Opinion: Proposed Restrictions on Landlords Could Devastate Investors—and the Housing Industry in General
"Landlord" is not a term I particularly like. It comes from the feudal era when serfs were tied to the land. Such an arrangement was fortunately abolished, so the concept of “landlord” really needs to be updated. New terms like “housing provider” sound a bit cheesy to me and “property owner” could denote either a homeowner or someone who rents out property, so it’s not very precise.
In addition, some landlords manage themselves and some hire out third-party property managers. Some investors actively seek out properties as their business and some just invest their savings into real estate. Regardless, despite my dislike of that antiquated word, I will use it for the remainder of this article.
And while there are a myriad of ways to invest and manage real estate, I will use the term landlord to denote the owner and manager of a property in order to keep what is already a very long article from becoming bogged down in caveats and minutia.
Current Uptick in Landlording Restrictions
Throughout the United States today, there is a growing hostility toward landlords and a major push against landlords’ ability to operate their businesses. Of course, I would never deny there are bad landlords out there (slumlords most notably). Indeed one of the reasons BiggerPockets exists is to educate property owners on how to manage their properties more efficiently and effectively—both to improve their own financial success and also to provide a better product to their customers (tenants).
Any good (or even decent) landlord despises bad landlords almost as much as tenants do, as these types give us all a bad reputation and make it harder for us to do business in general. And as anyone should be able to easily tell, what is true of landlords is true of every business, industry, and group of customers. Some are bad.
For this reason, tenants do need some protections. Landlords should have to give notice of entry, be expected to maintain livable conditions in the property, and go through a legal process for eviction that allows the tenant to rectify a delinquency. And there should be legal mechanisms for tenants to demand redress from negligent landlords, among other such protections.
Unfortunately, the laws we are starting to see proposed and passed are often counterproductive and unfair. Rent control—despite overwhelming evidence from both right-wing and left-wing economists that it doesn’t work—has passed in both Oregon and California. Minneapolis has passed major restrictions on property owners’ ability to screen for evictions, credit history, and criminal history, and Seattle has outright banned the use of criminal background checks.
Kansas City, where I live, has put forth a Tenant Bill of Rights, which would prohibit screening for evictions, credit history, or criminal history “unless the landlord can demonstrate the rental decision was based on all information available, including consideration of the frequency, recentness, and severity of a criminal record.”
This would seem to be quite vague and possibly violate Fair Housing, which requires we treat applicants the same. And while it doesn’t ban tenant screening, there is certainly a national push in that direction.
And by some proposal’s standards, that’s tame. Some just want to more or less ban the practice of owning and renting out property. Here, for example, is the proposal by People’s Action for “A National Homes Guarantee.”
“‘For us, this is the major intervention that takes housing off the market and decommodifies it,’ she (Tara Raghuveer, the Housing Campaign Director at People’s Action) says. The Homes Guarantee proposes taxing the appreciation of privately owned homes, while the 12 million new social housing units would put a massive number of new units off the speculation market entirely. The aim is to shift the paradigm—from homes as wealth stores to basic necessities.”
Their goal is, from what I can tell, 12 million units over a decade. Unfortunately, “taxing the appreciation of privately owned homes” would pretty much end real estate investment and residential development, if not homeownership itself. And given there was an annual rate of 1.3 million housing starts in October of 2019, even if this proposed government program delivered as planned (an unlikely event, to say the least), the total housing units added would very well be less than what it would be if they left well enough alone.
One might argue the housing being added by developers and investors is usually higher-end housing for wealthier clientele. While this is true, it underlies a complete misunderstanding of how the housing market works. Housing usually is built for a higher-end clientele, then as it ages, it shifts into more affordable housing. An A apartment becomes a B apartment after 15 or 20 years (or thereabout) and so on. Given newer construction is generally of higher quality (yes, there are noteworthy exceptions), each class of property improves over time.
In other words, in 10 years, A properties will be better than A properties today and B properties will be better than B properties today, etc. Furthermore, it’s real estate investors and landlords who buy those older properties, fix them up, and make livable accommodations out of them.
