Lenders fear worst from rent control measure on California ballot

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WASHINGTON — Mortgage lenders are anxiously following a ballot initiative fight over rent control in California that they say could be detrimental for the industry as a whole.

Industry leaders and other observers say Proposition 10, which expand rent control options for local governments, could thwart affordable housing efforts and lead to property devaluations. That would present new risks for lenders evaluating the creditworthiness of commercial developers and municipalities planning housing projects.

If Prop 10 passes, “we’ll now have to be very careful in terms of underwriting multifamily properties, especially municipalities that either will have or looks like they will pass rent control measures,” said Jeff Burns, a managing director of Walker & Dunlop and an officer of the California Mortgage Bankers Association. “You don’t want a situation where you’re overleveraging a property that pretty soon can’t get the rent increases that they thought they were going to be able to get on a property.”

The ballot initiative, which Californians will vote on Nov. 6, would repeal the Costa-Hawkins Rental Housing Act. The 1995 law prohibited cities from enacting rent control on any residence built after February of that year, and froze rent control laws in 15 cities that had already passed them.

Proponents of the measure argue that limiting rent hikes would help solve the state’s affordable housing crisis, but the mortgage industry has contended that such a policy would make that crisis even worse.

Even the possibility of rent control in the state is already dissuading lenders and investors from backing multifamily and single-family housing projects, said Steve Maviglio, the spokesperson for the No on 10 campaign.

“This has been noted in almost everybody’s report that this could hurt profits, and therefore trickle down to building less apartments, which means an impact on banks,” he said.

Brian Burke, the president and CEO of Praxis Capital, a real estate private equity investment firm that specializes in multifamily properties, has already decided that his company will stop doing business in the state, regardless of whether Prop 10 passes.

“Even if Prop 10 gets defeated, there’s nothing to say that there’s not going to be a Prop 11 next year and a 12 the following year until these misguided folks either get what they want or, less likely, get the message, so we’re just not going to buy anything in California,” he said.

If the ballot measure were to pass, it would allow all 539 local jurisdictions in the state to decide how to approach rent control. And while proponents argue that this would hand the power back to local officials and residents, opponents claim that it would create a confusing “patchwork” of regulations that might make it harder to do business.

“That could really impact rent growth,” said Burns. “We’re just going to have to be really, really vigilant about understanding what different municipalities are planning to do if the ball gets thrown back to them in terms of what kind of rent control they could put in place.”

During an Aug. 29 webinar the Mortgage Bankers Association held for commercial and multifamily real estate professionals, Tony Russo, a partner at Russo McGarty & Associates, called Prop 10 “the most significant threat to the industry we’ve seen in California in years.”

If Costa-Hawkins were to be repealed, it would almost immediately lead to reduced valuations “across the board,” Russo said.

“All of the owner-operators we’ve been talking to are bracing themselves for a significant drop in valuations,” he said. “Many projects are stalled today, some that had just started. We’ve talked to owners that are frustrated and that wouldn’t have moved forward if they had known this was coming.”

Regardless of the outcome of the proposition, the fight for and against rent control won’t end with California, experts say.

“We have noticed that in working with the national MBA, what happens in California tends to be replicated in other states,” Susan Milazzo, the chief executive of the California mortgage banker group, said during the organization’s webinar.

If Proposition 10 were to succeed, it is "certain to be emulated by other states," the MBA said in a recent press release statement opposing the ballot initiative.

New York state and the cities of Portland, Ore., and Seattle, in particular, are all likely paying close attention to which way the California measure goes , said Burns.

“I think anywhere where you’ve got already a high barrier to building new supply and you’ve got real high housing costs, they’re going to be taking a look at this and seeing if this is something that is politically feasible to do,” he said.

But proponents of Prop 10 argue that it is at least a step toward solving a crisis in the state tied to uncontrollably high rents. More than half of California renters are considered “rent-burdened,” meaning that at least 30% of their income goes to housing costs.

“In and of itself, Proposition 10’s passage does nothing but return to local government the authority to create policies to limit rent increases,” said Damien Goodmon, the director of the Yes on 10 campaign. “We’re going to see not just renters and landowners, but elected officials and other key stakeholders come to tables and figure out what type of housing policy works best for their city or county.”

Supporters of repealing Costa-Hawkins claim that doing so would boost the state’s economy and would even be beneficial for business. Many point to a McKinsey Global Institute report that found that California’s housing shortage costs the state more than $140 billion each year in lost economic output. That includes "lost construction investment as well as foregone consumption of goods and services because Californians spend so much of their income on housing,” the report said.

“In cities where there’s actually a stable rental market … that then encourages new construction to be geared for the incoming creative class, so to speak,” said Goodmon.

An analysis by the Sacramento Bee and the Bay Area News Group also found that real estate construction in California has correlated more closely with the economic cycle than with whether rent increases are restricted.

Still, proponents of the ballot measure point to a lack of research on the claim that repealing Costa-Hawkins would negatively affect construction and consequently lenders, said Goodmon.

“I would want to know where the actual studies are that suggest that this would have an impact,” he said. “They don’t exist; they’re simply theoretical.”

Others say there is no other workable alternative to solving affordable housing woes than making rent more affordable.

People are also increasingly frustrated that there are no other solutions to affordable housing in the works.

“More of the status quo will never alleviate the challenges that we face,” said Tracy Rosenthal, a member of the Los Angeles Tenants Union. “Another thing we have determined from the beginning is that the people who are most affected by the lack of affordability and by the displacement crisis, that those should be the people who determine the solution to those crises.”

Isaac Boltansky, the director of policy research at Compass Point Research & Trading, pegged the chances of Prop 10 passing at about 60% in a research note, but emphasized that the decision to enact rent control is ultimately up to local jurisdictions.

“Equity investors will likely shoot first and ask questions later if Prop 10 is passed in November, but we note that it will take time for the local governments to implement new rent control policies and industry interests will surely take their fight to the local level,” he said.

In fact, opponents of Prop 10 have already mobilized to continue the fight at the municipal level, said Maviglio.

“What you might be seeing now is there’s a lot of local measures being debated that would automatically kick in if Prop 10 passes,” he said. “A lot of the activist and tenant groups are already working on the local level to get something on their ballots.”

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