Earlier this month, California Governor Gavin Newsom signed legislation that will limit the amount of annual rent increases a landlord may charge residents living in apartment buildings throughout the state. The new cap of 5 percent plus inflation (CPI) will take effect on Jan. 1, 2020, and will impact all buildings that are 15 years and older. Its rolling mechanism will cause a new batch of buildings to fall under rent control each subsequent year. The good news is that the 5 percent + CPI is still a fairly aggressive increase, considering the average yearly rent growth in a mature market like Los Angeles is less than 2 percent.
The law will offer renters the ability to budget accordingly with predictable maximum allowable increases. Just as important, it will offer renters solace. Unless they are in breach of the lease, they will not be forced to leave, since landlords will now be required to show just cause to evict.
While this may seem like a big win for renters, one of the unintended consequences will be the almost certain yearly rent increase. Previously, landlords would have the option of not raising rents knowing that he or she is free to raise the rent in the future to whatever the market may bear at that time.
Under the new law, if rents are not raised every year, landlords run the risk of falling significantly below the market and negatively impacting value. This is especially true in markets that are experiencing higher yearly rent growth.
The buildings most impacted will be the largely untouched assets whose rents are significantly below market. Purchasers that previously viewed these deals as quick repositionings will now have to wait several years or more to bring all the units to market. While this will impact the price somewhat, it won’t be a deal breaker for many buyers still hungry for this product.
Vacancy Decontrol Under Attack
While heavy government regulatory oversight has rarely proven an enabler of industry growth, the new California rent control law will not have the apocalyptic consequences as originally predicted. However, while that may be good news for any market where rent control is being floated, many believe this is just the beginning of more government meddling and a precursor to the removal of vacancy decontrol, which the recently passed law in New York City targets.
Instead of allowing the free market to determine rents, vacancy control would limit the rent that a landlord can charge for a vacant unit to an amount predetermined by the government. This has had horrendous consequences, including causing landlords to become less inclined to renovate units and maintain the building to high standards, and impeding new development.
Vacancy control has created a cottage industry for rich residents to pay landlords a finder’s fee to get into these lower-than-market units. The net result is that landlords get expensive kickbacks and the wealthy get to pay significantly below- market rents. Virtually the only people that don’t benefit are the lower income earners that need these units the most. Yet another scenario in which the road to hell is paved with good intensions.
Nearly all economists agree that any form of rent control does little to help overall affordability and ultimately hurts the future renter. Rent control effectively takes units off the market by ‘locking’ them in place, which artificially pushes rent levels higher for the relatively smaller number of units that are available. More importantly, it does nothing to address the main reason for rent growth in the first place―increase in desirability of an area means more people want to live there.
The best path to alleviate the affordability crisis is not implementing rent control but rather easing regulations, reducing impact fees and fast-tracking permits so more development may occur.
Trends tend to start on the left coast and move eastward, so a cautionary tale to those in the wake of California’s ‘progress’…if rents start spiking, build more units.
Mark Ventre is a senior vice president at Stepp Commercial, a Southern California-based multifamily brokerage.