The Pros and Cons of Investing in Rent-Controlled Properties

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The mention of rent control is enough to make most apartment investors shudder—the notion of artificially capping rents flies smack in the face of American capitalism. But there are several misconceptions about rent-controlled properties. For some, they can be a great addition to their investment portfolios.

 

The Cons of Rent Control

Rent control regulations can be difficult to navigate.

Rent control regulations can be regulated at either the city or state level—or both. The state of California, for instance, allows rent control, but the decision is made at the local level as to whether to adopt a rent control policy.

It’s not uncommon for two adjacent communities to have different policies, one with rent control and the other not. The landscape is continuously evolving; investors need to track these regulations closely as there are routinely efforts (like ballot measures) to change policies.

Related: Rental Owners Everywhere Should Be Concerned About California’s Push for Rent Control—Here’s Why

Your ability to increase rents is capped each year.

Depending on the community, it’s possible that the rent control policy will prohibit landlords from raising rent more than 2 percent each year–in other words, rent increases essentially just keep pace with inflation. This may be completely out of line with market averages, particularly in hot-market cities, where rents have experienced double-digit increases over the past several years.

This ceiling can make deals less attractive to investors in search of strong cash flow.

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Rent controlled properties experience lower turnover.

Typically, low turnover is a good thing as far as apartment investors are concerned. However, some rent control policies stipulate that rents are capped each year until an apartment becomes vacant, at which point the landlord can increase the rent to market rate and then the new cap takes place each year thereafter under the existing tenancy.

To bring units to market rate, they must turn over at least every few years–but tenants in rent-controlled units tend to stay longer than average (sometimes 30-plus years!).

There’s less incentive to improve properties.

One unintended consequence of rent control is that, unable to increase rents, there’s no incentive to invest in a property beyond routine repairs and maintenance. Over time, this can lead to a deterioration (and therefore, value) of the property.

If you decide to sell in the future, your pool of buyers may be smaller.

Given the challenges associated with rent-controlled properties, some investors will never even look at these deals. This inherently shrinks the pool of potential buyers when it comes time to sell.

Related: Due Diligence: What Every Asset Requires Prior to Purchase

The Pros of Rent Control

Rent-controlled properties tend to have lower acquisition costs.

Investors typically use the current rent roll as a major factor when determining the value of a property. Rent-controlled properties, particularly if multiple units are below market rates, are therefore valued lower than what the free market would bear.

This results in lower acquisition costs, which may be a good way for an investor to enter a market they’d otherwise be priced out of by investing in a rent-controlled property.

You CAN increase rents.

Contrary to popular belief, landlords CAN raise rents in a rent control environment—they’re just limited as to by how much each year.

For instance, Oregon just passed a statewide rent control ban this past year that caps rent increases at 7 percent plus inflation annually. That’s a total of 10.3 percent this year. Statewide, rent growth has slowed to less than 2 percent a year since 2016, so the new law makes little difference to landlords looking to increase rents.

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There are usually policies in place to challenge the cap.

No community wants to see their housing stock decline. To prevent this, most rent control regulations contain provisions that allow investors to challenge the cap when making substantial renovations or improvements to the property.

Rent-controlled properties tend to have consistent cash flow.

Because rents are lower, and because tenants tend to stay in place longer, rent controlled properties tend to have consistent cash flow. What’s more, tenants in rent-controlled properties are less likely to move out during a downturn, which helps investors weather the ups and downs that are inevitable over the course of multiple real estate cycles.

Ultimately, the decision as to whether to invest in rent-controlled properties is a personal one. Rent control regulations can vary so widely–from highly restrictive policies in cities like New York and Los Angeles, to the more flexible rent control policy recently adopted in Oregon.

Anyone considering investing in an area with rent control should spend the time needed to understand the nuances of the policy. One misstep in violation with a rent control law could cripple an otherwise promising investment.

 

Would you invest in a rent-controlled property? Why or why not?

 

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