It’s been easy to see this coming, yet many in the industry are blatantly ignoring rent control on the horizon. I’m not a doomer and I don’t think rent control will take down the industry or create widespread foreclosures, but it is something to be mindful of and most importantly, plan accordingly if you’re a Landlord/Operator.
Recently for many Operators, Landlords, and Investors we’ve seen major moving parts within the multifamily industry over the last 3 years and rent control is perhaps the next natural progression aimed at putting a small dent in housing affordability. Between 2020 and 2023 there was double-digit rent growth in most markets driven by low housing supply and migration patterns. Life was good for an Operator….until it wasn’t. During this 3+ year period, many Operators felt the pinch of inflation, namely in labor and materials for value-add projects which were chasing, and getting, higher and higher rents. These higher rents were badly needed to justify higher and higher property valuations.
Fast-forward to today, as inflation continues to impact every American, Operators are now getting slammed by insurance companies re-rating their policies. In some cases, insurance policies increased by 30% (and continuing to increase). Within a 12-month time span, those so-called value-add projects that were to bring in an extra $150 per unit in cash flow were barely able to pay the higher insurance premiums.
And while that was happening, cities and towns were drunk on reassessing property values. Notice they never do a reassessment in a down market. Who can blame them, many cities and towns are still in debt from bad policies in 2020 and there’s a lot of ground to make up through higher revenue from property taxes. Yet another negative impact on Operators.
With that, we’re seeing a shift, a slowdown in rent increases as the need to reduce vacancies and reduce evictions takes center stage. We’re also extrapolating into the future to see how this all plays out and already playing out in some major cities.
Obviously, the housing affordability issue in this country is not going away. That’s not a revelation if you’ve followed the media recently or follow the industry. It’s simply too expensive to build and there’s not enough labor to quickly solve the under-supply of housing.
Here’s the problem with society’s growing demand. Existing Class B and Class C properties are relatively fixed in the quantity we have today. Meaning developers aren’t building any more B or C properties because they can’t, it’s too expensive. By default, anything newly built is defined as Class A. There are outliers with HUD financing, etc. but they don’t drive the market.
This increasing demand for B and C rentals, over the current stagnant supply, will naturally put upward pressure on rents.
This issue will be magnified when coupled with the decreasing desire for homeownership. Ownership limits mobility requires time to upkeep a home and a home is expensive to maintain. Society wants the white picket fence…just not the hard work and expense that goes with it.
As more and more households are pushed towards renting at higher rent/income ratios the politicians on both sides will weaponize rent control much like they are student loan forgiveness. And more regulation will come about as society cries out for more affordable rentals (we’re seeing this in Europe).
St. Paul Minnesota recently implemented rent control in 2021. Yet San Francisco, NYC, Washington DC, and Los Angeles all have some form of rent control, going as far back as 2014. The rent control regulations vary from city to city as do the results of these regulations. One thing is certain, the undersupply of rental units was a problem that was created decades ago by political factors and one that will continue to plague society.
Housing voucher programs will not grow as fast as demand for vouchers to afford these rentals. This is the perfect storm in the rental market that continues to brew. Yet we haven’t even factored in the waves of immigrants arriving daily into the US, putting stress on an already stressed rental market.
Most investors do not invest in the face of uncertainty unless there’s an attractive return. And rent control is causing uncertainty at the bottom line. New construction starts have pulled back due to interest rates, insurability, and labor/material costs…but also factored in are rent control concerns and whether the business plan is achievable going forward.
Many developers are also standing on the sidelines doing nothing more than evaluating their pro formas as well as their exit strategy. All while Milton Friedman’s quote: “Nothing is so permanent as a temporary government program.” rings in their ears and weighs on their decisions.
While navigating the real estate market can present its challenges, success is attainable for investors who approach it with a clear understanding of the complexities involved and a realistic view of the market dynamics.
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