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The Real Deal Los Angeles

Uncertainty around Prop 10 could slow multifamily market

Investors playing it safe until rent control’s future is decided in November
By Dennis Lynch | September 11, 2018 02:39PM

Bryan Shaffer and apartment buildings in San Francisco (Credit: Public Domain Pictures)

With less than two months to Election Day, the Los Angeles commercial real estate sector is nervously anticipating the outcome of Proposition 10.

If affirmed by voters on November 6, the measure would free municipalities around the state to expand rent control however they want. New rent control laws could slow development of multifamily projects and limit rental income for landlords.

Proposition 10 would repeal the Costa-Hawkins Rental Housing Act of 1995, which set limits on rent control ordinances statewide. Back then, the move was a response by state lawmakers to local rent control measures created in the prior decades amid a widespread tenant revolt against rising rents. But a housing affordability crisis in major cities like Los Angeles led to a new effort to free local governments to decide for themselves how they wanted to regulate rents.

Preoccupation over Prop 10’s passage has created a chill in the commercial sector. Some investors are backing off of projects, according to Brian Shaffer, a Principal and Managing Director at George Smith Partners.

“There’s just a lot of fear and a sense of ‘why not wait three month months instead of executing now?’” he said.

Shaffer said that investment sales brokers he speaks with have noticed “a major change” in investment in larger properties, in particular. Would-be deals are on ice until Prop 10 is decided.
That showed in The Real Deal’s roundup of the top multifamily investment sales in August. Not one property went for more than $30 million and the $81.3 million total of the top sales was the lowest total so far this year.

Oscar Diaz, an associate at Marcus & Millichap, a commercial brokerage, said the nervousness has reared its head at all levels. “Our business is cold calling hundreds of owners a week and what we’ve been hearing is they’re just waiting to see where Costa Hawkins will go,” he said.

Costa-Hawkins was passed as a measure to wrangle rent control measures around the state, most of which were passed in the late 1970s and 1980s. L.A.’s rent control laws went into effect in 1978. Costa-Hawkins essentially froze rent control in place, ensuring that no new units would be regulated after its passage.

But years of rising rents in L.A. have strengthened calls for expanded rent control measures. Rent control proponents argue it’s the only way to ensure that at least some housing stock is affordable for low-income renters.

Developers and investors argue that rent control is the wrong answer to California’s high rents and low inventory. Instead, they say, local governments should loosen regulations and allow more dense development in tight markets like Los Angeles in order to increase supply, which would naturally lower rents.

If it continues, a drop in multifamily activity would follow a record-breaking period of investment from June 2017 to June 2018, when $10 billion in transactions went down. That built on nearly $10 billion in transactions in 2016.

Proposition 10 is just part of the challenge facing the multifamily sector. Rising interest rates are also pressuring capitalization rates. By some calculations, years of strong rent growth is slowing to national averages as well.

Opponents of Prop 10 have raised $34.8 million to campaign against Prop 10 compared to the $12.6 million raised by supporters of the measure. Many of those opposition dollars came from within real estate.

Western National Group, an Irvine-based investment firm, has spent $3.7 million. San Mateo-based Essex Property Trust has spent $2.4 million, followed by Equity Residential’s $1.7 million and Avalonbay Communities’ $1.5 million.

As cap rates have dropped in California, many investors have looked to other states to buy and develop multifamily properties, Shaffer said. Passing Prop 10 would exacerbate that trend.

“It would in some ways benefit markets like Texas and Arizona,” he said. “We have investors going to Seattle and all over Washington State, to other markets that don’t have rent control.”