Over the past few years, residential rent regulations have been a topic of considerable interest nationally. In 2019, California implemented a statewide rent control law. That same year, New York’s state legislature also passed a wide-ranging new set of rent regulations.
It’s not just the largest cities and states that are pursuing rent regulation. Just a few months before New York and California, Oregon passed the first statewide rent control law in the nation. Other cities and states are looking at their own rent control ordinances.
We invest in Los Angeles County, which is one of the most heavily regulated rental markets in the United States. Multiple cities in the county have their own rent regulation ordinances, along with a state law that applies to most multifamily properties.
Potential partners, as well as fellow investors in other states, are often curious about how this all works. Specifically, people want to know whether the region’s many rent laws make Los Angeles an undesirable place to invest.
The answer is no. In fact, investing in rent regulated markets can be quite lucrative. Here’s why.
Rent Regulations Create Complexity & Thus Opportunity
Rent regulation laws are complicated. In Los Angeles County, different laws can apply to apartment buildings which are just a few blocks apart. Due to the COVID-19 pandemic, additional restrictions were put in place.
If you’re a landlord, it’s not easy to navigate these issues. You have to stay on top of changing, complex rent regulations. You must think creatively about how to generate more income from a property. This requires time, energy, and a tolerance for uncertainty.
This also costs money. You can’t operate in such a regulated environment without help from a skilled attorney.
That’s not all. If you’re going to complete voluntary tenant buyouts (i.e. offering compensation for tenants who pay reduced rents to move out), then you must budget for that. These expenses add up.
If this sounds challenging, that’s because it is. You have to build a range of skill sets, from understanding laws to negotiating to budgeting.
Now let’s take a look at an easier scenario. When leases end, you set new rents, at whatever rates the market will absorb.
Let’s say a tenant is paying $700 per month, but renovated apartments in the neighborhood rent for $1300. You simply wait until the tenant’s lease is nearly over, and you offer the tenant the opportunity to renew at an increased rate. If the tenant declines, they can move out. You renovate the unit (if needed) and rent it out at a higher rate. There’s no question of rent regulations, paying tenants to move, and so on.
In most of the United States, this is how it works. While rent control is expanding, it is still non-existent in much of the nation.
If you’re an investor, isn’t it easier to operate in a less regulated environment? As active investors in LA, we know many local folks who focus on properties out of state. As they see it, the less complexity, the better. The prices and rent regulations in Los Angeles scare many off.
Now, imagine you’re someone who’s willing to master these rules. You can take advantage of opportunities which scare the competition. When the rent regulated property with under market rents is listed, you know what to do. There simply aren’t too many other investors like you.
Business is all about finding your unique advantage. Mastering strategies around rent regulation could be one of yours. You can succesfully invest in properties which others cannot touch.
Rent Regulations Limit Housing Supply
Rent regulations can also place downward pressure on the housing supply. In other words, more rent regulations result in the availability of fewer housing units. There are a few ways in which this happens.
First, tenants in rent regulated units, who are paying low rents, are less likely to move out on their own. After all, where else locally will they find such low rents? As a result, units turn over less often. This reduces the vacancy rate, which benefits landlords. However, it reduces how many units are available for potential new tenants.
Second, property owners with low rents might choose to simply exit the rental housing business. Under California’s Ellis Act, if a landlord wishes to exit the rental business (and perhaps convert their property into condominiums or a hotel), they can do so (assuming they pay relocation fees to the tenants). The Ellis Act has a detailed set of procedures which property owners must follow when converting the use of a property.
Apartment to condominium / townhome conversions have become more popular in recent years. In some cases, property owners sell to developers, who then carry out the Ellis Act conversions.
Something worth clarifying: We’re not saying this is a good situation. We believe that Los Angeles would be far better off with more housing. This would improve the quality of life, and facilitate economic growth. However, from an investing perspective, the lack of supply benefits property owners.
Rent-Regulated Properties Can Fare Better In An Economic Downturn
During good times, rent control can feel like an impediment. After all, you’re trying to realize maximal income from your property. The law stands as an obstacle.
During the years following the 2008 financial crisis, rents in Los Angeles rose quickly. Suppose rent regulations only allowed you to raise rents by 3% per year. Yet, market rents grew by a larger amount. This means that on under-market rental units, you fell further behind market rates.
Properties with multiple units below market rents tend to sell and refinance for less. This means that your overall return on investment is reduced. Of course, you could buy out tenants and renovate units. The thing is, this isn’t cheap.
Yet, during economic downturns, rent regulations can benefit you. Let’s consider the COVID-19 pandemic.
In many Los Angeles neighborhoods, tenants moved out. Rents dropped precipitously. If you owned market-rate housing in such neighborhoods, you might have been in some financial distress. Certainly, your cash flow fell.
Owners of under-market, rent-regulated housing were often less impacted. Most rent-regulated tenants knew that they were not likely to find a better deal. If possible, they stayed in their current location. Some tenants did lose their jobs, and fell behind on rent. Yet, the majority continued to pay.
This means that in an economic downturn, where rents drop, rent-regulated units can protect you economically. Real estate investing isn’t just about capturing the upside. It also requires meaningfully hedging against downside risks.
The Final Word
Rent regulations create serious complexity for you as a property owner. You have to master complicated regulations. If you want to vacate rent-regulated units, you’ll often need to spend substantial amounts on tenant buyouts, as well as attorney’s fees.
Yet, there are also some advantages. Rent regulations are inherently challenging to work through, which means that at least some of your competitors won’t be able to. Rent regulations also typically boost overall market rents in an area, and act as a hedge during an economic downturn.
We intend to continue investing in rent-controlled properties in the years to come. For those who have learned this space, it is quite a lucrative niche.