibility until today.

All in all, this property is a massive, massive winner for this fellow, accounting for nearly 50% of his net worth.

But, what would you do in his shoes given his current predicament? And, anyone else experiencing anything like this?

Luka Milicevic · Answer

Economists on both sides of the coin agree that rent control is not the way to go....

Since I can't draw a supply/demand sketch on bigger pockets, I might be able to attempt to explain the general principle behind it.

Rent control is an artificial price ceiling set by regulatory bodies (government).

If it is set above the free market equilibrium, it has no impact on the market. IE: If rent control is set to a max of 10k/month, but the free market won't pay more than 2k/mo, then it has no impact.

It has to be set to below the FME to have any impact.

As a result, it causes a shortage in housing.

Why?

It increases demand for rentals, as more people can afford the artificially low price and subsequently decreases supply as investors don't want to supply rentals at artificially low prices, therefore seek different opportunities elsewhere.

This doesn't sound all too bad, but the BIGGEST issue with the shortage in housing supply.....

There is zero incentive to maintain a property, or let alone make improvements.

If I have a run down property, with a housing shortage it will rent. If my current tenants need something fixed, I have no incentive to fix it as they have no where to go. I have no incentive to make my property look prettier than the investor next door bc neither of us are competing for a higher price....because we can't charge one.

As a Swedish socialist economist once said: "The fastest way to destroy a city is by bombing it, the second fastest way is implementing rent control"

and as a communist Vietnamese economist once put it: "Where the American's failed to destroy the city of Hanoi, rent control succeeded"

All that to say....

If you are still living in California, please reach out to me and I'll help you move to Nashville. (Everyone is doing it...and you should too!!!)

Yonathan Randolph · Answer

The guest is probably wrong about rent control restricting him from raising the rent next year. If you rent out a single-family house or condo as a single rental unit, then it is exempt from San Francisco’s 60%×CPI rent control thanks to California’s Costa-Hawkins law (Civil Code 1954.52 https://leginfo.legislature.ca...). A single-family house or condo owned by a human (not owned by an REIT, corporation, or LLC) is also exempt from  the statewide CPI+5% rent stabilization law (AB 1482 https://leginfo.legislature.ca...), although you have to include a notice in the lease that it is exempt. So it is probably safe to rent out the unit today and keep raising the rent to market rate in the future.

However, although a single-family house or condo in San Francisco does not qualify for “rent control”, all rentals now qualify for “just-cause eviction protection” due to a new ordinance that took effect Jan 2020 (https://sfbos.org/sites/defaul...). Also, you can’t raise the rent substantially over market rent with the intention of eviction by rent increase (https://www.kqed.org/news/1183...). So if you ever intend to move back in to the condo or sell it, then you may not want to rent it out, since you won’t be able to evict the tenant based on your own life events.

Greg M. · Answer

I've seen numerous articles stating that rent is down 20%-25%. If his numbers are correct, rent is down for his unit 55%. That is way out of line. Something doesn't add up.

I expect rents there to bounce back. They might not hit prior levels super fast, but they will go back up. God only knows why, but some people find that s***hole of a city appealing and actually want to live there. I would rent it out, but find a solution to the rent control issue. There has to be a creative way to rent it for a certain amount, while only collecting a lower amount. Something like a lease that says rent is $5,000 a month, but for every month rent is paid on tine there is a $2000 discount that applies, but only for the first year.

Lawrence Leung · Answer

@Scott Trench and @Mindy Jensen You guys bring up a great conservation topic as always, but unfortunately the basis and context for this one is wrong as the scenario you suggest should never happen. Any informed or educated investor in San Francisco would never let a condo sit vacant because a condo (in most cases) is not subject to rent control as @Yonathan Randolph correctly pointed out.

The guidance we have shared with many of our clients during Covid-19 is to be aggressive with the pricing of their condos because of the one two punch of both anemic demand and high inventory in this property type. Expect to take a loss in the near term, but be patient because when the market bounces back to the new "normal" we can raise the rent back to a higher market rate.

JD Martin · Answer

I was actually thinking a less harsh version of the same thing (well, maybe just as harsh since I'm a Jersey guy too). If you're going to claim a year/years long tax deduction from the empty place it better be able and ready to be rented, which would mean for me that I would do just that - list it at the price I wanted so I had something to show the IRS.

As for the rest:

1. I invest (so far) only in my local market and that has done very well for me.

2. We don't have any rent control around here. Unless you count renting out to Section 8, which is something of a voluntary rent control.

3. I would likely sell and/or harvest my gains by refinancing. I suspect he's overestimating the value of the property and would find that out pretty fast if he went to refinance.

Scott Trench · Answer

@Taylor L. I think I'm aligned with you on that at a high level, but the question is how and when to take that equity out.

For example, a 1031 exchange requires him to A) Learn how to invest in real estate in a new market, which to do responsibly is a significant time investment, given the size of the $1M in equity. And B) He will need to transact on a speedy timeframe in the 1031 exchange. Not doing a 1031 will result in a substantial six figure tax bill and force him to redeoploy the cash somewhere else, like equities, etc.

This is the story of the residential real estate market in America today. Most rentals are owned by guys like Mike (the guy we interviewed) - folks who own just one investment and that investment is a big part of their portfolio.

To exit the property, he will need to sell it, and the stakes for that are really high. He has to be comfortable that he CAN sell the property at anywhere close to what he believes it is worth, and that he isn't leaving a lot on the table by seeing if the city bounces back next year. He can afford to pay the $2,000 bill (think of it as the fee for the option he is purchasing) each month quite easily, and can stem the bleeding at any time... just at the possible cost of leaving himself with a less valuable property with a tenant locked in at the lower rate.

Matthew Paul · Answer

If it was his principle residence , there may not be any capitol gains depending on how long ago he moved . If so , i would sell and kiss California good bye .

Brian Garlington · Answer

This has to do with the type of property, in the market he is in. In San Francisco, a lot of condo's are selling for under asking price.....and they are also hard to rent out because people in The City feel "cramped" in a lot of them. Plus, San Francisco is a notoriously ridiculous tenant friendly city. They make neighboring Berkeley and Oakland seem like Alabama when it comes to tenant friendly laws.

If he wants to hold off on renting out his place and let it "bleed" cashflow then that is his choice. He may be able to pull cash out or do a heloc and invest in a cashflow friendly market to help him float the 'bleeding" as well.

Greg M. · Answer

It's not unavailable, it's just available at a price that is above the equilibrium level of the current market. Everyone is free to set a price for their goods. After all, would you work for $5 a hour if offered?

People need to stop pretending that homelessness is caused by high rent. Look up the causes. Around 75% are related to things other than loss of income. Sadly, most of the people who lose their job and become homeless do so because they failed to plan.

And please cut the bull shit about overly strict qualifications. There is nothing overly strict to confirm the person you are turning over an extremely expensive asset to not only has the ability to pay the rent, but also has a track record of being financially responsible and responsible with other people's property.

If you really want qualifying standards to be lessened, then contact your elected officials and let them know to make evictions easier and faster. Let me remove someone from my unit in 3 days and I'd take a chance on pretty much anyone!

Calvin Kwan · Answer

@Yonathan Randolph is correct. The story doesn’t add up. It also sounds like his condo is relatively newer, given the rent he used to command. Property built after a certain date is not subject to rent control either.

Intentionally Leave Property Vacant Due to Rent Control?

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