The below article was written by Mercedes Shaffer, an agent with Pacific Sotheby’s International Realty.

 

For the past year and a half, the eviction moratorium forced landlords to bear the burden of providing appropriate housing for tenants who, in turn, only had to pay little to none of their rent if they said they were financially impacted by COVID-19.  The government moved quickly to aid tenants, while landlords still had to pay their bills and taxes.  In addition, some cities and counties in California also mandated that landlords are not allowed to raise the rent during the pandemic, and that they have to wait for one year after it is declared over before implementing any rent increases.  

Government Overreach

Since when did it become okay for the government to usurp this basic tenant of capitalism and private enterprise?

Not only is this overreaching for government to impose on landlords, it is also blatantly one-sided.  I didn’t see any senate bills passed by the government stating that landlords wouldn’t have their property taxes raised until one year after the crisis is declared over, or better yet, those who were financially impacted by COVID-19 wouldn’t need to pay taxes until they receive their landlord rent relief funds.  What gives the government the right to tell landlords that they must do without their rental income, yet law makers aren’t offering any concessions to housing providers on taxes?  

California Real Estate Market

While the multifamily rental market has faced many challenges due to government restrictions, the owner occupied single-family real estate market keeps getting hotter.  Every month, new sales price records are set in neighborhoods across California with buyers getting into bidding wars and homes selling for significantly above the asking price.  This has also buoyed the price of multifamily properties, yet because rents are restricted from being able to keep pace with the market, this is shifting how investors evaluate rental properties.

Cash Flow Counts

In the multiunit market, investors are often weighing the delicate balance between leverage, appreciation and cash flow.  The substantial increase in real estate prices is in stark contrast with government-imposed rent restrictions making it even harder to build a residential housing business with positive cash flow.

To illustrate the shift, a triplex in Costa Mesa was recently listed for $1,600,000; it was on the market for 10 days and sold above asking for $1,675,000*.  The gross annual rental income was $72,000 (GRM 23)**.  By comparison, five years ago in Costa Mesa, a similar triplex was listed for $1,075,000 – it was on the market for 62 days and it sold for $1,042,000.  The gross annual rent was $74,100 (GRM 14). Essentially, a triplex sold for $633,000 more today and the income per year was $2,000 less than five years ago.  

This means that if a property is purchased with long-term tenants in place who are not paying fair market rents, it will require a significantly larger down payment, or more time to build equity and gradually raise the rents before a property will be cash flow positive and pencil out as a good investment.  

Unintended Consequences

Not only are property prices skyrocketing, but rent prices are rising rapidly too.  Perhaps in part due to the eviction moratorium, there is very little rental inventory available. In today’s real estate market and political climate, the quickest way to achieve positive cash flow and take advantage of the low interest rates and soaring rental and real estate prices, is if the tenants move out and at that point you are allowed to raise the rent to today’s fair market value. 

While this likely wasn’t the intent of law makers, the rent restrictions have created a condition that motivates landlords to encourage long-term tenants to move rather than to stay.  This is often the only way for many owners to achieve a positive cash flow and is another example of shortsighted government interference with the fundamentals of supply and demand pricing and is damaging to both tenants and landlords.  

 

Vacancy Control?

If this isn’t bad enough, the government is also trying to pass laws that restrict the amount landlords are able to raise the rent even after a tenant has moved out.  Housing providers should be incentivized to provide the best quality housing and most responsive service to tenants by being allowed to reap the financial rewards of whatever the market is willing to pay.  If this law passes, it will significantly impact the value of rental properties compared to their single-family neighbors.

The more the government places restrictions and controls on rental properties, the more difficult it will be for multifamily housing to generate positive cash flow.  At present, it continues to be a great way to build wealth, though finding the right deal demands more expertise, strategy and planning than ever.  It also requires our voice and vote to send the message that government is unfairly disenfranchising landlords and we won’t stand for it.  

Owning rental property, building wealth, and growing passive income is the great American dream – and must be preserved.  

*Data taken from the Multiple Listing Service.

** For detailed information on GRM, read my article in the August issue of AOA Magazine.

 Mercedes Shaffer is an agent with Pacific Sotheby’s International Realty and specializes in investment real estate and 1031 Exchanges.  For help with buying or selling investment property, Mercedes can be reached by phone at 714.330.9999, by email at [email protected] or visit her website at www.InvestingInTheOC.com.  DRE 02114448.