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California’s New Rent Control Law Poses Questions for Multifamily Investors

Industry experts say that for the time being, the allowed rent increases will stay within the market-wide average.

Now that California’s governor has signed a new rent control bill into law, apartment investors and developers are hoping that lawmakers will take action to create new housing.

“Now, we must get very serious about passing legislation that’s going to develop housing quickly,” says Tom Bannon, CEO of the California Apartment Association (CAA), a statewide organization representing the rental housing industry.

California’s new rent regulations—as they are currently written—should not have a drastic impact on most apartment properties, industry sources say. However, investors had already begun to demand higher cap rates in California markets including Los Angeles and San Francisco, as they worried about lawmakers attempting to pass even tougher rent control laws.

“What other boneheaded idea will these people pursue next?” asks James Costello, senior vice president with research firm Real Capital Analytics (RCA).

Cap rates on apartment properties in California averaged 4.9 percent in the second quarter of 2019, according to RCA data. That’s 30 basis points up from 4.6 percent the year before. “This time last year, talk already started that cap rates were going to go up because of possible rent regulation,” says Costello.

Over the same period, the total amount of dollars that investors spent on apartment properties increased: to $25.8 billion in the second quarter of 2019 from $22.1 billion the year before, according to RCA.

Meanwhile, California is unlikely to be the last state to seriously consider creating new rent regulations or toughening existing laws. “We have seen momentum towards rent stabilization and towards anti-gauging measures across the country,” says Flora Arabo, national senior director of state and local policy for Enterprise Community Partners, a non-profit dedicated to affordable housing.

Impact on rents

Governor Gavin Newsom signed California’s new rent control law, the Tenant Protection Act of 2019, on Oct. 2. When it takes effect Jan. 1, California will become the second state in the nation to pass a statewide rent cap—Oregon passed a similar law earlier this year.

The new law will limit annual rent increases to 5.0 percent plus the rate of inflation for much of the state’s multifamily housing stock. For example, the current rate of inflation in California would allow a maximum annual rent increase of 8.0 percent, according to CAA calculations.

That is likely to restrict the ability of property owners to quickly raise rents at properties where the rents are currently below market. The prices sellers can achieve for those properties are likely to fall accordingly, as buyers refuse to overpay for unrealistic rent growth projections.

“If you start putting limits on things, the assumptions that people have been using start to break apart,” says Costello.

However, the prices for apartment properties overall are likely to remain stable. The limits set by the new law will allow the rents at most apartment buildings to keep up with the broader rental market. “It won’t have a huge effect on the majority of assets,” said John Chang, senior vice president and national director of research services with Marcus & Millichap, speaking on a webinar on Oct. 10. “Generally speaking, rents are not rising more than 5.0 percent plus inflation.”

New law spares new development

California’s new rent control law is also designed to focus on older buildings and excludes new developments. Advocates from the CAA added an amendment to the bill that exempts apartment buildings from the law’s rent cap and “just cause” eviction provisions until they are 15 years old. That should mitigate the bill’s impact on future development of rental housing, according to the CAA.

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