René Nelson with Pacwest Commercial Real Estate and Zoe York, MAI Appraiser with Duncan and Brown, discuss the impact of rent control in the Eugene–Springfield area, looking specifically at value-add opportunities for older properties renting below market. René is committed to helping investors understand rent control and its potential impact on the multifamily market.
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Rent Control and Multifamily Property Investment
Zoe York: I’d really love to hear about your perception of rent control.
René Nelson: Rent control is impacting a lot of my multifamily owners that I deal with on an ongoing daily basis. I continue to educate myself and learn as much as I can so I can help give them advice and tell them here’s when you need to contact an attorney, here’s where you need to ask your property manager some of the important questions. You definitely need to be using the newest rental agreement forms, as an example. I am always advising people to consult with their real estate attorney, because one mistake can cost a minimum of three months rent plus the damages. It can get really expensive quickly.
That said, I also feel like it’s important to learn the ins and outs and what we’re going to be able to do as property owners. I’ve attended seminars and done a lot of research to keep on top of the latest information.
In our area there are a lot of 1970s and 1980s apartment units, where people really haven’t done much for improvements and their rents are below market. Their rents are in the $662 to $700 range for a one bedroom, one bath, but right now if you looked in the Eugene market, I’d say it’s closer to probably $850 at a minimum. So if you’re at $650 because you have been lagging behind the market and you haven’t had any vacancy, you’re going to have a tough time at 10 percent rent increases annually to catch up to where you should be at 850.
For that reason I think a lot of multifamily owners may consider selling because they’re just going to get to that point where they’re concerned about rent control, they don’t like the government mandating what they should be doing. And I think for a lot of people may also be in that final stage of retirement and now they’re looking at rent control, thinking, “I wonder if they’re going to change the rule or the limit.” Because at 7 percent plus the 3 percent CPI, it’s around 10.3% this year, but if they lower that in the next legislative go round, maybe in two years, they could change that. There’s no guarantee that it’s going to stay at a 7 percent on an annual basis. Last year San Francisco was around 1.7 percent. If all of sudden rents were capped at 3 percent, then that’s hard to even keep pace with maintenance and repair and property taxes.
Using Value-Add to Increase Rents
I have been encouraging my multifamily owners that are wondering what to do to consider a value-add opportunity, where they transition their tenants out. Of course, they have to ask their attorney or their property manager and talk about this, but there is a carve-out in Senate Bill 608 that allows you to give a 90-day no-cause notice if you’re going to have a family member that lives in the property or if you’re going to do a substantial rehab or renovation to the property.
An easy measurable tool for this is habitability, which I heard an attorney explain at a seminar. His example was that if you’re going to go into an apartment and rip out the bathroom and the kitchen, then the unit would have no hot water, no toilet, no sinks, and no way to cook, making the unit technically not habitable. If you have an available unit in your apartment complex, you have to move them there first. But let’s say it’s your average 20-unit apartment complex and it’s 100 percent full and you want to go in and rehab five of those units, you could give notice to those tenants. In this situation, the owners are going to have to pay one month of rent because that allows the tenant to have some cash to pay deposits for when they want to move. But this gives multifamily owners the opportunity to go in and rehab those units and get rents back up to where they should be.
Zoe York: I agree with that, and I do think habitability is an important thing to consider and to talk to an attorney about. Owners want to meet that standard of the unit not being habitable for renovation, because if you have below market rent in this strong market, it’s going to be very tempting to go in and just paint and do the floors and call that a significant renovation. I’m not sure that would classify as not being habitable, so I think multifamily owners are going to want to be careful. They should talk to their attorneys, make sure they’re not doing the bare minimum, which could get them in trouble and open them up to liability.
We have a lot of these older complexes that have deferred maintenance, and so they need some improvements anyway. A lot of them need improvements to the exterior and to the roof. And those types of improvements would not classify for making the unit uninhabitable, but if you’re going to do those things anyway, this is a great opportunity to get your rents up to market and kind of loophole around the rent control. When you’re looking at a pretty significant capital expenditure, but you’re looking at a capitalized a couple hundred dollars per unit per month rent increase, I think it probably does start to pencil out for property owners.
Another consideration is if you have a property that’s below market like that and you don’t have the value-add when you go to sell it. You basically have to get your rents back up to market over the long-term with the rent increases in order for you to maximize your property value. That makes you not very liquid in your real estate during that stabilization time, or you have to be willing to take a hit because somebody else is going to have to do that stabilization.
I think you take a risk as a property owner if you’re just slowly increasing your rents with the rent control ordinance because over that stabilization period, your property is worth less because the rents are lower. This makes value-add an important opportunity to make sure that your real estate is a little bit more liquid by adding that value immediately rather than waiting for the market to catch up.
René Nelson: I agree. I’ve put together a rent control packet especially for out-of-town investors because I think a lot of owners are unsure how to proceed since Oregon is the first state that now has statewide rent control. I want to educate owners on what they need to do to protect themselves.
Zoe York: I think at this point owners need prudent management and to really understanding what they can and cannot do. The rent control cap is very large. We’ve previously discussed that historically rent increases have been at 3 percent per year, and 10 percent is well above that. The true impact on values right now doesn’t appear to be on anything that’s not well below 10 percent below market rent. But I think the big problem for investors right now is this concern that it might change in the future.
We seem to have this balance of what’s currently happening with rent control, and numerically it’s not actually causing that much of an impact, except for the properties that are well below market, and the fear of what could happen. You have the investor perception of fear of change and fear of government control in the future. I believe those two things are going to be balanced for both investors coming into Oregon and current property owners; both have to deal with what is actually happening as well as their perceived risk. Because this is a fairly new bill, we’re going to see over the next 9 to 12 months what’s actually going to happen in the market.
If you have questions about rent control and investing in multifamily properties, contact me today: René Nelson 541-912-6583 / firstname.lastname@example.org www.eugene-commercial.com. You can also visit Rent Control Central.