By Ari Chazanas, Lotus West Properties, AAGLA Board Member
A marked increase in housing rental costs in major American cities has renewed a decades-long debate on the efficacy of rent control legislation as a solution for reducing homelessness. This legislative stop-gap, which is aimed at putting “caps” on maximum rent prices, has grown particularly more attractive in light of the significant rise of homeless rates in cities where the average cost of renting an apartment has exponentially increased in recent years. So when investors hear the words “rent control,” they may immediately shy away from investing in properties that fall under these regulations.
But there are numerous advantages to buying rent-controlled buildings, and once you know the specificities of the state and local rent control laws in the area where you plan to invest, you can gain a better understanding of the limits set on rent prices and the exemptions that might exist under certain circumstances.
Understanding How Rent Control Works
The intent of rent control is to make housing more affordable for lower- and middle-income residents in markets where inventory is at a premium. Although the regulations and statutes governing rent control may vary by state, the basic intent of these laws is to place a cap on the increase of rent for as long as a tenant has rightful occupancy of a unit and, in some instances, these laws could place additional restrictions on rent costs and even severely limit or prevent evictions of tenants from rent-controlled units.
But many see rent control in its current form as an impediment to development and that could sour some investors on viewing these properties as smart investment options. Below-market rental prices are not a component of every rent-controlled situation, and a savvy investor can find many other sources of revenue within a property, along with multiple opportunities for bringing units to fair market value within the prescribed regulations of rent control laws.
The Advantages of Investing In Rent-Controlled Properties
While it’s true that you can be limited in how much rent you can charge tenants in rent-controlled properties, local laws do provide clear and concise regulations that investors may realize work in their favor after all. Don’t be swayed solely by the fact that units are rented below market rate; consider the many benefits that come with investing in rent-controlled properties. Even the most cautious investor might find the silver lining in an otherwise riskier-than-normal investment proposition.
Reduced Purchase Price
In my experience, the cost to acquire a property that falls under rent control regulations is typically lower than properties of similar size and occupancy that meet or exceed market rate. Investors who purchase rent-controlled properties often do so with the intent of owning them for longer periods of time.
Investors who choose to purchase rent-controlled properties do so knowing they can enjoy a significant upside in the future, positioning themselves to enjoy a significant return on investment through increased rental revenue in the future. The reason being that a property can regain its fair market value after all of the current tenants in residence move out of the building. Rent-controlled property investments are ideal for investors who like to purchase a property and maintain that building as part of their investment portfolio for the foreseeable future.
Steady Revenue Earnings
There are two definite advantages to owning a property governed by rent control. The first is a drastically reduced tenant turnover rate. Fewer tenants moving out means a low risk of vacant units. When a tenant enjoys below-market rent costs, he or she is far more reluctant to move out. This reduces the risk of trying to put a vacant unit back on the market.
Landlords don’t want to spend money advertising the vacant unit, screening potential future tenants and dealing with the clean-up and renovations to put the unit back on the market. Low turnover rates mean potentially high upside for property owners. A rent-controlled building all but guarantees little to no turnover from year to year.
If the property has all or nearly all units rented, you could be waiting a very, very long time to return those rental units to current market value. A tenant must move out of the unit before it can be rented at a higher cost. So, it makes the most sense to purchase a rent-controlled property that has a higher number of vacant units. Once all of the current tenants have vacated the premises, the entire building can start to enjoy current fair market rent value.
As for the units that are leased, find out how long the current tenants have lived in those units. If those tenants have been renters for a long period of time, don’t expect them to leave anytime soon. It might benefit you to move on and find another property to purchase as you could be waiting years, perhaps decades, to make improvements and put vacant units back on the market at fair value.
Cap Rate Outlook
This can be tough to determine but analyze the rent-controlled property you plan to purchase by both the current and future cap rates should you have the opportunity to return a vacant unit to the market at the present fair market value. But still keep in mind how long the current tenants might plan to remain in their units. If you expect tenants to vacate their units in the next six to 18 months, purchasing the property at a lower cap rate might result in a smart, lucrative investment. But if they aren’t planning on leaving for the next 10 to 15 years, the investment becomes less lucrative, even at a higher cap rate.
Let Me Leave You With This…
Always do your homework when you consider any substantial financial investment, but this is even more important when investing in rent-controlled properties because the laws are always changing. It can be very easy to lose money because local statutes or regulations governing rent-controlled properties are rewritten or altered with little advance notice.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation. Ari Chazanas is the founder and Chief Executive Officer of Lotus West Properties, a property management and investment firm based in West Los Angeles. He is a member of the Board of Directors of the Apartment Association of Greater Los Angeles. This article was first published Forbes Business Council, and is being republished with permission of the author.