Finally, I can’t help but add that “decommodifying” real estate sounds awful similar to a particular political system that was thoroughly vetted throughout the 20th century and found to be an unmitigated disaster in terms of economic growth, human freedom, environmental degradation, technological advancement, and—of course—mass murder.
I won’t get lost in hyperbole here though. Thankfully, most of these proposals don’t go anywhere near that far. Even still, many of the tamer ones will make things worse.
Many Proposed Measures Are Counter-Productive
Even if you believe landlords are pure, unadulterated evil, presumably you would want to pass laws that actually made things better. The above laws will not. In fact, they would make things much worse.
We’ll start with rent control. One study of economists found a resounding 93 percent(!) believed “a ceiling on rents reduces the quality and quantity of housing.” The left-leaning Brookings Institute sums up the research on it quite nicely:
"New research examining how rent control affects tenants and housing markets offers insight into how rent control affects markets. While rent control appears to help current tenants in the short run, in the long run it decreases affordability, fuels gentrification, and creates negative spillovers on the surrounding neighborhood."
Markets facing housing shortages (like Oregon and California) are absolutely shooting themselves in the foot by disincentivizing home building with policies, such as rent control. And the very arduous building codes that California, in particular, is known for make matters even worse.
Indeed one study found that, “The broader point—which isn’t remotely controversial—is that California cities have some of the most restrictive building laws in the nation, and this is a big reason why the state’s per capita home supply is 49th out of 50 states, and why it costs so much to live here.”
Oregon and California also rank second and third for homelessness nationwide, and the research clearly shows that contrary to their intentions, these measures will just make housing even less affordable.
Preventing (or severely impeding) landlords from screening for evictions or felonies is truly another matter entirely. While I fully understand that people need second chances and also that it can be difficult to find a place after an eviction or felony, it is completely unreasonable to prohibit property owners from doing what banks and employers (including the government) do—namely screen applicants.
Reality is reality, and unfortunately, the recidivism rate stands at 43 percent. Every landlord I’ve ever talked to has noted that they had to increase their screening to stay in business due to the costs of bad residents. We ourselves have had several tenants do over $10,000 of damage.
And there are stories worse than that. Restricting screening is adding a major cost to landlords that many either can’t or will choose not to absorb by divesting.
Of course, I should be fair and note I’ve heard horrible stories about landlords from tenants, as well. This is why there does need to be laws to protect tenants. And even still, it’s also clear that there are people who will rent to those with checkered pasts, as well as charities that help in this regard. I've seen enough background reports from people with multiple evictions to know there are landlords who do. We ourselves do (as well as most landlords I know) after a certain amount of time has passed. And the best way to incentivize landlords to lease to such people is to create an abundance of housing (i.e., to incentivize construction and renovation) so supply outpaces demand.
Indeed such laws would be very bad for most tenants. Does Seattle, for example, really want to mandate that a landlord lease one side of a side-by-side duplex to a convicted rapist when a single woman lives on the other? One of the biggest complaints I’ve heard from tenants is “the landlord will put anyone in here.” Most tenants (including me when I was a tenant less than a decade ago) would not just want landlords to have the right to screen for criminal history—but would demand they exercise that right!
If politicians make it riskier for real estate investors to do business, simple economics tell us that less capital will go into housing. Less capital going into housing reduces supply and when supply is reduced and demand held constant, prices go up. These kinds of policies will clearly make housing less affordable.
Then why not have the government provide housing itself? I won’t deny that there are some limited instances this may make sense, but the government’s track record here is astoundingly dismal. Foreseeable catastrophes such as Cabrini-Green, Pruitt-Igoe, and the Robert Taylor Homes tended to concentrate poverty and increase crime and welfare dependency. As a study by the Federal Reserve Bank of Cleveland found, “…closing large public housing developments and dispersing former residents throughout a wider portion of the city was associated with net reductions in violent crime, at the city level.”
Section 8 vouchers are thereby much better than public housing. And while many landlords take vouchers, some don’t. Now there are laws in some states and proposals elsewhere to prohibit “source of income” discrimination. Instead of this all-stick approach, a much better solution would be to reform HUD and demand accountability. The Baltimore Sun elucidates the issue quite well,
“In May of last year, Johns Hopkins University and The Poverty and Inequality Research Lab produced an in-depth study for the U.S. Department of Housing and Urban Development. The researchers interviewed 127 landlords in Baltimore, Cleveland, and Dallas and analyzed 1.5 million administrative records on landlords and tenants in the HCV program. Roughly 40% of the landlords in the study were black, and 13% were non-black minorities; 60% of the landlords owned 30 or fewer units, with 20% owning fewer than 5 rental units.
