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Opinion

Rent control will kill multifamily real estate

One of the side effects of years of denying the truth about inflation and the rising cost of living in the U.S. is the ongoing destruction of multifamily rental properties as an asset class. The happy campers at the Federal Reserve Board and Bureau of Labor Statistics tell us that inflation is low, sub 2%. In fact, across the country real people are experiencing real inflation closer to double digits, a harsh reality that is causing a groundswell of progressive proposals from modest rent control to effective confiscation of multifamily real estate in states like New York.

The proportion of Americans who own a home or hope to has fallen dramatically since 2008, creating a vast sea of permanent tenants that provide fertile ground for socialist elements to recruit new supporters. The Real Deal reports ("How rent control battles are playing out across the US") that in Philadelphia, radical progressive groups have organized renters into a "tenant union." "Now, organizers and socialists show no signs of stopping, as they canvass neighborhoods in small teams to build support for rent control," TRD reports. It continues:

"Much of the reason the debate is generating such interest now is simply demographics: at least 5.4 million single-family homes were converted into rentals in the decade after the foreclosure crisis. No longer just a stop on the way to homeownership for those near the poverty line, the share of renters has dramatically increased. Renters are now the majority in the 100 largest cities in the United States, according to a 2017 Harvard study."

Back in August, the Institutional Risk Analyst featured an interview with Dale Hemmerdinger ("The Interview: Hemmerdinger on the End of Hope for NY Multifamily Housing"), the head of a New York family that has developed multifamily rental properties for generations. He talked about how the new rent control laws passed by the New York Legislature would slowly kill multifamily rentals in New York as an asset class. He told the IRA:

"By limiting the ability to move rent-controlled apartments to market rates, you have taken away any hope for investors to make these properties grow in value. And you have damaged these assets in terms of financing. Who wants to finance a property that cannot recover costs and therefore must slowly deteriorate?"

A combination of rising costs for living and construction, increased prices for property and also restrictive zoning rules, have effectively blocked the construction of new housing, according to consumer activists. But the truth is that "affordable" housing has not been economically viable in major American cities for half a century. Building below-market rentals in American cities such as New York and Chicago always required subsidy. With costs rising to more than $5,000 per square foot to acquire and build in the five boroughs of New York, the amount of subsidy required to rent a new unit below market rates makes such projects impossible.

The sad part of the latest upsurge in progressive angst is that rent control laws are not going to increase the stock of affordable housing in major U.S. cities. In the past, when confronted by confiscatory rent control laws, owners of housing would simply convert the units into condominiums. In this, more extreme cycle of contrived socialist anger from aspiring politicians, many developers may be forced to take far more desperate action.

Going forward in New York, owners are likely to simply gut vacant, unimproved apartments units in the rent control system and wait for the law to change. Renting an apartment that has not been refurbished in decades creates enormous risk for tenants, landlords and lenders. Since the New York State Legislature and Gov. Andrew Cuomo have decided to prohibit landlords from recapturing capital costs needed for refurbishment, a number of landlords have decided to simply take these units off the market. Market prices for rent-controlled buildings will fall and many of these properties could eventually be abandoned, as occurred in the 1970s.

In financial terms, the damage has already been done in cities like New York, which passed a very aggressive rent control law last year. Lenders are already backing away from these assets due to the likelihood that the income generated by the property will fall. Banks involved with lending on multifamily properties nationally have hundreds of billions of dollars at risk. Bond investors own many billions of dollars more in mortgages and other financing to support this asset class. As tenant advocates press for even more restrictive rules for rents and capital improvements to support asset values, look for the flow of investment into multifamily real estate to dwindle.

California will cap rent increases under a new law signed by Gov. Gavin Newsom. Some call the measure the most significant piece of housing-related legislation in the hyper-progressive state, but California politicians still refuse to relax zoning rules to spur more construction of affordable housing. California talks about helping affordable housing, but its powerful homeowners and developers refuse to support polices that would allow new construction in affluent areas of the state in practice.

The pretext used by Newsom for imposing rent control is the growing homeless problem in cities such as San Francisco and Los Angeles, where tougher rent control laws already exist than the statewide measure just signed. "If rent control helps reduce homelessness, why is the problem so prevalent in the very cities that already have it?" writes Jim Breslow in the New York Post. "And how is extending it to the rest of the state supposed to address the issue?"

The short answer to that question is it's not. Rent control laws are unlikely to increase the stock of affordable rental housing in major U.S. cities, but this is a global phenomenon. Countries such as Germany and Denmark are adopting rules to control rent and discourage foreign investors in multifamily real estate. But investors and landlords are not the enemy. The real problem with the cost of housing in most industrial nations is inflation — the real rate of increase in the cost of living. Inflation is an issue that eventually turns on monetary policy and the ebb and flow of the financial markets.

A century ago, in the years immediately following World War I, many U.S. cities tried their first experiment in rent control, with disastrous results. Wages and prices were also tightly controlled during the war years, but these measures were eventually abandoned as unworkable because of persistent inflation in the basic cost of living in major cities. Then, in the 1920s, the Fed actually allowed wages and prices to fall in order to correct financial excesses. Imagine allowing rents and home prices to go down. Today, in the post-2008 world, policymakers fear deflation more than any other possibility and thus open advocate higher inflation.

Until such time as the Federal Open Market Committee is willing to allow wages and prices for necessities and housing to deflate, there is little hope of seeing a solution to the problem of affordable housing. As progressive politicians try to gain favor with consumers with rent control laws, the stock of affordable housing is likely to shrink as banks and private investors increasingly shun multifamily real estate as an asset class. And as the stock of affordable housing dwindles in cities like New York, Los Angeles and San Francisco, look for a lot more political rhetoric, but little in the way of actual relief for inflation-stressed consumers.

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