Statewide Rent Control in California Isn’t Detouring Lenders

The movement for multifamily rent regulation has gained momentum nationwide over the past few years, and the pandemic has increased political and popular support for tenant safety. The negative effects that these policies will have on multifamily property owners and their capacity to upkeep and create housing has been vocally expressed.

According to a report by the National Multifamily Housing Council from earlier this year, owners are actively avoiding markets with rent limits or seriously considering leaving markets that enact these rules.

However, according to industry experts who spoke with Bisnow, California’s state and local rent control and limit regulations haven’t had a significant influence on multifamily financing. However, some projects, like value-add deals, have become more challenging to complete as a result of these and other laws affecting multifamily developments, particularly the still-in-effect eviction ban in Los Angeles.

Across the country, rent control is becoming more prevalent. In 2021, St. Paul, Minnesota, approved a 3% rent cap. According to a recent article in The Wall Street Journal, legislation that might establish rent restrictions has been proposed in at least a dozen states. The legislation would prevent rent increases by landlords of more than 2% to 10%. According to the WSJ, rents have increased nationwide by an average of 18% since the start of the pandemic. According to Insider, the states with cities that are considering similar restrictions are diverse in terms of geography, demographics, and ideologies. They include Arizona, Florida, Illinois, Kentucky, New Jersey, New York, Washington, and Massachusetts.

In 2019, Gov. Gavin Newsom signed AB 1482, which places a 10-year cap on how much landlords can raise rent in a sizable number of buildings throughout the state. California has had rent regulations in various forms for decades. Rent increases of more than 5% plus inflation per year are prohibited for multifamily landlords, as well as for owners of condominiums and single-family houses who are 16 years and older. According to the statute, landlords are also required to give “just cause” for evictions.

According to Doug Perry, senior vice president of sales at Archwest Capital, the law didn’t have the significant effect that many in the CRE industry had hoped.

The landscape didn’t shift overnight, according to Perry, whose company is a direct commercial lender with a nationwide concentration on multifamily and mixed-use properties. Rent control rules haven’t affected the way we underwrite loans, but they have made some situations a little more difficult.

For instance, it could be more challenging to complete a value-add project that entails purchasing a property with a lot of unfinished maintenance, upgrading it, and then boosting the rent.

Perry adds, “Those projects don’t get done as much because they can’t be done from a compliance standpoint with the rent control laws.”

There are workarounds that can be useful, such as “cash for keys,” in which a renter is given a lump sum in exchange for leaving a rental property. Most of the time, the rent for the apartment can be changed to reflect market rates. However, it can cost a lot of money to evict residents, and that money isn’t going toward the main goal of these projects, which is to improve the building so that the apartments can draw higher-paying renters.

According to Perry, “there are occasions when the expense of doing it increases the cost of the entire project to the point where it’s just not a profitable endeavor, and it doesn’t make sense.”

According to Perry, the impact of municipal rent control laws, as opposed to state-level ones, may be greater for smaller investors and individual owners who have investments in areas with such laws, but this is only a problem for specific projects and not a general problem.

Value-add deals may take longer to complete if there are eviction moratoria, like the one that is still in place in Los Angeles.

Shahin Yazdi, partner and managing director of George Smith Partners, which arranges loans for CRE borrowers nationwide, said that it is “simply not as realistic” for the borrower to expect to be able to turn around an entire building when there is an eviction moratorium and you can’t perform no-cause evictions.

Instead, it is necessary to diminish expectations, either that it will take longer to empty the building or that it won’t be empty enough. This means that the transactions must make financial sense even if only a portion of the building—say, half or a third—is made accessible to new, wealthier tenants. But in other situations, the resilience of multifamily during the epidemic has made this conceivable.

Regarding Los Angeles and its current eviction moratorium, Yazdi noted, “Multifamily continues to be a great performing asset, even with people not paying.” The rate of foreclosures did not soar. It’s a wonderful asset class for lenders since landlords, who may have made some postponed payments, nonetheless make their mortgage payments.

Despite the optimistic response from the lender side, a study released in January 2022 by the National Multifamily Housing Council revealed that efforts to enact rent control are having an impact across the country, not just in California.

The study asked 78 CEOs and senior executives at national “apartment-related enterprises” if the growing number of areas that had implemented, strengthened, or were considering rent control or rent ceilings had an impact on development and investment decisions. 32 percent of respondents claimed to already steer clear of rent-controlled areas, and 26 percent claimed to have reduced their investment in these areas due to local rent-control strategies.

However, almost the same number of respondents (23%) stated that despite rent restrictions, they have no plans to alter their investments or developments in these locations.

California appears to stand out from the pack of rent control initiatives despite their rising popularity across the nation. The NMHC survey asked participants to indicate the markets they actively avoid because of current rent control laws or the potential implementation of new regulations. According to NMHC, out of the 31 respondents who responded to this question, 55% mentioned certain markets in California or the state as a whole.

According to Jim Lapides, vice president of strategic communications for the National Multifamily Housing Council, “California is a uniquely challenging environment to operate” because of the state’s rent control laws as well as the laws that local governments have either approved or are preparing to pass. It adds up for every city that enacts new rent control legislation and every moratorium that is still in place.

Despite these obstacles, investing there is still profitable, according to Lapides, and investors will continue to do so. According to a year-end analysis by CBRE, which used data from Real Capital Analytics, the greater Los Angeles region attracted $58.8B in investment expenditures in 2021, making it the biggest beneficiary of those funds. With nearly $35 billion in tourism, the Bay Area placed fourth. The statistics showed that apartments were the asset class that attracted the greatest investment in the East Bay and greater Los Angeles. (Offices in San Francisco received the most investment.)

According to Lapides, “California is always going to be an appealing market because there are tens of millions of residents, there are huge marketplaces, and it’s vital for the industry.” However, the course they have been on will seriously harm them.

In contrast, Perry observes a pattern of adaptation to the challenges that California has so far generated.

The reality is that rent control is in place throughout the state and has been for some time. We have learned to live with it, adjust to it, and make it work from both a lending and a borrowing position, Perry said.

The SVN Vanguard team can help with your Multifamily Real Estate needs. We can help you find the ideal multifamily property for sale or lease. Interested in discussing a sale leaseback? Contact us.

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