“The report found evidence suggesting that administrative and procedural factors deter landlord’s participation, not racial discrimination (‘It is not the source, it is the strings,’ decry the landlords). The study also found evidence that administrative and procedural requirements are key factors deterring landlords’ participation, not profitability or social biases that many tenant advocates claim.” [Bold Mine]
What Landlords Offer Society
It’s quite odd to me that landlords are sometimes seen as substantively different than other entrepreneurs or investors. Would politicians and community activists prefer real estate investors just sent their money to Wall Street instead of investing it in their own backyards, simultaneously improving and maintaining properties in their communities?
And it’s not a small sum invested either. In 2012, BiggerPockets and Memphis Invest conducted a survey and found that the 28.1 million American real estate investors put in $9.2 billion to renovate housing. That number has certainly gone up substantially in the past seven years. And while much of that was to renovate dilapidated properties in order to resell, a huge amount went into rentals, as well. Further, that $9.2 billion doesn't count institutional investors, real estate development, commercial renovations, or the costs that go along with property management (such as turnover expenses).
Again, would it be better if these 28.1 million real estate investors sent all that money to Wall Street?
More people are also choosing to rent, which creates a greater need for landlords and property managers. Yes, affordability is the biggest reason—which means we should incentivize building and renovation. But more people, particularly millennials, are choosing to rent.
As Apartment List notes, “In 2019, 12.3 percent of millennial renters said they plan to ‘always rent,’ up from 10.7 percent just one year ago.” Some also prefer the “lifestyle benefits,” such as “more flexibility to explore living in new cities and neighborhoods, they can access new amenities at home, and they can avoid the hassle of home maintenance and unexpected housing costs.”
After the 2008 crash that, depending on your perspective, was caused by Wall Street banks or government/Federal Reserve policy (but not by landlords), there was a desperate need to buy and renovate the massive stock of foreclosed and vacant properties. One study that for the most part decried investors buying such properties (although it at least noted there are many “responsible investors”) made some key points worth discussing.
“More than 60 percent of damaged REOs, and about 20 percent of REOs and short sales are purchased by investors. In neighborhoods with a large share of damaged REOs, therefore, investors represent a major share of property owners, the majority of whom (58 percent) intend to rent out their property.”
The study sees this as being less than ideal. And perhaps it is less than ideal, but what is the alternative? Homeowners weren’t buying damaged REOs, because most homeowners want to buy something ready to move into. Plus at that time, banks would rarely lend on rundown properties, and most homeowners don’t have the cash on hand for such repairs.
So, the correct interpretation of this study seems rather obvious: Without real estate investors and landlords, these neighborhoods would have been utterly ruined. Most of the vacant and damaged properties would have stayed that way. This blight would have encouraged crime and discouraged future homeowners from moving in, creating what amounts to a neighborhood death spiral.
Again, I’m fully aware that there are horrible landlords out there. Sure. But even with bad landlords, most are not terrible people out to screw their tenants. They’re just in over their head, or they ran out of money to do repairs or something along those lines. Again, the large majority of tenants are good people. And even those who are evicted or agreed to trade “cash for keys” (an arrangement most landlords offer tenants instead of eviction) usually just fell on hard times.
If we can assume the best about most tenants, I think it’s only fair to do the same with most landlords. Indeed the above-mentioned study notes that “Most [landlords]have no formal training in real estate property management, and their competence and skill to maintain the property varies greatly.” The study also recommends more landlord training, which happens to include “best practices in applicant screening” by the way.
Related: Tenant Screening: The Ultimate Guide
And it’s only when something goes wrong that we tend to notice these things. I rarely think to myself, “Wow, what a great restaurant this is. They made my sandwich correctly and served me promptly.” Most landlords maintain their properties, make prompt repairs when needed, and treat their tenants fairly. Many landlords even do the maintenance and leasing work themselves; being a property owner is effectively their day job. Yet this sort of becomes background noise, as it did for me when I was tenant.
