In my readings recently, I stumbled upon an article concerning rent control – a subject pitting two economic groups squarely against one another. If you’re the owner of residential rental units, you object to a governmental agency dictating what price you may set on your property. If, however, you’re the traditional apartment dweller, you favor it because it guarantees all tenants will enjoy accommodations at prices they can afford. In this way, they claim, the problems of affordable housing will be resolved and along with it the eradication of homelessness.
Those of you who don’t fit into either of these categories may be ambivalent, for most of us tend to ignore matters we perceive will not personally affect us. In this particular case, things are not quite as simple as they appear, for everyone may have a vital stake in what transpires.
A number of things are in the works in California. In the northern part of the state over the past two years, rent control appeared on municipal ballots in seven Bay Area cities, winning approval in two: Richmond and Mountain View.
In Los Angeles County, where the cities of Los Angeles, West Hollywood and Santa Monica have long regulated rents in this fashion, there’s an impetus for more of the same in four adjoining communities, with Long Beach, Inglewood, Glendale and Pasadena considering whether to join them. Petitions are being circulated and if enough persons sign them, the measure will be decided by the voters this coming November. Proponents maintain this will be the “salvation for renters.”
Of even greater significance is a statewide effort to put an initiative on the November ballot to repeal the Costa-Hawkins Act law limiting rent control throughout the state. Enacted in 1995, it places limits on municipal rent control ordinances in two major ways. In addition to prohibiting cities from placing controls on single family houses and condominiums, it also exempts multi-family structures constructed after 1995 from those controls.
In addition, for those properties subject to rent control, it guarantees an apartment owner’s right to re-rent, when vacant, at any price the owner chooses – normally the market price. For this initiative to appear on the ballot, it must [have received] the approval of 365,880 registered voters by June 25th. By March 1st, its advocates collected over 25 percent of the signatures required; only time will tell whether their efforts are productive.
We might end our discussion at this point and, depending upon our individual biases, conclude all persons opposing rent control are greedy profiteers who wish to hold tenants in perpetual bondage, while those supporting it desire nothing more than to sponge off the wealth of the productive segment of society by enacting unjust laws. Yes, we might of course, but we’d be missing all the ingredients which go into a most complex matter.
The fact is whenever vital necessities of life, such as housing, are involved, huge sums of money are on the line. And when this is the case, the financial repercussions can be immense … and often unexpected.
For a view of how rent control can function, New York City provides an excellent example. Its program, begun in 1943, is the longest-running in the United States, controlled by the federal government from 1943 until 1950, and thereafter by the state. With more than 800,000 units currently under rent stabilization, its operation defies description. Tenant qualifications periodically change over the years, reportedly to curb perceived abuses, which allow the wealthy to enjoy rent increase protection intended to protect the working class.
At the other end of the income pyramid you’ll find a West Village townhouse just hitting the market for $11.25 million – and comes with two rent-regulated tenants who are living quite economically. One tenant pays $127.61 a month for a spacious 1,000-square-foot, fourth-floor apartment inside the five-story townhouse at 59 Morton St. The other pays $627.78 a month – up from $615 a month in 2011.
All the while, Eva Tucholka of Harlem, aged 72, retired, and subsisting on food stamps and $2,123 in monthly Social Security benefits, somehow hopes her $2,126 per-month rent can somehow be reduced. “I don’t really know what to do,” said Tucholka.
Perhaps Gabriel Levicky of the Bronx, 68, who lives just down the street from the building that recently sold for $20 million might utter the same words. He applied and received approval in February 2016 for a rent freeze at the legal rate of $1,653 per month. But because the freeze didn’t apply to a lower preferential rent, he was entitled to when his lease came up for renewal later in the year, his landlord raised the rent by $175 per month. “This recent rent increase is rather steep and tough. Please reconsider and recalculate it,” Levicky thereafter wrote to his landlord, K.S. Realty. He received no response.
Enough of how governmental rent control programs metastasize over time. Let’s consider instead why housing shortages exist – which invariably lead to homelessness and demands for rent control. This will not be a hypothetical tale with a contrived moral. This is for real and you must pay attention to the numbers, for therein lies the crux of the problem. This concerns a 32-unit apartment complex in Indio, California, acquired in July 2015, at a purchase price of $2,150,000, containing 16 each one and two-bedroom units, with rents ranging from $675 to $850. The first month’s gross rental income of $21,685 generated a net loss of $832. Now, nearly three years later, rents range from $775 to $950, with last month’s rental income $27,036 and cash flow $3,207. With a 2017 net income of $63,042 and roughly $50,000 in deferred maintenance, the property’s capitalization of net income (cap rate) is an adequate 5¼ percent.
Next, some crucial details: There are no vacancies but, instead, a waiting list of prospective tenants. There is, surrounding the property, a number of acres of vacant land zoned R3 – suitable for apartments – which remain vacant year after year. Now the poignant question: With the obvious demand, why are no new apartments built on the vacant land? Sorry, but the answer requires some more numbers. If the owner of the vacant land chooses to construct 32 units similar to the adjacent apartment – 26,400 sq. ft. of rentable space – a construction cost no less than $150 per sq. ft. totaling $3,960,000 is barely the beginning. Then add engineering and architectural costs, off site expenses of utilities, sewer hookup, sidewalks, and whatnot, together with the fees and assessments to the city and other governmental agencies. It’s likely these additional costs will come to no less than $40,000 per unit; adding another $1,280,000 brings the development price to $5,240,000. And don’t forget, thus far we’ve figured the land as free, so only its current owner can build at the price we’ve calculated.
Finally, let’s presume the building is in place and, because it’s shiny and new, will generate 20 percent more net income than the existing building, or $75,650. What then must be its cap rate? The calculation is simple: 75,650/5,240,000 X 100 = 1.44%. Let me ask you a question: After you’ve thrown your land into the deal free of charge, will you be eager to develop a housing project yielding an annual return of 1.44 percent? Chances are the land will sit vacant for a long time, as will thousands of similar parcels across the nation.
The end result: Housing – affordable or otherwise – will not be built; the homeless will continue to be without shelter; and everyone will accuse everyone else of being inconsiderate, or insensitive to the needs of the poor, or whatever other phrases are coined to disparage those of another political persuasion.
A final thought: I’m convinced the fundamental defect in our nation’s economy is our current high unemployment rate, coupled with an average income that has scarcely increased over the past decade. I realize, of course, the U.S. Bureau of Labor Statistics’ official unemployment rate is 4.1 percent, but the U-3 category they’ve chosen is meaningless – intentionally so.
I believe actual unemployment exceeds 20 percent and will continue to grow as technology in its many forms eliminates whole categories of jobs. I’m distressed to say whatever comes to pass will not be pretty.
[Editor’s Note: According to several press releases, supporters of the Affordable Housing Act [AHA] will submit over 565,000 signatures in support of the measure to the state.” “They needed 365,880 by June to qualify.”]
Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. You may view them on http://www.roadwaytoprosperity.com.