The re­al­ity of rent con­trol in San Jose

The Mercury News - - Open Homes - Michael Shields, CCIM SILICON VAL­LEY MUL­TI­FAM­ILY GROUP Michael Shields is an apartment/in­vest­ment bro­ker and the manag­ing di­rec­tor of Silicon Val­ley Mul­ti­fam­ily Group — [email protected]­mul­ti­fam­ily.com.

In mar­kets that strug­gle with a high cost of liv­ing, rent con­trol is pro­moted as an al­most prov­i­den­tial gift — fi­nan­cial re­lief pro­vided by mu­nic­i­pal­i­ties, for its cit­i­zens. Un­for­tu­nately, there are long-term re­al­i­ties of rent con­trol that most mul­ti­fam­ily own­ers and in­vestors (not to men­tion econ­o­mists) warn are not worth their long-term con­se­quences. With the April 2016 approval of its up­dated Apartment Rent Or­di­nance, San Jose be­comes the lat­est “worth it or not worth it?” case study on the ul­ti­mate price of rent con­trol.

Un­der San Jose’s new rent con­trol di­rec­tive, as of June 17, 2016, own­ers of mul­ti­fam­ily prop­er­ties built be­fore 1979 may only in­crease rents by up to 5 per­cent, in­stead of the 8 per­cent pre­vi­ously al­lowed — a re­duc­tion of 3 per­cent. The new or­di­nance elim­i­nates the 21 per­cent in­crease pre­vi­ously al­lowed if rent had not been raised in the last 24 months. It also elim­i­nates any debt pass-through and places much greater re­stric­tions on pass­ing through the cost of cap­i­tal im­prove­ments re­stric­tions for pre-1979-built as­sets.

In all, th­ese new rules ap­ply to ap­prox­i­mately 44,000 apart­ments that house 11 per­cent of San Jose’s res­i­dents. Pro­po­nents of rent con­trol ar­gue that th­ese rules en­sure a por­tion of the lo­cal mul­ti­fam­ily in­ven­tory is pro­tected as af­ford­able hous­ing. That it al­lows low- and mid­dle-in­come res­i­dents to re­main in the city, near jobs and other re­sources.

Un­for­tu­nately, there is a dark side to rent con­trol, with key draw­backs that the Na­tional Mul­ti­fam­ily Hous­ing Coun­cil sums up as fol­lows:

• De­te­ri­o­ra­tion of Ex­ist­ing Hous­ing.

Case stud­ies sup­port that rent con­trol re­duces an owner’s re­turn on in­vest­ment, which in turn de­creases their de­sire or abil­ity to im­prove units. The re­sult: a drop in the qual­ity of ex­ist­ing rental stock.

• In­hi­bi­tion of new con­struc­tion

Low re­turn rates in rent­con­trolled mar­kets drives in­vestors to more prof­itable mar­kets. This de­creases the con­struc­tion vol­ume of new units and/or cre­ates sce­nar­ios whereby mul­ti­fam­ily as­sets are con­verted to other uses.

• Re­duced Prop­erty Tax Rev­enues

As prop­erty values among rent-con­trolled build­ings drop, so do the taxes that a mu­nic­i­pal­ity can as­sess on those build­ings.

• High Ad­min­is­tra­tive Costs

The mu­nic­i­pal in­fra­struc­ture re­quired to cre­ate, mon­i­tor and man­age com­plaints and appeals within a rent con­trol sys­tem can be tremen­dous, and of­ten out­weigh the short-term ben­e­fits en­vi­sioned for rent reg­u­la­tion.

• Low In­come Res­i­dents Still Lose Out

Those liv­ing in a rent con­trolled unit of­ten cling to their units, even after their in­come ex­ceeds the in­tended lim­its of af­ford­able hous­ing. Some renters also unof­fi­cially sub­let their units to fam­ily or friends, in or­der to re­tain con­trol of a low rent base. This re­duces the in­ven­tory of avail­able rent con­trol units for the true low-in­come wage in­di­vid­u­als who need them. It also cre­ates new fac­tors that all renters in this cat­e­gory must con­tend with, such as find­ers fees and other en­try costs.

