Over the past few years, several major metropolitan areas, including Portland, Oregon, and St. Paul, Minnesota, have introduced rent control policies. Some states have also enacted rent control regulations. The Biden administration has also proposed a nationwide cap on annual rental rate increases.
Rent control legislation limits the amount landlords can charge for rent on their properties. Some rules include strict guidelines on the amount of rent landlords can charge, while other policies limit rental rate increases to changes in inflation. Controlled rents aim to keep rental rates affordable for low- and middle-income households. While that may be admirable, it doesn’t always work out well for either tenants or real estate investors.
In this article, we’ll examine rent control policies on real estate investing and explore ways to adapt.
Understanding Rent Control Policies
Rent control first gained steam during World War II. New York City was the first to introduce it when waves of new immigrants flocked to the area seeking a fresh start. It began with rental caps, which restricted landlords from raising rents past government-mandated amounts.
Later versions of rent control expanded to Boston, Los Angeles, Seattle, and San Francisco. Those policies allowed landlords to increase rents to cover increases in insurance, taxes, and other pass-through costs. Some rent control legislation enables rental property owners to reset rates at market prices once a tenant decides to move out. Other rules place strict restrictions concerning lease renewals, making it harder for landlords to discontinue a lease without meeting specific requirements.
Existing legislation aims to cap rental rates to inflation. For instance, in 2019, Oregon enacted a statewide law limiting rental rate increases to 7% annually plus inflation, or 10%, whichever is lower. Santa Ana, in Orange County, Florida, passed a similar law limiting rental rate increases to the area’s inflation rate. These new attempts at rent control encompass more properties and enhanced tenant protections for real estate investors to navigate.
Pros and Cons of Rent Control Policies
While the premise of a rent control policy may sound promising to tenants seeking affordable housing, it’s not all sunny skies and rainbows. There are definite benefits and drawbacks to rental caps.
Pros
A rent control policy may offer a few advantages for investors and tenants:
- Improved Tenant Stability: Living in a rent-controlled property may encourage tenants to renew their lease and stay in properties for longer since moving may lead to increased monthly rental rates.
- Greater Market Stability: Owning a rent-controlled property allows you to better predict future rental income flows. Since there are fewer market extremes, forecasting cash flows is easier.
- Positive Community Impact: Rent-controlled neighborhoods are more likely to have long-term tenants, allowing neighbors to get to know one another and creating more community cohesion.
Cons
The drawbacks of rent control legislation include:
- Lower Investment Returns: Property owners seeking profitable returns may find it harder to earn their desired ROI. That makes future investments in the rent-controlled area less desirable.
- Decreased Property Values: Rent-controlled properties are less likely to attract other investors because they know they won’t be able to command higher rental rates. This leads to depressed property sale prices.
- Fewer Upgrades and Limited Maintenance: Investors earning reduced profits on their properties may have less incentive to upgrade the rental or provide ongoing maintenance, resulting in property deterioration.
- Market Distortion: Rent control policies may discourage property developers from building new units in the area, as they may have trouble recovering their investments. This can lead to a limited supply of available units.
Current Implementation of Rent Control Policies
Over the past five years, several major cities and states have expanded or enacted rent control legislation.
Where It’s Happening
The Biden administration’s newest proposal for nationwide caps on rental rate increases would affect rental property owners with over 50 units. If it becomes law, landlords will have a choice: limit annual rent increases to 5% or forego federal tax breaks on property depreciation. It would initially be in place for two years, allowing developers to build new housing units to alleviate housing supply issues. However, the proposal isn’t expected to move forward until after the elections, so there’s no telling whether it will pass.
The new proposal has sparked a nationwide conversation between economists, lawmakers, developers, investors, and the public. Economists are largely against the idea, for fear that caps will limit profits, lead to fewer new builds, and may expand to cover more properties. Some also worry that developers may stop investing in rental properties and instead look at other opportunities.
Over the past five years, various cities and states passed rental cap legislation, including New York City, Los Angeles, California, and Oregon. California’s state-wide rental cap limits rental rate increases to 5% plus the change in annual cost of living, or 10%, whichever is lower. Oregon has a similar law, limiting increases to 7% plus the yearly change in the area’s inflation rate or 10%, whichever is less.
Impact on Investors
How do proposed and existing rental caps impact investors? A nationwide cap wouldn’t apply to smaller investors with a handful of properties. However, more prominent developers and real estate investors could see reduced profits, making it harder to justify large-scale investments. They may look to other real estate investment opportunities in commercial or industrial properties.
Less restrictive policies, like California’s and Oregon’s, include rent increase caps. However, they also account for inflation, so it’s possible to earn a return and recoup enough investment to support ongoing upgrades and maintenance.
Strategic Considerations for Investors
The impact of newly enacted rent control legislation for real estate investors remains to be seen. However, since investors with properties in rent-controlled areas have less ownership over rental price increases and may face enhanced tenant rights, it’s essential to reevaluate your investment strategy. Here are a few considerations to keep in mind.
Adjust Your Investment Approach
Buying property in a strict rent-controlled area may not provide the ROI you want from a rental property. Consider investigating other regions that don’t have rent control policies or take a more flexible approach.
Identify Alternative Markets or Property Types
Suburban and rural areas are less likely to have rent control laws. You may also consider investing in other types of property besides residential homes, like commercial or industrial properties.
Revise Financial Models and Projections
Before investing in a rent-controlled property, pay careful attention to financial models. Consider different factors, including rental rate increase caps, potential decrease in property value, and maintenance costs, to see what the ROI looks like.
Managing Costs and Maximizing Returns
If you own property in a rent-controlled area, focus on controlling your costs. You might also offer value-added services your clients appreciate, allowing you to charge extra, such as regular lawn care or access to amenities like concierge services.
Staying Compliant
Other cities and states may follow in the footsteps of Oregon, California, and New York and enact future rent control legislation. Stay on top of emerging laws that impact your properties so you remain compliant with legislation.
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