Rent control is a nation-wide issue. That said, some states like California have passed rules that determine how landlords operate in regards to rent and just as importantly management. January 1, 2020, California passed Assembly Bill 1482, or the “Tenant Protection Act of 2019” – The law, which was designed to prevent “egregious” rent hikes and assist renters who were struggling to pay for housing, caps rent increases statewide and provides “just cause” eviction protections to tenants throughout California. The recent changes in legislation have brought mass attention to rent control laws and have raised questions about the rent controls effectiveness.
However, the reality is that growing demand and limited supply are the root of the problem – not rent control; the government interventions are actually contributing more to the problem, creating challenges related to obtaining building permits, construction, managing buildings, and overall improving the communities. Below we will outline what rent control is, and why it is not a solution to the ongoing problem related to housing demands.
What is Rent Control?
Rent control places a limit on the amount that a landlord can charge for leasing a home or for renewing a lease. These restrictions are a government program, usually enacted by municipalities, and are intended to keep living costs affordable for lower-income residents. Rent control laws can be defined on a federal, state, or level; however, they are more commonly enforced via city ordinances. The restrictions can vary but usually outline rules related to three different aspects: prices paid for rent, evictions, and pass through laws. Although they sound like a great thing for tenants, they can actually be a bad situation for everyone in the long term. Please note, just because a landlord can, doesn’t mean the market will pay for it. In a free market system, supply AND demand are the drivers of price.
Problem #1: Caps on Rent Reduces Capital Invested in Properties
Each municipality will identify a specific rent cap according to their needs. For example, in the recent legislation passed in California, landlords cannot raise rent more than 5 percent, plus the local rate of inflation, in one year; in New York City however, rent control is based on the maximum base rent system in which maximum rent is identified for each unit and landlords are permitted to raise rent every two years up to 7.5% until the maximum is reached.
Although this percentage seems high, the reality is that capping the rent increase negatively impacts a landlord’s ability to maintain and improve their building. Landlords are responsible for the upkeep of the building, taxes, and utility bills, to name a few, and these expenses that landlords incur do not have a cap. Each year plumbers, contractors, and other workers are raising their rates to meet the economy. In fact, in many markets, expense growth can reach 7-8% – Pair this with CPI and landlords can investment doesn’t work long term; especially if no one moves out.
This scenario disincentivizes investments because often landlords cannot raise rents enough to cover the costs of the building. It also results in discouraging development and has historically led to the deterioration of housing stock and the conversion of existing units into condos.
In fact, some cities are even discussing locking rents in place – This would mean that when a tenant moves out, even if the rent is below market, the landlord cannot bring the rates up to market value. This restriction would drastically decrease the number of investors in an area and result in a decline in the quality of the properties.
Problem #2: Caps on Rent Cause More Rent Increases
Many property owners do not follow a strict guideline on when and how much they raise rent; in fact, many landlords do not even raise rents on an annual basis. However, by implementing a cap on rental increase, governments are forcing landlords to change their strategy and continuously raise rents. This is because, generally speaking, landlords can maintain their rents as is and implement an increase when needed to meet their financial shifts – So, if they remodel a unit, they can bring the rents to market, even if they were drastically below prior. With a cap on rent increases, landlords are forced to raise rents annually simply to prepare for the future.
From a real estate perspective, this annual increase is essential to ensure that the landlord remains in an optimal position if they every decide to sell or refinance. In addition, following any vacancy, landlords are forced to rent their units out for maximum value to again be prepared for their future and avoid any financial consequences.
Problem #3: “Just Cause” Eviction Requirements Can Hurt the Community
In a community where there is no rent control in place, landlords have the freedom to re-tenant their properties once a lease had expired. However, the “just cause” section of the bill identifies eviction provisions that limit a landlord’s rights, and create costly hurdles for landlords when evicting a problematic renter.
Within this clause, landlords are restricted to evicting a tenant only if they have broken one of the rules defined by the city, or governing agency, as justifiable eviction. In many incidences, this list does not cover scenarios in which you would expect; for example, if a tenant vandalizes a unit or is a nuisance causing noise throughout the night, the tenant may be protected by “just cause.” The only common reason for eviction is non-payment of rent, which also presents many more challenges in itself. The result of this can be detrimental to the landlord’s property, as well as to the community in which they are trying to establish. It promotes opportunities for bad tenants and removes the ability for a landlord to manage the tenants at their property.
Additionally, “just cause” creates limitations on the development of a property. If an apartment owner is looking to remodel or redevelop the entire property, but they have a tenant that refuses to leave, then they are faced with a property they can not improve.
Problem #4: Rent Increase Pass Throughs Are Not Often Granted
When a landlord incurs additional expenses on their property, they can pass through rent which means that specified operating expenses “pass through” from the landlord to the tenant. This clause is to promote landlords to spend capital on improvements; the additional costs would then be passed to the tenants. The common example of this scenario (until recently) was in the San Francisco housing market where landlords were drastically increasing rent through the pass-through clause. However, this clause is constantly being battled by residents, stating that they are not being granted the rights that rent control offers them. As a result, cities and governments are revising their laws related to pass through, removing the ability for a landlord to pass through the cost of improvements of a building. This, combined with capped rental increases, is causing investors to move away from specific markets and is causing landlords to stop the improvement and maintenance of their properties.
Confronting the Real Issues
The real issue of the debate of rising rents lies in an understanding of the supply and demand problem. For example, in California, the population has continued to rise and housing supply has not been able to keep up. As a result, landlords are increasing their rental units to get the maximum return on their units, while working to maintain 100% occupancy. They are not against affordable housing, but need to manage their building to ensure that they are well positioned for the decisions they make in the future. In order to confront the problem of affordable housing, governments need to focus on increasing supply rather than limiting property owners’ opportunities.
