Many of you are probably aware that California passed a new bill, Assembly Bill 1482, that enforces a new Statewide Rent Control on all apartment buildings with 2 or more units. This is major news in the multifamily market. It dramatically changes the way apartment buildings operate and how investors view these assets. In certain parts of California rent control already existed, but this new law will affect every multifamily building with 2 or more units statewide! So, what does this mean for these buildings and most importantly their valuations?
First, let's take a quick look at what the new rules look like under Bill 1482. The bill limits how much apartment owners can increase rents on apartments in buildings with 2 or more units. Rent increases are now limited to 5% per year plus inflation or 10% whichever is lower. Secondly, it requires that landlords have "just" cause for any eviction. There are other details to the bill, however, in my opinion, these two restrictions are the most crucial when it comes to how apartment buildings are valued and invested in.
When it comes to investing in multifamily properties, investors are strictly concerned with the revenue the building brings in and the potential upside that can be capitalized on. So, putting a limit on increasing rent by 5% per year is very important when underwriting buildings' revenue over the lifetime of the investment. Previously, if a building was NOT subject to rent-control, landlords could serve rent increases to what they deemed "market rate". To be honest, though, typically market rent isn't increasing much more than 5% per year, even in hot markets like Los Angeles. Therefore, in my opinion, this restriction shouldn't be too concerning to investors when it comes to the valuation of a building because increasing rent by 5% per year should stay in line with where the market is trending. It is something that should be considered though in really "up-and-coming" neighborhoods such as Boyle Heights or Highland Park in LA.
It is the second restriction mentioned above that really changes the game for investors. The fact that landlords now must have "just" cause to evict a tenant is what completely changes the way multifamily properties are valued. Let's say an investor is looking to buy a building that has some very low paying tenants. Before, if the building was non-rent control, the investor could buy the building, serve the tenant a 60-day notice, rehab the unit, and put it back for lease at market rate. This is what we call owners capitalizing on a building's rental upside. Investors could buy buildings, not for their current income but instead for their potential income. So, buildings that had very low income could still sell for a high number because the buyer knew they were going to vacate most of the building and bring the rents up to a number that justified their purchase price. With Bill 1482 passing this is no longer the case. Owners can now only evict tenants if they have "just" cause (i.e. nonpayment of rent, criminal activity, illegal sublease, etc.). Investors will no longer buy buildings based on their potential income rather strictly what is in place ultimately resulting in a large change in buildings values in California.