The Ridgeview Report
Rent control arrived in Minnesota in 2021 when St. Paul passed the Rent Stabilization Ordinance. The impact on new property development was striking, resulting in a 50% decrease in permits for new construction. The truth is though, most operators of existing multifamily assets in St. Paul haven’t felt the effects yet. Rent growth has remained subdued, staying well below the annual limits. Only the owners of older, poorly maintained properties are the ones feeling the effects. Gone are the hoards of buyers looking to acquire and renovate derelict buildings. For the rest of the owners, operating apartments in St. Paul looks very similar to the pre-rent control period. The implication of rent control is it takes a decade or two for the knock-on effects to really take place.
Ridgeview Property Group has elected to avoid rent control markets, including St. Paul. We don’t believe it's in the best interest of our investors. But what’s in the playbook for operating apartments when rent control has been long established? This week’s newsletter takes lessons from Los Angeles to find out.
Los Angeles City Council enacted rent control laws that would end up surviving through today. Multiple economic booms during those decades have led to a massive delta between market rents and rent-controlled rents. Here’s how a seasoned operator will maximize their property’s performance when their property is subject to rent control.
Assume every tenant will stay long-term
Over enough time, the rent for tenants living in properties with rent control will fall behind the prevailing market rates. This serves as a strong incentive for tenants to stay in their apartments long-term. In Los Angeles, it's not unusual to find tenants who have stayed in the same apartment for decades.
Approving an application is a long-term commitment, which is why property managers exercise greater scrutiny when evaluating criminal l histories and checking landlord references. It is better to keep an apartment vacant than to risk contending with a problematic tenant for a decade or longer.
Maximize the allowable rent increase each year
Choosing to forgo rent hikes for only a year or two can result in decreased rental income for multiple years if not decades. There is no ability to catch up if an owner fails to increase rent for any period of time.
The expenses related to roof and boiler replacements as well as annual property taxes are not decreasing any time soon. Owners must ensure that their operating costs do not outpace the growth in rental income.
It is better to wait it out, than to reduce rent
When a rental market experiences a downturn, apartment owners may be better off sitting on vacant apartments versus lowering the rent. Once rent has been reduced, that lower rent is the new standard. Case-in-point, Los Angeles owners who chose to reduce their rents during the Savings and Loan Crisis in the 90s often have notably reduced rental income today, three decades later.
During off-peak seasons when rental demand is weaker, it’s not worthwhile to drop the rent to fill a vacancy. Instead, operators opt to keep their properties vacant until they can secure the highest possible rent.
Renovate less often
Operators rarely enhance occupied apartments because the expenses for these improvements won't be offset by higher rental income.
Vacancies are gold. When a unit becomes available, it's wise to upgrade it with Class A finishes, aiming to optimize both rental income and the quality of potential tenants. Last week’s newsletter covered why we always renovate. You can read the full article here.
Exempt properties historically experience strong rent growth
Buildings less than 15 years old are generally exempt from rent control. Rent-controlled apartments rarely become available for lease. When rental demand increases, all prospective renters find themselves competing for rent control-exempt apartments. This heightened competition results in fast-growing rents within exempt buildings.
Rent control automatically applies once an apartment building hits 15 years old. At that point, the building’s value diminishes greatly.
Conclusion
Rent control laws require multifamily operators to run a different playbook than is typical. The leasing strategy must take into account the likelihood of tenants residing for a decade or longer. Raising rent each year is no longer optional, it’s mandatory. During periods of softened rental demand, property managers need to be strategic when faced with the need to reduce rents. Holding the apartment vacant until the market strengthens may be the smarter long-term choice. Investing in updates for occupied units is often impractical as the expense won’t be offset by increased rent. Finally, in times of increased demand, rent-controlled units are hard to come across, causing exempt properties to experience dynamic rent growth.
Ridgeview Property Group’s viewpoint is that operating in rent-controlled markets is not in the best interest of our investors. We want to buy where the population is increasing, incomes are rising, and consequently, the real estate accrues massive value. Over the long term, rent control diminishes the ability of the real estate to accrue that value. There are too many growing markets available to invest in that won’t require the headaches and limited upside of rent control.
Market News
Jersey City Rent Control Controversy
The Jersey City Rent Leveling Board has unanimously ruled that two buildings, 155 Washington Street and 100 Warren Street, owned by Equity Residential, are subject to rent control. This decision comes after tenants at Portside Towers, a 527-unit complex, complained about steep rent increases of up to 40 percent, which were attributed to an algorithm. It was revealed that the ownership failed to file for an exemption from rent control on time, making both buildings retroactively subject to rent control under a 1987 state law. Tenants are now seeking rent rollbacks to 2016 levels and damages for overpaying rent from 1998 to 2016, amounting to a significant liability for Equity. The ruling has been praised by city officials and tenant advocates, but landlords are expressing concern over the potential precedent this case may set for similar disputes in Jersey City and New Jersey as a whole.
Source: TheRealDeal. Tenants at Equity Residential building secure rent control. https://therealdeal.com/new-york/tristate/2023/10/23/tenants-at-equity-residential-building-secure-rent-control/
Tips and Tricks
Tips:
Rent Control- Rent control is a set of regulations or policies imposed by local governments to limit the amount landlords can increase rental rates on residential properties. These regulations typically place restrictions on how much and how frequently rents can be raised. Rent control aims to provide affordable housing options for tenants and protect them from steep rent increases, but it can also have various economic and social impacts, both positive and negative, depending on the specific policies and local housing market conditions.