California rent control – the unintended consequences

What is rent control in California?

The California rent control law, also known as the California Tenant Protection Act of 2019 or CA AB 1482, is a law that limits rent increases for residential rental properties in California. The law, which went into effect on January 1, 2020, applies to properties built more than 15 years ago (applied on a rolling basis) that are not covered by other local rent control ordinances.

Under the law, landlords are generally limited to increasing rent by no more than 5% plus local inflation per year or 10%, whichever is lower. The law also includes other provisions to protect tenants, such as a ban on "no-fault" evictions (not based on the tenant's actions or behavior) and a requirement that landlords have a valid reason for evicting a tenant.

California is not alone when it comes to rental affordability challenges caused by rising rents. Recent estimates from the Census Bureau point to over 40%, or 19 million, of renter households being “cost burdened” by housing expenses – spending more than 30% of their income on housing costs. As this number has climbed, so has the political pressure in many areas for new policies to support renters.

The California rent control law has been controversial since it was passed, with some arguing that it is necessary to protect renters from excessive rent increases and others arguing that it will discourage new investment in rental properties and lead to a decrease in the quality of rental housing.

The unintended consequences of rent control

Laws that impose rent caps and other forms of rent control are meant to protect renters from excessive rent increases. Still, they can have unintended consequences on real estate valuations, markets, and the community's well-being.

Valuation impacts

One potential impact of rent caps is that they can reduce the value of rental properties. Because landlords are limited in the amount of rent, they can charge, decreased gross potential revenue can translate into lower valuations. However, this is mainly dependent on how restrictive the rent caps are.

Investment impacts

Another potential impact of rent caps is that they may discourage new investment in rental properties. Landlords may be less likely to purchase or maintain rental properties if they cannot charge market-based rents. This could lead to either a decrease in the supply of rental properties and/or a decline in the quality of the existing stock. A decrease in the overall supply could drive up rent prices in the long run, while a reduction in the current stock could decrease the quality of life for the renters.

Renter's benefit, but not without a cost

Overall, the impact of rent caps on real estate valuations and markets is complex and multifaceted. Many research studies have analyzed this topic over the years, only to find that the impact and effectiveness of these types of policies depend on the perspective from which effectiveness is being judged. For example, some recent papers have shown how rent control policies help increase tenant well-being and promote economic stability for renters but decrease market supply and contribute to increased market rents.

What other markets have imposed similar restrictions?

There have been many cities and states in the United States that have introduced rent caps since 2010. Some examples include:

• Oregon: In 2019, Oregon passed Senate bill 608, a statewide rent control law that allows cities to implement rent caps on properties over 15 years old.

• New York, NY: In 2019, New York City passed Senate bill S6458, a rent control law that limits rent increases for rent-stabilized apartments to 2.5% per year.

• Washington, D.C.: In 2020, the District of Columbia introduced a temporary rent control law that limits rent increases to 2% per year for properties with a rental license.

These are just a few examples of rent caps introduced in the United States in recent years. It is worth noting that rent control policies vary significantly from jurisdiction to jurisdiction, and many other cities and states have implemented similar policies.

Where does California rent control go from here?

Ultimately, due to the high limit, the impact of AB 1482 has been less pronounced in valuations. With the cap being the lower of 5% plus local inflation or 10%, the immediate value impact has been insignificant as appraisers typically do not model projected rent growth at that level.

In the case of renovations, a valuation may see notable rent increases year-over-year, but these increases are due to rent premiums from these unit renovations and are not restricted by this rent control law.

While the immediate impact of this law may not be pronounced, there may still be long-term effects. In recent quarters, some markets have experienced very strong fundamentals, and the rent control law has limited their current rental rates. Assuming the strong fundamentals persist, the recent California rent control law may result in prolonged periods of positive but slower rent growth as building owners capture increased market rents later in the cash flow for properties in higher-growth markets.

Recently city councils are facing increasing pressure from tenant groups to pass even more restrictive caps on tenant increases. With inflation at a 40-year high, more than 1.3 million California households report being behind on rent payments. City councils, including Antioch, Oakland and Santa Monica, reduced the rent increase cap to 3%, while Pomona and Bell Gardens limited increases to 4%.

An alternative to rent control laws

At a time when property owners are facing rising operating costs, pressure to cap rent increases below the rate of inflation may lead to further declines in the maintenance of rent-controlled housing stock. It may be time for cities to consider incentives for developers to provide new affordable housing rather than imposing additional restrictions on the existing stock.

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