By Gabe Johansen
Over the last few months, you have undoubtedly read numerous articles about rent control. With the passage of SB 608, Oregon became the first state in the nation to introduce a form of statewide rent control which was passed under the guise of rent “stabilization”. While the new changes for landlords are many, there is one question on a lot of minds that has not been answered. How does rent control affect the value of multifamily property?
The answer to this question is multifaceted. There are many factors that weigh on the value of real estate, especially when considering the income-generating nature of multifamily real estate. With rent control now in place for 2019, rent increases can no longer exceed 7% plus the West Region Consumer Pricing Index (currently 3.1%). For the average property owner, this is not an onerous restriction. In most cases, managers do not increase rents by more than 10% in any given year because landlords prefer to keep their current tenancy in place and avoid costly turnover expense and vacancy loss. But what happens if one decides to sell or refinance their property? Let’s take a look at three factors that affect the value of rental property.
Prior to the passage of SB 608 on February 28th, 2019, the common practice of listing brokers was to price properties based on pro forma rents. In a seller’s market when rents are on the rise, buyers are lined up and willing to pay top dollar for an income stream that does not yet fully exist. It is then the job of the buyer to increase rents as quickly as possible in order to make their investment cash flow. If a property’s rent roll is already near market levels, the value of the property can be based on current income. However, if there are tenants currently paying below market rents, the new rent control laws are going to make repositioning the asset a much longer process. This is already having a negative effect on the values of under performing properties.Sophisticated buyers are not willing underwrite the value of a property based on rents that will not be achieved within the first year or two of ownership.
Since the passage of statewide rent control in Oregon, multifamily brokers are starting to take a new approach to pricing. Brokers arrive at listing prices based on the income that a property will produce after its initial round of rent increases within the guidelines of SB 608. This means that if a property’s rent roll is trailing the market by more than 10%, it will be difficult to maximize its appraised value in the event of a sale or refinance, thus bringing the market value of the property down.
SUPPLY AND DEMAND
While the legislature is currently working on ways to increase the supply of housing, historical data shows that rent control slows development, creating a greater shortage. If this holds true for Oregon, we will see a decline in the number of multifamily units being developed and a further increase in the demand. For investors, this is good news in regards to the value of their multifamily holdings because it limits competition from new properties that are coming online.
An artificially low inventory will drive rents higher and thus continue to push the value of multifamily properties to greater heights. As long as the demand from renters remains, multifamily property will appreciate as a result of higher yields albeit at the cost of Oregon families, many of whom are already struggling to make ends meet.
Supply and demand will drive the market to value property based on scarcity. In 2019 Q2, Oregon saw a 38% decline in multifamily transactions and out of state investment dropped to nearly zero. Much of this could be due to the pipeline shadow of 2019 Q1 that had many investors scared to make a move, not knowing what the new rent control laws may look like. This may be a boon for local buyers because it will reduce acquisition competition, but the value of multifamily property could decline due to a decrease in overall buyer demand.
Now that the dust has settled, investors are coming back to the market. Some owners have decided to sell because they no longer wish to deal with the tightening landlord-tenant laws and other owners have decided it is a good time to reposition their portfolios and are now more aggressively pursuing 1031 tax-deferred exchanges. Listings are going live at a pace we have not seen for some time which creates a different form of competition and can place downward pressure on prices. With more sellers and less buyers, we are beginning to see equilibrium in the marketplace and while property values will continue to improve over time due to supply and demand, the days of explosive growth are probably over for now.