Recently, California has imposed several unfunded mandates on rental owners. Other states don’t impose similar costs on rental owners. Sacramento has not yet lost enough millionaires and high-income taxpayers to restrain their policies. Most local owners recognize these mandates are likely to continue. The economics of rental ownership are shifting.
Background
California government policies created a rental housing shortage. California has built about half as many apartments and condos as we needed. It may take longer than a generation to build enough rentals to house all Californians.
Government policies and the unintended consequence of an immense rental housing shortage have made millions of rental owners in California far wealthier than rental owners in markets without a government-created rental housing shortage. These rental owners are neither super-rich tycoons nor absentee landlords.
The retired schoolteacher who lives near you could be a rental owner. “Most rental properties, about seven in ten, are owned by individuals, who typically own just one or two properties,” according to Pew Research. The biggest group of rental owners are retired people who depend on their rental income to pay the bills.
Most California rental property is owned by California residents. Millions of rental owners did quite well by doing business here. However, past profit does not obligate owners to pay more taxes or collect less revenue.
What’s Changed
Legislators recognize rental owners are a relatively small group and poorly organized politically. Legislators also know that few citizens understand the economics of rentals. Rental owners are a convenient target for unfunded mandates and other changes in the law.
In November 2020, California voters rejected rent control three to two. That should have been the final word on rent control, but it wasn’t. Within four months the legislators contradicted the voters. Governor Newsome signed a statewide rent control law.
Every business is affected by cost increases, but landlords are treated differently from other businesses. There are no limits on how much a lender, trash company, or contractor can charge the owner, but state law restricts what rental owners can pass on to residents.
During COVID, landlords could not evict residents for not paying rent, even if COVID had not infected anyone in that rental household. Many owners, including our family, absorbed a $10k or larger loss during COVID because tenants did not pay rent and didn’t cooperate with the landlord,so the landlord could recoup money which the government allocated to soften the blow. There was no cost to the tenant to sign paperwork, but thousands of tenants chose to block owners from collecting rent from the government even though the government had allocated funds for that purpose
State government has also made it harder for landlords to exercise prudent business judgment. Recently the state government blocked landlord access to public records which show which people have been evicted, and thus have higher collection risk. A retailer can learn if an applicant has a shoplifting conviction, but rental owners can’t learn if an applicant has not paid a previous landlord.
So, landlords are more likely to encounter tenants who simply don’t pay their rent. Then what? Effective 2023, landlords won’t have the ability to garnish the wages of most renters, although all other creditors can use that legal recourse.
The Benefits of Rental Ownership
On the flip side, let’s remember the tax benefits of rental ownership. All business owners, including rental owners, can deduct interest costs. Interest is often the biggest cost of ownership.
Tax law recognizes that physical assets, like vehicles and buildings, wear out. Rental owners can depreciate the value of the structure over 30 years. Building codes and practices mean most buildings will last more than 30 years. Those two tax deductions have been an important part of why so many millionaires own some income property.
California calculates property taxes based on the sale value. The maximum property tax increase is 2% annually. So, a property that doubles in value in ten years will have a property tax increase of less than 25%. That is a big and rare benefit for owners of California apartments.
What May Lie Ahead
Legislators may have the illusion that they can impose almost any cost on rental owners and there will not be any consequence for the resident or the government coffers. That notion seems unlikely.
Most legislators probably do not know how many rental owners sell and move their equity to other states. Yet thousands of rental owners won’t buy another California income property. Fewer buyers of apartment assets will mean lower prices. That affects all owners and our heirs and the tax man.
California government collects far more tax when a property is reassessed at sale. Legislators may not care if they are hollowing out an important source of future tax revenue. State assembly members are termed out in six years and state senators after eight years. By the time it becomes obvious that their choices have created a budget shortfall, they will have moved on. Think they’ll care about the state budget?
Since there are no easy, effective solutions, what might make sense for California?
If you own California rentals, which straw will be the last one for you?
Terry Moore, CCIM is an investment real estate broker with a proven history of success in creating value, 1031 (tax deferred) exchanges, and building wealth through apartment investments. He has taught at UCSD, National University’s MBA program, the Appraisal Institute, SD County Tax Assessor, California Association of Realtors and is a National Certified Commercial Investment Member. For more information contact Terry at [email protected], call 619-497-6424 (Direct), 619-889-1031 (Mobile) or visit www.SanDiegoApartmentBroker.com. (License #0091851).