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New Rent Control Proposal: Could This Be The End Of Landlording As We Know It?

by Darren Sager on May 20, 2014 · 9 comments

  
Post image for New Rent Control Proposal: Could This Be The End Of Landlording As We Know It?

A few evenings ago I attended a meeting of the Property Owners Association of NJ and as usual there’s a point in our meeting when the attorneys who work with our group get up to speak about what changes have recently taken place that we landlords need to be aware of.

Besides the mentions of changes that needed to be in our leases going forward, there was a moment during the presentation that caught my attention, and that of everyone else in the room.

They mentioned two words that have been my bane since I started investing in Real Estate: Rent Control.

I am not a fan of rent control. I never understood how its beneficial to any market.

I know that it was recently mentioned on Podcast 66 with Michael Blank who mentioned it, saying that there are cases where it can be beneficial, but (and no offense to Michael) I personally have never seen a case where its been beneficial to anyone including the tenant!

Related: BP Podcast 066: Flips, Apartments, & Protecting Yourself From Professional Tenants with Michael Blank

My personal opinion is that it destroys markets instead of protecting them. So when attorney Derek Reed said those two words, yes it grabbed my attention!

According to most recent news there is much talk about Newark, NJ changing its rent control ordinance. The proposal, should it pass, will in my opinion immediately cause investors to look away from this market.

In fact it will probably make them run away from it. Derek was kind enough to share a handout to anyone that was interested.

According to his handout, a landlord in Newark can currently raise rents up to 5% per on dwelling units 49 or less, and 4% if they’re 50 dwelling units or more.

The proposal seeks to limit the raise to equal or less than the CPI (Consumer Price Index) for the preceding 12 months for the New Jersey area, but never to exceed 4%.

Using CPI multifamily property owners would have obtained, on average, a 2% rent increase since 2009 and possibly as low as .8%. That alone would send me running however it’s just the beginning…. and it doesn’t end there.

Additional proposed changes include:

Major Capital Improvements (MCI):

Current ordinance allows a landlord to recoup the cost of MCI however the proposed changes eliminates MCI for “Major New Improvements”.

That means if the existing elevator needs replacing you will not be able to recoup the costs of upgrading it since it’s not “new”. According to Reed this could deter property owners from replacing critical building items such as roofs, boilers, elevators, risers, etc. And the sentiment amongst the group came out in the form of moans and groans.

Vacant Unit Rent Increases:

The current ordinance allows owners to apply for a 25% increase of a previously rented unit that had undergone renovations equal to $100 per room.

In most cases that could be just painting a room and you can get a price increase. The new proposal seeks to limit the increase to 20% of the previous rent as long as the renovations equate to $5,000 per room.

This is a 4900% increase and as Reed pointed out, simply unrealistic.

I don’t know of any of us that would consider investing and fixing up a rental knowing that they couldn’t bring the unit to market value in rent after performing renovations.

Reed states that the typical one bedroom apartment there has 3-4 rooms. Owners would spend $15,000-$20,000 in order to be eligible for an increase of 20%. So, chances are most owners will not make upgrades or repairs as a result of this.

Substantial Compliance:

This is most important as the new proposals say that unless the property owners are not in violation of “heat, hot water, water, air conditioning, elevator, and all health, safety and fire violations, as well as ninety percent (90%) qualitatively free of all other violations” they will not be allowed to increase the rent a single penny.

According to Reed there is no way that a landlord can prove “Substantial Compliance” in a city where the inspectors are already in in short supply and overworked.

Can we expect this to happen or is this pandering to the voter base?

If this language is adopted by Newark property values will instantly decrease. I don’t know of a single potential landlord that would be willing to invest in Newark under these scenarios.

Reed brought up an interesting point when he asked the group how many of us had property in Newark. A fair amount raised their hands. I did not.

Still it didn’t matter because Reed went on to tell us that this was not just a problem for Newark, NJ, it was a problem for all of us.

If language like this could get adopted in Newark it would make it much easier for the language to be adopted in other towns locally and then in other counties and other states.

Rent control anywhere is a national issue when you’re a real estate investor. Nowhere else in society are we limited in how much we can earn off our investments.

Related: The Impact of Rent Control on Landlords: A Commentary

If overall property ownership is decreasing nationwide and more people are renting, its a threat that language like this can get adopted anywhere. We landlords it seems, will consistently be portrayed as bad people, taking advantage of others however that’s not the case.

The majority of us aren’t large holders with hundreds of rental units. We just people like anyone else trying to do our best and make a decent living.

Right now Newark is experiencing a boom of investment in places like downtown and the Ironbound section. This area is now being sought after by those who like great food and an easy commute into New York City.

Housing prices have increased sharply over the past couple of years as demand for the area has gone up. Its helping revive neighborhoods and the city itself.

Conclusion

It’s the opinion of many other than just myself that Newark, NJ hasn’t lost the stigma it attained in the 1960’s when it experienced race riots.

From that point on the city has had a dark cloud hanging over it, similar to Detroit. There have many who’ve tried to revive the city and great things have taken place. Sharpe James brought in the New Jersey Performing Arts Center and other improvements.

However he’s since been to prison for conspiring to sell 9 city lots to his mistress. After James, Corey Booker came in and did a world of good and the city has now seen its best years since before the riots.

Unfortunately he’s gone now.  And now it looks like Newark could be going back to the ways that made it a blight on the landscape of New Jersey. This is very sad.

In my last train ride into New York City (which takes me through Newark) I marveled at the site of new construction. There were cranes reaching high into the sky of downtown Newark where there hasn’t been any in a very long time.

