The below article was written by Gabe Johansen of SMI Commercial Real Estate from the Rental Housing Journal.
Over the last few months, you have undoubtedly read numerous articles about rent control.
With the passage of SB 608, Oregon has become the first state in the nation to introduce a form of statewide rent control, passed under the guise of rent “stabilization.” While the new changes for landlords are many, there is one question on a lot of minds that has not been answered: How does rent control affect the value of multifamily property? The answer to this question is multifaceted.
There are many factors that weigh on the value of real estate, especially when considering the income-generating nature of multifamily real estate. With [the Oregon] rent control now in place for 2019, rent increases can no longer exceed 7% plus the West Region Consumer Pricing Index (currently 3.1%). For the average property owner, this is not an onerous restriction.
In most cases, managers do not increase rents by more than 10% in any given year because landlords prefer to keep their current tenancy in place and avoid costly turnover expense and vacancy loss. But what happens if one decides to sell or refinance their property?
3 Factors That Affect the Value of Rental Property
1. Income Approach
Prior to the passage of the [new Oregon] SB 608 in February 2019, the common practice of listing brokers was to price properties based on pro forma rents.
In a seller’s market when rents are on the rise, buyers are lined up and willing to pay top dollar for an income stream that does not yet fully exist. It is then the job of the buyer to increase rents as quickly as possible in order to make their investment cash flow. If a property’s rent roll is already near market levels, the value of the property can be based on current income.
However, if there are tenants currently paying below-market rents, the new rent-control laws are going to make repositioning the asset a much longer process. This is already having a negative effect on the values of underperforming properties. Sophisticated buyers are not willing to underwrite the value of a property based on rents that will not be achieved within the first year or two of ownership.
Since the passage of statewide rent control in Oregon, multifamily brokers have begun to take a new approach to pricing. Brokers are now arriving at listing prices based on the income that a property will produce after its initial round of rent increases, within the guidelines of SB 608. This means that if a property’s rent roll is trailing the market by more than 10%, it will be difficult to maximize its appraised value in the event of a sale or refinance, thus bringing the market value of the property down.
2. Supply and Demand
While the [Oregon] legislature is currently working on ways to increase the supply of housing, historical data shows that rent control slows development, creating a greater shortage.
If this holds true for Oregon, we will see a decline in the number of multifamily units being developed and a further increase in demand. For investors, this is good news in regards to the value of their multifamily holdings because it limits competition from new properties that are coming online.
An artificially low inventory will drive rents higher and thus continue to push the value of multifamily properties to greater heights. As long as the demand from renters remains, multifamily property will appreciate as a result of higher yields – albeit at the cost of Oregon families, many of whom are already struggling to make ends meet.
3. The Market
Supply and demand will drive the market to value property based on scarcity. In the second quarter of 2019, Oregon saw a 38% decline in multifamily transactions and out-of-state investment dropped to nearly zero. Much of this could be due to the pipeline shadow of 2019’s first quarter, which had many investors scared to make a move, not knowing what the new rent-control laws might look like. This may be a boon for local buyers because it will reduce acquisition competition, but the value of multifamily property could decline due to a decrease in overall buyer demand. Now that the dust has settled on Oregon rent control, investors are coming back to the market.
So How Does Rent Control Affect the Value of Multifamily Property?
Some owners have decided to sell because they no longer wish to deal with the tightening landlord-tenant laws; other owners have decided it is a good time to reposition their portfolios and are now more aggressively pursuing 1031 tax-deferred exchanges. Listings are going live at a pace we have not seen for some time, which creates a different form of competition and can place downward pressure on prices. With more sellers and less buyers, we are beginning to see equilibrium in the marketplace, and while property values will continue to improve over time due to supply and demand, the days of explosive growth are probably over for now.
Multifamily Rents Grow More Slowly as 2019 Shapes Up to Be a Weak Year
The average U.S. multifamily rent has risen $14 over the last three months, “which is a decent performance but far short of the levels of recent years,” according to the May report from Yardi Matrix.
“Year-to-date through May, rents were up 1.2% — again, good but not up to the recent past. In fact, over the last six years, only in 2017 (1.7%) did rent growth fail to reach 2.0% year-to-date through May,” the report says.
Multifamily Rents Grow Slowly
- U.S. multifamily rents increased by $5 in May to $1,442. Because rents increased less than they did in the same month in 2018, year-over-year growth fell 50 basis points from April to 2.5%.
