Will rent control dent the multifamily market? Lenders, investors weigh in

“There is a lot of headroom to earn a fair rate of return,” Chiu says

TRD LOS ANGELES /
Oct.October 14, 2019 08:00 AM
From left: Gavin Newsom and David Chiu (Credit: Getty Images and iStock)
From left: Gavin Newsom and David Chiu (Credit: Getty Images and iStock)

Ben Lamson, the founder of Bluestar Properties, has been a real estate investor, owner and manager in the Inland Empire for three decades. But California’s march toward a landmark rent-control law served as his eviction notice.

Lamson sold his $15 million portfolio of apartment buildings in a swath of Southern California that extends from Victorville and Lake Elsinore to Long Beach and Torrance. He’s packing up and moving to Nevada, making property investments in what he described as a “friendlier state.”

“They are all sold and gone,” said Lamson of his California portfolio. “You can raise rents but money goes out the other side. The straw that broke the camel’s back was the rent control legislation.”

On Oct. 8, Gov. Gavin Newsom signed into law Assembly Bill 1482, which sets rent caps and implements “just cause” eviction rules, making California the third state in the nation to pass such legislation. Lamson believes the law may lead to “a flattening of property valuations – if not retrenching.” Investors across the country are sounding similar alarms in the wake of major rent reform across the U.S.

But the author of AB 1482 thinks it strikes a balance between renter and real estate industry interests.

“There is a lot of headroom to earn a fair rate of return on their investments,” Assemblyman David Chiu (D-San Francisco), said in an interview with The Real Deal.

“The builders didn’t want the legislation to disincentivize new construction, or impede new construction,” Chiu added.

Neil Axler, a valuations expert at B. Riley Financial subsidiary Great American Group, already sees downward pressure beginning to build on values.

“At the end of the day it may be harder to [borrow] money,” he said.

Axler began evaluating an undisclosed parcel for a client in Los Angeles last week, exploring various redevelopment opportunities such as retail, hotel and multifamily.

“It’s the first property we looked at since the law was signed,” he said. “If we did the valuation today, I’d assume that we’d take into account the Jan. 1 effective date. Once we see how it shakes out, we may see values go down.”

The law will cap annual rental increases for multifamily properties to 5 percent plus the consumer price index (estimated at up to 3.5 percent). It’s aimed at halting rent gouging by landlords who were raising rent prices to an average of $2,320 per month amid growing demand, according to a Marcus & Millichap report over the summer. Another key provision in the law is 15-year exemptions for annual rental increases for new multifamily buildings.

“My gut tells me it’s not going to be positive,” Axler said. “I’d say landlords aren’t going to be happy with this.”

Robert Noble, chief lending officer of Irvine-based First Foundation Bank, which has nearly half of its $4.5 billion lending portfolio tied up in multifamily loans, said the law could lead to changes in underwriting.

“You always have to take into account rent-control guidelines,” said Noble, whose bank’s average multifamily loan is roughly $2.8 million and has an average yield of 4.2 percent.

So far, California’s rent-control law hasn’t pummeled bank stocks, unlike what happened in New York when Dime Community Bank, New York Community Bank and Signature Bank lost a combined $2.5 billion in market capitalization leading up to the passage in June of that state’s rent laws.

The New York reforms placed significant limits on annual rent increases landlords could push through – roughly 2 percent — versus the 5 percent plus CPI amount permitted in California.

Jim Markel, regional manager at Marcus & Millichap in Los Angeles, said he doesn’t see the law as a “death blow.”

“Builders still are very bullish on building in California,” he said.

Brandon Smith, a debt broker at CBRE’s L.A. office, said he’d expect hiccups only in very few situations.

“I’d say 95 percent of the deals shouldn’t be affected by this,” he said, adding that he could foresee problems for properties in “severe disrepair” with slim profit margins. “These sorts of deals may not make sense any more.”

Steve Moss, an analyst with B. Riley who follows several multifamily lenders, warns that the jury is still out on the direction of property valuations in California. That’s in contrast to “New York’s punitive” law, Moss said, which disincentivizes investments in property and is “draconian.”

“I don’t get that same sense at this time in California,” he said. Mortgage brokers already forecasting declines here “probably should sharpen their pencils and get a better idea of what is going on,” he said.

Noticeably absent from the local headlines in the rent control debate this summer were trade groups representing mortgage brokers, bankers and builders, who didn’t take sides too strongly.

Tom Bannon of the California Apartment Association, the largest statewide landlord trade group in the country, conceded that the new law could have the unintended effect of slowing down new construction.

“I’ve not heard that there is an issue yet for lending on new projects,” said Bannon, who was a key lobbyist involved in the legislation. It does, however, add “another cloud in deciding whether to invest in multifamily housing in California.”


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