It would be sad to see the progress come to an end. If it can happen here in New Jersey it will happen in Los Angeles, Chicago, Seattle, Denver, Miami, San Francisco, etc. Do I need to list more?

What do you think the impact will be if this proposal is approved?

What can we do to make sure it doesn’t happen?

Be sure to leave your comments below!

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{ 9 comments… read them below or add one }

Bruce Silverman May 20, 2014 at 8:23 am

Socialism at it’s finest! This is why these “social” policies don’t work. They take all the incentive away from investors, not only to buy investment property, but to improve it. Money losing investments are standard for Governments, not individuals. Unfortunately, government run public housing has always been a disaster, so they want to leave it up to private individuals to own and manage the property, then dictate how they do it!!! Like most government run programs, it makes no sense, is not economically viable and will lead to less housing and in poorer condition.

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Alex Craig May 20, 2014 at 8:24 am

Free-market should determine rent not government. I have a couple of investors that have bought property through me in Memphis and Little Rock because they live in the New Jersey area and don’t like the rent control scenario. Sure looks like it is already causing investors to run to other markets that are more landlord friendly.

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Adam Arrigoni May 20, 2014 at 8:33 am

Already happened in San Francisco….

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Kevin Yeats May 20, 2014 at 8:58 am

Politicians, policymakers and regulators who propose price controls would fail Economics 101. All goods are allocated in some way based on the relative value that the end consumers place on that good. When demand increases, prices rise incentivizing suppliers to produce more. When prices are held low by price controls suppliers find other ways to sell the good and receive something close to the “market value” from the willing buyers. Key fees and reduced maintenance are two of the most obvious means. Perhaps landlords in Newark, if facing rent controls on a residential unit will start charging parking fees or other fees for amenities. In the long run, the quality of the housing will decrease as capital moves to where it earns the highest return … a lesson that those that advocate for price controls have never learned.

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stephen May 20, 2014 at 10:24 am

With business you: “follow the money” to answer the question of why a decision was made.

With politics you: follow the vote-buying” to answer the question of why a decision was made. In poitics and with politicians it’s never altruism – it’s always vote buying.

In the US we have evolved a system were pretty much all votes are bought-and-paid-for in some way. And in this case the equation is very simple: there are more votes to be bought from tenants than there are from landlords.

Despite all the ‘warm & fuzzy’ talk to the contrary – the hard truth of the matter is that ‘Good for the neighborhood’, ‘Good for the city’, ‘Good for society’, or even ‘Good for the people’ has nothing to do with it.

The only possible start at solving the problem lies in the mandate: “Never vote for an incumbent.” But so far I seem to be the only one who thinks that way.

stephen
————

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James Hiddle May 20, 2014 at 12:10 pm

Sounds very socialistic if you ask me!

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Erik Little May 21, 2014 at 6:22 am

I see housing ‘buyers clubs’ in the near future…lets see how this goes. People are just going to look for ways to make the deserved money. Worse case senario, we will all pack up and leave leaving the city in the dumps with vacant properties and squatters everywhere.
Erik

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Jason May 22, 2014 at 5:52 pm

Many new rental developments in New York City use rent stabilization to collect a tax abatement. These are market rate apartments that are offered a rate stabilized lease as part of an incentive to build in under appreciated markets. It has been so successful that those areas would hardly be considered under-appreciated, such as the Financial District and Williamsburg. This is nothing more than a win-win for developers and the community.

I do not think in general it is something to fear, it’s just another policy that can be leveraged. Sure there are exceptions to every role (a rent stabilized tenant got a $17 million buyout recently at 15 Central Park West for example, but then again it is one of the most successful condo-conversions in history). And landlords with rent stabilized units often scrutinize applicants for available units higher, giving them a better tenant pool overall.

You claim in this that you do not want landlords to be perceived as the ‘bad guy’ yet your position is hostile to the common good of the community. It one thing to fear the unknown – it’s another to start pointing fingers before anything substantial is discussed.

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David Weiss May 22, 2014 at 9:00 pm

When I first read this article, the first comment was by an experienced investor who landlords exclusively in rent-controlled areas. She had a link to another web site where she’d posted an article detailing tactics for maintaining profitability in rent-controlled cities. I followed the link. There was very solid advice there. The comment appears to have been deleted for violating BP policy, (Maybe she could write a similar article for BP?!)

My point in mentioning it: change is scary, but change is also inevitable. Learning how to manage change and adapt to evolving circumstances is a crucial skill to any long-term businessman. Other investors have figured out how to profit in heavily rent-controlled cities. Clearly, they have something to teach that’s worth learning.

To quote Warren Buffett: Be fearful when others are greedy and greedy when others are fearful. Here’s one example of how one might apply Buffett’s wisdom to Newark. If the predicted mass exodus of investors fleeing Newark materializes, it will mean an influx of properties hitting the market at fire-sale prices as investors offload their portfolios. A savvy Newark investor might take advantage of this opportunity to meet with their CPA and lawyer to develop a strategy of picking up select fire-sale properties, selling some via wrap mortgages (producing passive income margins exceeding what was possible as rentals) and keeping others with little or no cash flow as rentals, using depreciation from the new properties to eliminate the taxes on the profits from the wraps. Under this strategy, an investor could increase their profits even from a portfolio with numerous no-cash-flow or even negatively cash-flowing rentals.

Yes, an investor might have to learn new strategies (how to owner-finance via wraparound mortgages and how to evaluate rentals when the priority is depreciation instead of cash-flow, in the preceding example). But that seems to me to be a small price to pay in order to figure out how to make money in environments blessed with a sudden reduction in competition from other investors.

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