- Although rent gains are in line with the long-term average, 2019 is shaping up to be weaker than the last few, much more robust, years. Year-over-year rent growth has dropped 80 basis points over two months and 110 basis points over three months.
- After sharing the spotlight with Las Vegas last month as the top metros, Phoenix pulled ahead in May atop our list of major metros with a 6.8% growth rate. Las Vegas is second at 6.6%, followed by Sacramento (4.1%) and Atlanta (3.9%).
2019 Could Be Shaping Up to Be a Weak Year for Multifamily Rents
“This is notable because the bulk of rent growth tends to occur in the first half of the year. If the past is any guide, 2019 would be hard-pressed to continue the bullish outcomes of the last six years if things don’t improve quickly,” the report says.
Demand in the desert continues to show up in the year-over-year numbers, according to the report.
- Rents increased 2.5% year-over-year in May, down 50 basis points from April and 80 basis points from March. The year-to-date increase of 1.2% is the slowest rate of growth since 2011.
- The Renter by Necessity (RBN) category (3.0%) continues to grow at a faster rate than the Lifestyle category (1.7%). Only eight metros top the 2.5% overall national average in Lifestyle rents, but 22 metros top 2.5% growth in RBN rents.
- Phoenix (6.8%) overtook Las Vegas (6.6%) in May to lead the rankings. The metros are No. 1 and No. 2 in both Lifestyle and RBN rent growth, and both have increased occupancy rates of stabilized properties by 20 basis points over the past year (Las Vegas to 95.0% and Phoenix to 95.5%) despite adding a significant amount of new supply. Meanwhile, Houston (0.4%) and Seattle (0.8%) have the weakest growth.
“The National Association of Business Economists released a survey that found a growing number of prognosticators increasing the odds that a recession will start in 2020,” the report says.
“Even though a recession in the near term remains a minority opinion, however, the downside risks are growing. The biggest reason cited is trade uncertainty, with 88% of economists surveyed downgrading growth forecasts because of President Trump’s policies on trade, which include tariffs on imports from China and Mexico. The other top reasons cited for the weaker growth outlook are stock market volatility and slowing global growth,” Yardi Matrix says in the report.
A Landlord’s Open Letter on Why He is Getting Out of the Business – Will California Rental Property Owners Follow?
By the Editors of the Rental Housing Journal
Here is one landlord’s open letter on why he’s getting out of the rental property business, and therefore no longer needs our newsletter. It is something he thought we should share with our readers.
It’s just too depressing reading about how landlords are being trampled by the city, county and state. I have to say, at this time, I’m delighted to not own any rental properties in Oregon.
Three years ago, I owned and operated four apartment complexes in Portland, Salem and Keizer that totaled 180 units. Although some of the rental rules and regulations at that time were starting to become burdensome, I was able to tolerate the continued intrusions and changes that the county, city and or government agencies imposed on us landlords.
Sadly, because of politics and where the bulk of the votes come from, Oregon appears to be headed into an extremely “tenant-friendly” state that basically is handcuffing landlords’ ability to place qualified tenants in their properties.
It seems like any rejected or non-qualifying applicant is free to claim discrimination and or harassment by the “bully landlord.” To me, that’s just legislatures, council members and/or city officials looking for votes. Shame on them.
I sold my properties just in time, and that’s 180 units of families that had a great landlord taking care of them.
And, I didn’t just let anyone in (as the “government” is pushing for), so I carefully screened all applicants, because it wouldn’t have been fair to the good tenants if I had just turned a blind eye and start accepting non-qualified applicants.
I feel for my previous tenants, but I couldn’t be happier to have moved on.
I truly believe landlords will soon take heed and go elsewhere where they are appreciated as the “real” taxpayers and not just people the state can walk all over.
Thanks again, and best of luck with those liberals of Oregon. I sincerely hope my message will inspire landlords in Oregon to challenge the regulatory agencies that are continuously punishing landlords just because some tenant feels wronged.
Gabe Johansen is the Willamette Valley’s #1 apartment broker and the principal broker and owner of SMI Commercial Real Estate, LLC. Reprinted with permission of the RentalHousingJournal.com which is an interactive community of multifamliy investors, independent rental home owners, residential property management professionals and other rental housing and real estate professionals. It is the most comprehensive source for news and information for the rental housing industry. Their website features exclusive articles and blogs on real estate investing, apartment market trends, property management best practices, landlord tenant laws, apartment marketing, maintenance and more.