Lenders aren’t scared off by California’s statewide rent control

The movement for multifamily rent regulation has gained momentum nationwide over the past few years, and the pandemic has increased political and popular support for tenant safety. The effects that these policies will have on their business and their capacity to create housing have been vocally expressed by multifamily owners as a source of concern.

Owners are actively avoiding markets with rent limits or seriously considering leaving markets that enact these rules, according to a report by the National Multifamily Housing Council from earlier this year.

However, according to industry experts who spoke with Bisnow, California’s state and local rent control and limit regulations haven’t had a significant influence on multifamily financing. However, some projects, like value-add deals, have become more challenging to complete as a result of these and other laws affecting multifamily developments, particularly the still-in-effect eviction ban in Los Angeles.

Across the country, rent control is becoming more prevalent. In 2021, St. Paul, Minnesota, approved a 3 percent rent cap. According to a recent article in The Wall Street Journal, legislation that might establish rent restrictions has been proposed in at least a dozen states. The legislation would forbid landlords from raising rents by a percentage more than 2% to 10%. According to the WSJ, nationwide rent increases since the start of the pandemic have averaged 18%. According to Insider, the states with cities that are considering similar restrictions are diverse in terms of geography, demographics, and ideologies. They include Arizona, Florida, Illinois, Kentucky, New Jersey, New York, Washington, and Massachusetts.

In 2019, Gov. Gavin Newsom signed AB 1482, which places a 10-year cap on how much landlords can raise rent in a sizable number of buildings throughout the state. California has had rent regulations in various forms for decades. Rent increases of more than 5% plus inflation per year are prohibited for multifamily landlords, as well as for owners of condominiums and single-family houses who are 16 years of age or older. According to the statute, landlords are also required to give “just cause” for evictions.

According to Doug Perry, senior vice president of sales at Archwest Capital, the law didn’t have the significant effect that many in the CRE industry had hoped.

The landscape didn’t shift overnight, according to Perry, whose company is a direct commercial lender with a nationwide concentration on multifamily and mixed-use properties. Rent control rules haven’t affected the way we underwrite loans, but they have made some situations a little more difficult.

For instance, it could be more challenging to complete a value-add project that entails purchasing a property with a lot of unfinished maintenance, upgrading it, and then boosting the rent.

According to Perry, “Those projects don’t get done as much because they can’t be done from a compliance standpoint with the rent control laws.”

There are workarounds that can be useful, such as “cash for keys,” in which a renter is given a lump sum in exchange for leaving a rental property. Most of the time, the rent for the apartment can be changed to reflect market rates. However, it can cost a lot of money to evict residents, and that money isn’t going toward the main goal of these projects, which is to improve the building so that the apartments can draw higher-paying renters.

According to Perry, “Sometimes the cost of doing that drives the cost of the whole project to the point that it’s just not a profitable project, and it doesn’t make sense.”

The impact of municipal rent control laws, as opposed to state-level ones, may be greater for smaller investors and individual owners who have investments in areas with such laws, according to Perry, but this is only a problem for specific projects and not a general problem.

Value-add deals may take longer to complete if there are eviction moratoria, like the one that is still in place in Los Angeles.

Shahin Yazdi, partner and managing director of George Smith Partners, which arranges loans for CRE borrowers nationwide, said that it is “simply not as realistic” for the borrower to expect to be able to turn an entire building when there is an eviction moratorium and you can’t perform no-cause evictions.

Instead, it is necessary to diminish expectations, either that it will take longer to empty the building or that it won’t be empty enough. This means that the transactions must make financial sense even if only a portion of the building—say, half or a third—is made accessible to new, wealthier tenants. But in other situations, the resilience of multifamily during the epidemic has made this conceivable.

Regarding Los Angeles and its current eviction moratorium, Yazdi noted, “Multifamily continues to be a strong performing asset, even with people not paying. The foreclosure rates didn’t skyrocket. Landlords, maybe they did some deferred payments, but they continue to make their mortgage payments, so it’s a great asset class for lenders.”

Despite the optimistic response from the lender side, a study released in January 2022 by the National Multifamily Housing Council revealed that efforts to enact rent control are having an impact across the country, not just in California.

The study asked 78 CEOs and senior executives at national “apartment-related firms” if the growing number of areas that had implemented, strengthened, or were considering rent control or rent ceilings had an impact on development and investment decisions. According to 32% of respondents, people who practice rent control already shun those markets, and 26% indicated they had reduced their investment in those markets as a result of the local rent control policies.

But nearly as many respondents — 23% — said they don’t plan to change anything about their investments or developments in these areas despite rent control.

Despite the growing popularity of rent control pushes across the country, California seems to stick out among the crowd. Respondents to the NMHC survey were asked to list markets they are specifically avoiding, either due to existing rent control measures or the threat of new policy adoption. Of the 31 respondents who answered this question, 55% indicated specific markets in California or the state as a whole, NMHC said.

According to Jim Lapides, vice president of strategic communications for the National Multifamily Housing Council, “California is a uniquely difficult place to operate” because of the state’s rent control laws as well as the laws that local governments have either approved or are preparing to pass. It adds up for every city that enacts new rent control legislation and every moratorium that is still in place.
Despite these obstacles, investing there is still profitable, according to Lapides, and investors will continue to do so. According to a year-end analysis by CBRE, which used data from Real Capital Analytics, the greater Los Angeles region attracted $58.8B in investment expenditures in 2021, making it the biggest beneficiary of those funds. With nearly $35B in tourism, the Bay Area placed fourth. The statistics showed that apartments were the asset class that attracted the greatest investment in the East Bay and greater LA. (Offices in San Francisco received the most investment.)
According to Lapides, “California is always going to be an attractive market —  there’s tens of millions of people that live there, there are huge markets, it’s important for the industry. But this trajectory that they’ve been on is really going to hurt them.”
Perry, by comparison, sees a pattern of adaptation to the hurdles that California has created so far.
“The reality is rent control is here, statewide, it’s been here for a while, and we’ve learned to live with it, adapt to it, and make it work both from a lending standpoint and from a borrower standpoint,” Perry said.
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