Throughout the US, communities are pushing for rent control measures in an attempt to keep housing affordable. These measures may be off-putting to some investors, who fear that multifamily assets will be politically bottlenecked in these markets. Rent control doesn’t kill profitability, though. Rent-controlled properties can present an opportunity to CRE professionals who understand how these properties operate and what these local regulations often entail.
Modern rent control dates back to post World War II, with additional measures being adopted during president Richard Nixon’s 1971 wage and price controls. These measures are diverse but generally restrict the amount by which rents can be raised annually and limit the basis for carrying out convictions to criminal activity and nonpayment. Newer units are often exempt from rent control measures, which apply to units that are older and may have fallen into disrepair.
Why Invest in Rent-Controlled Assets?
There are several factors that make rent-controlled properties more attractive to companies active within the multifamily sector.
The cost of acquisition for rent-controlled properties is generally much lower than the average rate for non-rent-controlled assets. Further, there is less competition for these assets as most institutional funds shy away from them, leaving ample opportunity for smaller firms and mom-and-pop investors to move into this space. The bidding wars that have become so common in a competitive, late-stage CRE market are not fought so hard for rent-controlled properties because they are passed up for other assets that come with fewer regulations and are seen as more profitable.
Once a rent-controlled asset is acquired, there are sometimes stipulations requiring capital improvements to be made, as these properties are generally older construction (built before 1995). Acquiring an asset at a lower price leaves additional capital to put toward these improvements, and many cities allow for temporary rent increases to recoup these costs and some even allow landlords to directly bill tenants for up to 50% of expenses for repairs that primarily benefit the occupying tenant.
Tenants at rent-controlled properties do still vacate but at lower rates than market-rate properties. Rent-control measures put a cap on the annual increment of allowable rent increase, but they do not halt inflation of rents altogether. These factors in tandem create a slow and steady path to profitability, while ensuring higher occupancy. In other words, rent-controlled assets compared to market-rate ones are the tortoise and the hare—and slow and steady wins the race.
In some markets, such as New York City, when a property reaches a certain price point in rent and original tenants have vacated, assets become deregulated. While it may take some time to reach this point, rent-control may allow firms to acquire and improve assets over time as value-add projects. Regulated status may scare away competition, but over time it protects landlords from market turbulence and vacancy as assets are improved and eventually deregulated, at which point profitability can continue to improve.
Acquisition Best Practices
Before deciding to acquire a rent-controlled property, thoroughly research the market you are looking to buy in. Some assets will turn over faster than others, like properties where the majority of tenants have resided there for a shorter amount of time and where rent is above at least half of market value. The history of rent control legislation in the area is another consideration. If policies have generally been temporary and allowed for eventual deregulation, there is a better chance that the asset will perform favorably over time. Likewise, if legislators allow improvements to be partially billed to tenants, value-add measures are much less expensive in the long run.
If you are patient and don’t mind investing for the long-haul, a rent-controlled asset may be an opportunity worth looking into. Although many CRE professionals shy away from these properties, they can be one way to break into oversaturated markets while still profiting in the long term.
For more information about emerging CRE regulations, watch our free on-demand webinar CRE Outlook: The Convergence of Capital, Regulation, and Technology