A Tale of Two Counties
By Mercedes Shaffer l Published in AOA Magazine
The Bureau of Labor Statistics has announced the 12-month adjustment (April 1, 2021 - April 1, 2022) in the Consumer Price Index (CPI) for the Los Angeles, Long Beach and Anaheim (Orange County) region has been set at 7.9%. This comes as no surprise as consumers have seen prices go up sharply for home sales, gas, food, supplies, services and even utilities. Most of us are seeing a 25% or greater increase in prices for building supplies, and 15% or greater for trades people. The steep rise in prices is felt everywhere – well almost everywhere.
If you own rental property in a city that has adopted a more restrictive local Rent Stabilization Ordinance (RSO), your local government will not allow you to keep pace with inflation.
One of the most extreme examples is the city of Los Angeles. Beginning on March 30th of 2020, the city of Los Angeles implemented a local “state-of-emergency” COVID-19 renter’s protection ordinance that prohibits owners from increasing the rent until one year after the emergency has expired, which is slated for the end of Mach 2023. This means that the rent freeze would last until April 1st of 2024. That’s FOUR YEARS that property owners will be forced to keep their rents far below market value.
While the city of Los Angeles has some of the most restrictive Rent Control Laws, many other cities in LA County and throughout California have local ordinances that are more restrictive than the California statewide rent cap that is established by AB 1482, which allows for an increase of 5% plus CPI, with a maximum 10% increase.
In Orange County, fortunately, all rental properties that are subject to statewide rent control can raise the rent to the maximum allowable 10% rent increase after providing a 30-day notice to tenants, and while this allows owners to keep pace with today’s inflation, it’s still out of sync with the housing and rental market, which has gone up on average of 20% in the past year. The only exception in Orange County is the city of Santa Ana, where there is a 3% cap on annual rent increases this year.
The Rising Cost Of Property Ownership
For property owners whose rental homes are subject to more restrictive local Rent Stabilization Ordinances (RSOs), providing rental housing won’t pencil out. A sustainable business needs revenues to exceed operating expenses and the government hasn’t put a freeze on raising property taxes which will increase by 2%, even during COVID. Other overhead costs related to upkeep and maintenance expenses such as landscaping, termite and pest control, property management fees, plumbing, painting, utilities and waste management fees have gone up significantly due to inflation.
Property owners are held to a rigorous standard for providing safe housing, and in addition to standard code compliance, a new ordinance in Los Angeles and San Francisco requiring seismic retrofits to be performed on soft-story buildings will set owners back tens to hundreds of thousands of dollars. To make up for these enormous expenses, housing providers will need to borrow money or dip into their savings to cover the cost of upkeep and compliance -- which will drive many to defer maintenance, or lose their business and be forced to sell.
The Decrease in Cash Flow and Property Valuation
Any investment property that is subject to a more restrictive local RSO will suffer from significantly below market rental income which will in turn negatively impact property valuation. As an example, let’s take 2 Fourplexes, one in Los Angeles and one in Costa Mesa. They both started out with equal rental income ($10,000 total per month for the past 12 months) in 2019, but beginning August 1st, 2020, all the rents for the property in Costa Mesa went up by the maximum allowable 5.7%, then in 2021 they went up by 8.6%, in 2022 they increased by the max allowable 10%, and if this inflation trend continues over the next 2 years the rents can go up another 10% each year. By the end of 4 years the property in Los Angeles that was subjected to a rent freeze would receive $93,744 less in income than the one in Costa Mesa. That’s a huge loss for those who invested in providing rental housing for people in Los Angeles.
The rental earnings for the property in Los Angeles would never be able to catch up to the one in Costa Mesa, especially because once rent increases are reinstated in Los Angles, the local RSO will likely be more restrictive than the state rent cap, so the losses would become exponentially greater with each passing year.
In addition, by the end of four years if they both decided to sell their properties using a 20x GRM (annual income multiplied by 20), the property in Los Angeles would be worth $867,360 less than the one in Costa Mesa. GRM is a common formula that investors use to determine the value of a property and it is only one of many factors an investor looks at. The multifamily property in Los Angeles would be much less desirable as an investment due to the lower rental income, as well as due to the lower projected future income as a result of the rent caps, so it would be reasonable to estimate the loss at around one million dollars in appreciation in the span of just four years.
While the income discrepancy between rental properties in Los Angeles compared to those in Costa Mesa is huge, it doesn’t compare to properties where tenants aren’t paying any rent. Beginning March 4, 2020, through the end of the local emergency, no owner can evict a residential tenant for nonpayment of rent if the tenant is unable to pay rent because of circumstances related to the COVID‐19. In this scenario, if all 4 tenants didn’t pay rent for four years (3 years for the state of emergency plus one year to evict the tenant), the income difference would be approximately $574,000. COVID rules do NOT allow landlords to miss tax payments or defer legally required upgrades and maintenance and I’m unaware of any other business that has this same burden.
Sacrificing Long-Term Safety
Besides the diminished rental income, which in turn impacts the valuation of the property, there are other factors that are likely to make the property in Los Angeles even less valuable, such as the likelihood of deferred maintenance because of a lack of funds from low rents. This then leads to an overall deterioration of the neighborhood as surrounding apartment buildings experience the same funding shortfalls. When neighborhoods start to worsen it’s not uncommon to see more crime and violence, so the long-term unintended consequences of rent control, including the COVID-19 “safety” measures, is less safety for tenants and residents of the city.
I believe the threat of increased crime and violence that will likely arise due to government mandated below market rents are much more dangerous than the possibility of catching COVID-19. This emergency order was supposedly put in place to stop the spread of COVID-19, but let’s face it, nobody’s been sitting in their apartment in LA for the past three years having no contact with anyone from the outside world. Also, unemployment is at an all-time low so there’s no reason for people who want to work to be financially impacted by COVID-19. These measures represent yet another short-sighted pandering by politicians that will have the opposite effect on their constituents – less safety and worse living conditions.
Discrimination Against Rental Property Owners
The Rent Stabilization Ordinances unfairly targets property ownership as a business. California claims to stand up for equal opportunity and non-discrimination, yet this law blatantly discriminates against the rental housing industry. To put this in perspective, tradespeople, auto dealers, grocery stores, gas stations, hair salons, etc. do not have any restrictions placed on how much they can charge nor are they forced to provide goods and services for free. They are subject to the free market that our capitalist economy is based on.
We stand together or we fall apart! Petition For What You Deserve
Whether you own a rental property in a city that has a local restrictive RSO or not, everyone needs to write to city and state politicians and express why rent stabilization ordinances and eviction moratoriums are unjust and discriminatory so that property owners are allowed to run their business as they see fit. If government stayed out of regulating the rental industry, the end result would be better housing, happier tenants and healthier cities.
If you have questions or comments I can be reached by phone or text at 714.330.9999, by email at InvestingInTheOC@gmail.com or visit my website at www.InvestingInTheOC.com. Mercedes Shaffer is a real estate agent with Pacific Sotheby's International Realty and specializes in helping clients buy and sell residential and multifamily rental properties and perform 1031 Exchanges. DRE 02114448.