Apartment and single-family rental investors are laser-focused on rental rates and all of the factors that impact it.
There is good reason for this focus: rental income determined by a property’s rental rates provides operating capital for an investment property and largely determines how profitable that asset will be, as well as how attractive investors can make the property to current and potential tenants. Investors naturally want to maximize rental income to increase returns and their ability to improve upon their investment.
Rent control legislation is a factor that can significantly affect rental income. This is why it is especially important for investors to understand what rent control is, why it is so controversial, the difference between rent control and rent stabilization, and how rent control can impact a rental investment and its returns.
What is rent control?
Rent control is the term applied to statewide legislation that sets a cap on the amount of rent a landlord can mandate for a leased apartment or home in a particular municipality. This cap applies to both new leases and renewals.
In order to qualify for rent control, tenants must live in an apartment building that was constructed before 1947, the apartment they are in must have been occupied by the same family since 1971, the apartment must have been passed down to them from a family member, and the succeeding family member must live in the apartment for at least two consecutive years before they inherited it.
The idea behind rent control is to make housing more affordable for renters in that municipality by preventing rental rates from rising too high—a particular concern in urban markets with low affordability and where market-rate rents have a history of skyrocketing, such as San Francisco and New York.
In early 2019, California passed AB1482, also called the Tenant Protection Act of 2019. The bill was intended to prevent “egregious” rent hikes across the state, where many are struggling to afford housing, housing is scarce, the homeless population is rising, and the poverty rate stands as the second highest in the country.
While the bill aimed to provide renters with many protections against rising rental rates and eviction, its author, Assemblymember David Chiu, shied away from calling it a rent-control bill. Nevertheless, several groups opposed it, including the California Rental Housing Association, which represents landlords. Other groups criticized the bill for not prioritizing the construction of more housing to reduce costs and alleviate the housing shortage.
Rent control is on the California ballot again in 2020 as Proposition 21, which aims to dismantle the Costa-Hawkins Rental Housing Act. Without this act, local governments would be able to control vacancy, enact rent caps and apply local rent-control ordinances to new apartments as well as to a greater number of condos and single-family homes, according to the California Apartment Association.
Why is rent control such a controversial topic?
Proponents of rent control believe the legislation allows more apartment communities and single-family rentals to become within reach for a greater number of people, thereby helping to ease the housing shortage in these markets for lower-income renters and reducing evictions and homelessness; however, there are differing views on whether the legislation actually achieves this goal.
In fact, to date, rent control legislation has only been enacted in a few states and regions throughout the country—New York, New Jersey, Maryland, California, Oregon and Washington, D.C.—and 37 states have passed laws forbidding local municipalities from enacting these programs.
Many groups argue that rent control has the opposite effect than its intention. According to Brookings, while rent control appears to help affordability in the short run for current tenants, in the long run it actually decreases affordability, fuels gentrification (which opponents say leads to higher rental rates and less affordability), and generates negative effects on neighborhoods surrounding rent-controlled properties, including lower property values and dampened interest in investing in those neighborhoods.
What is rent stabilization?
There are several differences between rent control and rent stabilization. While rent control freezes rental rates at a certain level, rent stabilization allows for controlled rental rate increases of a small, pre-established percentage each year, a scenario that is slightly more favorable for investors and property owners than rent control.
More apartments qualify for rent stabilization than for rent control, the criteria for the former being that the building was constructed before 1974, has six or more units, has a rental rate of no more than $2,700 per month, and the renter earns less than $200,000 a year.
Similarly, while rent stabilization is aimed at increasing affordability, housing security, and lease-renewal rights for renters, it can negatively impact investors for the same reasons that rent control does. Additionally, the small rental-rate increases allowed by rent stabilization may not cover repair costs or provide investors with enough incentive to improve their properties.
How can rent control impact an investment and returns?
Most apartment and single-family-rental owners, developers, and managers are opposed to rent control because it hampers their ability to own, build, and manage thriving apartment communities; relieve urban blight; and provide housing that is affordable and attractive to renters.
Many argue that rent control exacerbates the housing shortage rather than alleviating it by creating incentives for some people to hang onto rent-controlled apartments even if they don’t need or occupy them. Rent control may also create inequities in that renters will tend to live in apartments that are bigger or smaller than they need simply because they are rent controlled and affordable.
Another argument against rent control is that it disincentivizes investors from placing capital into rental properties. When there is a ceiling placed on how much income a property can generate, investors are less likely to make timely necessary repairs and renovations that would allow rent-controlled properties to be as appealing to renters as properties without those restrictions. Either the capital isn’t there for those repairs and renovations or the profit margin is so low that investors can’t justify the expense – therefore maintenance gets deferred and improvements get shelved. This can limit return on investment and make owning rental property much less desirable.
On the other hand, those who promote rent control say it helps communities by allowing people who otherwise wouldn’t be able to afford rent in certain markets to live in those markets. There would be less housing insecurity and less worry about losing one’s home because the landlord raised the rent by too much.
Understanding rent control and how it impacts real estate can and should inform buyers’ decisions about these assets. Rent control can profoundly affect an apartment building’s or single-family rental property’s profitability. As such, investors should take rent control into serious consideration before acquiring properties that qualify for this legislative program in order to maximize their return on investment.