In any business, sometimes it’s profitable to get involved in a sector that has some major “barriers to entry.”
A barrier to entry is an obstacle – such as government regulations, education hurdles, or licensing requirements -that make it difficult for new business operators to enter a given market. In rental real estate investing, the barrier to entry can exist in towns that have rent control regulations and statues in place.
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What is Rent Control?
The concept of “rent control” refers to particular laws or ordinances that maintain price controls on the leasing of residential housing. Rent control is intended to protect tenants who live in privately owned residential properties from excessive rent increases by mandating gradual rent increases, while at the same time ensuring that landlords receive a fair return on their investment. However, rent controls also stymie many income owners, but they do create an opportunity for the imaginative and enterprising income investors.
Why is Rent Control Good for Income Investors?
Rent Control regulation typically follows a pattern that, over time, decreases the available supply of rental units, thus increasing the excess number of tenants in need of rental units. This excess demand puts income investors in the driver seat and creates two major opportunities:
- Negotiation power when it comes to dealing with current and future tenants
- Opportunity to find income properties that have been allowed to deteriorate due to the owner’s inability to raise income effectively – thus forcing them to sell at a discount
How to Produce Profit under Rent Control?
Sure, the enterprising income investor can find income properties selling at a discount in rent control municipalities but the question remains – how can YOU be a better owner than the previous seller? Here are a few methods that you can utilize to create a profit in rent control municipalities:
- Hardship Increases: If you are going to be buying properties with below market rents then you can apply for hardship increases with the help of your landlord-tenant attorney. Rent control regulations typically permit raises for special hardship cases because, as I mentioned earlier, rent control regulations still want landlords to “receive a fair return on their investment.” Regulations for different cities define a fair return differently, so check into your rent control law before applying for a hardship increase. In my target investment cities, a net rate of return less than 7% per annum typically allows a landlord to apply for a hardship increase.
- Reduce Turnover Expense: In municipalities with no vacancy rental control, you as the landlord have the negotiation power with tenants when it comes to turnover related repairs. Normal painting and cosmetic rehab that you would have to complete in non-rent control municipalities can be partially eliminated as long as the unit is rentable by regulations standards. Yes, tenants may ask for new painting or certain cosmetic repairs but remember – you should have a long list of anxious prospective tenant as these tenants know that their rents cannot be increased above the rent control rules; hence, they will often accept units with cosmetic flaws. This reduction of turnover expense will increase the bottom line cash to the landlord owner as well.
- Capital Improvements: Rent can be raised typically in rent control regulation municipalities by completing significant capital improvements to the tenant’s units or the building itself that are distinguished from ordinary repair, replacement or maintenance. Capital improvements can be done in the following ways:
- Addons- Adding items such as laundry, parking space or self storage space and including it’s use within the tenant’s monthly rent can increase your net cash flow and your asset value. For instance, if you installed self storage bins and gave the tenants access to them for an additional $25 per month. This add-on will increase you annual rent by $300 per year which in a 10% Cap neighborhood will increase your asset value by $3,000.
- Conversion- This idea comes from Mr. William Nickerson who states that “sound conversions will remain rentable in competitive market and may often represent highly profitable investments.”I utilized his idea of conversion to convert a spacious studio apartment at one of my properties into one bedroom unit by adding a wall, closet and other bedroom-oriented features. This conversion allowed me to increase the rental value from $550 per month to $675 per month on a recently vacated apartment – within a rent control municipality. How did I fare after adding the wall? The conversion to a one-bedroom apartment increased my monthly cash flow by $2,100 per year in turn increasing my asset value by $21,000 @ 10% cap rate. Overall the cost to add the wall and make minor space oriented modifications was under $4,500. If you are a return metrics fan like me then this is how it played out:
- Payback Period: Under 3 years from just net cash flow gain
- ROI: 46% (Not Accounting for the Increased Net Asset Value of $16,500)
Don’t be affraid to become an enterprising income investor and seek out opportunities in rent control cities. Often, this great “barrier to entry” can be a large benefit to your income investing business over the long run.