(Although, it should be noted that some go above and beyond, like this landlord in Connecticut, who found new homes for his 30 displaced tenants after a fire.)
Still, the variance incompetence amongst landlords leads to another important point. Since the days of margin buying have mostly gone by the wayside, stocks are no longer particularly risky to invest in. Yes, you could lose your principal, but you won’t go bankrupt if the Dow crashes.
Despite that fact, I strongly believe real estate is overall a superior investment. Indeed I believe the evidence is in, and investing in real estate is the best way for someone of modest means to become independently wealthy. (And this is something the government should be encouraging.) That being said, it’s undeniable that it requires a good amount of cash and often a good amount of debt.
There seems to be this myth that property owners just sit back and collect checks. In reality, the primary way most property owners make money is by equity build-up through appreciation and principal pay down—not cash flow. Investors who buy without debt will have substantial cash flow, sure. But again, they could just as easily send that money to Wall Street. Indeed if the property has debt on it, there usually isn't a huge amount of cash flow left over after all expenses.
For high-priced, coastal markets, this is basically a universal truth. This is less true with multifamily than single family houses. Although according to CBRE, the national average cap rate (which equals the annual profit of a property bought if there is no financing) was only 5.2 percent for infill and 5.49 percent for suburban multifamily properties in the first quarter of 2019. The cash flow is nice for the long-term investor, but it's not exorbitant, and it's by no means the primary way real estate investors work toward becoming wealthy.
Furthermore, the stereotype that investors make a fortune off poor people in bad neighborhoods is simply untrue. Ben Leybovich has made an extremely strong case that houses bought for under $30,000 simply do not cash flow, because the operating costs exceed the rental income. The evidence is overwhelming that one needs to be a specialist to succeed in such areas.
The last thing we need is to make it even harder to succeed as an investor in more dilapidated areas. This will just drive even more capital away, and increase the blight in those locations all the more.
I have seen quite a few investors go under (especially those who bought those really cheap houses in rough areas), and I have even bought several properties from investors being foreclosed on or investors who were foreclosed on. And I’ve had to tell some who were upside down on their mortgage that there was nothing I could do.
Even major investment companies, such as Maguire Properties (which had a portfolio of $2.88 billion in 2007) go bankrupt sometimes. A study in Economic Quarterly found little difference between foreclosure rates of owner-occupied and non-owner-occupied properties in the lead-up to the crash.
“In this study, a mortgage is considered in foreclosure if the mortgage defaults following origination. For example, mortgages originated in 2004 to non-owner occupants experience a foreclosure rate of 6.9 percent, which is slightly lower than the 7.5 percent foreclosure rate for owner occupants for the same origination year… For the years 2005–2007, foreclosure rates for non-owner occupants were 12.8 percent, 20.0 percent, and 17.4 percent, respectively. During the same years, the foreclosure rates for owner occupants were 12.3 percent, 18.7 percent, and 15.1 percent, respectively.”
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Being a landlord is more than just being an investor. It’s typically being a business owner, and it comes with noteworthy risks just like any other business. It’s not some mint that just prints out money.
I tend to be a free-market guy, but I won’t deny that the government can have a positive part to play in housing. Utah’s much-touted “Housing First” program’s results have been unintentionally exaggerated. It doesn’t appear to be a program that can help on a national scale, especially in areas with massive homeless problems, such as Los Angeles. Even still, it does appear to have done some good.
That being said, much of what the government has done, is doing, and has been proposed is counterproductive.
Furthermore, property owners and landlords have an important entrepreneurial role to play in our economy. It’s not fat cats sitting back collecting money. Instead, it’s usually the same kind of entrepreneurs whom those on both the right and left tend to appreciate—no matter what they think of the massive companies listed on the Dow Jones.
Landlords are just entrepreneurs and investors who have chosen housing as the industry to set up shop in. And severely restricting landlords’ ability to do business is going to hurt a lot of those entrepreneurs and investors, as well as the housing industry in general, making housing all the less affordable.
How do you feel about these types of landlord restrictions?
Weigh in with a comment below.