At its most er­rant, rent con­trol can also breed a unique form of dis­crim­i­na­tion. As the NMHC says, “By elim­i­nat­ing rents as the ba­sis of choos­ing among a pool of po­ten­tial cus­tomers, rent con­trol opens the door to dis­crim­i­na­tion based on other fac­tors.” Among th­ese are in­come and credit his­tory, race, sex, fam­ily size and “other un­law­ful fac­tors” that bias the se­lec­tion process in spite of Fair Hous­ing laws.

The lead­ing ur­ban pol­icy magazine City Jour­nal has high­lighted rent con­trol’s very counter-in­tu­itive re­al­ity. It points to New York City as a prime ex­am­ple, not­ing that, “It has fi­nally dawned on many New York­ers that rent con­trols, far from solv­ing the city’s hous­ing prob­lem, are a prime cause of it.” Even with 1.1 mil­lion rent-con­trolled apart­ments, Jour­nal re­ports that NYC’s mid­dle-class fam­i­lies still strug­gle with crowded liv­ing con­di­tions, a mo­nop­oly of rent-con­trolled units among the wealthy and lim­ited new con­struc­tion to help ex­pand lo­cal hous­ing op­tions.

In fact, ac­cord­ing to the magazine, “Har­vard’s Joint Cen­ter for Hous­ing Stud­ies dis­cov­ered that Man­hat­tan’s high-in­come neigh­bor­hoods and a few wealth­ier ar­eas in Queens won the lion’s share of New York’s rent sub­si­dies (“rent sub­sidy” be­ing the difference be­tween the max­i­mum rent for a reg­u­lated apartment and the ac­tual rent for a com­pa­ra­ble un­reg­u­lated unit.)” Why? Be­cause, “The great­est sub­si­dies go to sta­ble house­holds liv­ing in de­sir­able apartment build­ings and neigh­bor­hoods…” As a re­sult, “Poor and mi­nor­ity fam­i­lies, es­pe­cially large house­holds with chil­dren, don’t ben­e­fit in the least from rent con­trols.”

What Can Own­ers Do Now?

As the NMHC asks: Why should the uniquely pub­lic burden of pro­vid­ing sub­si­dized hous­ing to the poor and mid­dle class be borne solely by providers of rental hous­ing?

Even be­fore stricter rent con­trols are put in place, San Jose values still pale in com­par­i­son to nearby, non­rent-con­trolled com­mu­ni­ties. In 2015, for ex­am­ple, San Jose’s mul­ti­fam­ily aver­age per-unit sales price was $219,554. In the rest of Santa Clara County, the per-unit sales price was $439,425. As th­ese fig­ures show, the aver­age value in non-rent­con­trolled com­mu­ni­ties is con­sid­er­ably higher, of­fer­ing an in­vestor a far greater op­por­tu­nity to re­coup in­vest­ment dol­lars from ei­ther buy­ing a prop­erty with de­ferred main­te­nance or from ren­o­vat­ing and im­prov­ing a cur­rently owned prop­erty.

In­vestors know this sce­nario well, and be­cause of it, are al­ready buzzing about ex­chang­ing their San Jose as­sets for prop­er­ties in nearby, non­rent-con­trolled com­mu­ni­ties. Oth­ers are in the process of buy­ing and are sim­ply say­ing, “Not in San Jose.” And so their in­vest­ment dol­lars — and their tax rev­enues — are go­ing else­where, such as Moun­tain View, Sun­ny­vale, Camp­bell, Santa Clara or Mil­pi­tas. In the long run, this takes an en­tire mar­ket — like San Jose — out of a deal­maker’s re­al­is­tic play­ing field.

Those who op­pose rent con­trol gen­er­ally agree that our so­lu­tion to high rents and tight in­ven­to­ries in­volves a re­turn to the ba­sic fun­da­men­tals of eco­nomic stim­u­la­tion. Some ex­am­ples: Fed­eral and state pro­grams that pro­vide fi­nan­cial as­sis­tance to low-in­come renters and, in turn, in­crease their abil­ity to stim­u­late the econ­omy through buy­ing and rent­ing ac­tiv­ity. Also, pro­grams and poli­cies that sup­port eas­ier ren­o­va­tion or new con­struc­tion of af­ford­able hous­ing units — a move that in­creases and di­ver­si­fies San Jose’s mul­ti­fam­ily in­ven­tory rather than nar­row­ing it.

In this new re­al­ity, San Jose own­ers have a few op­tions. Op­tion one: Hold on to their prop­erty and live with the lower in­come, lower re­turns and in­creased man­age­ment obli­ga­tions. Op­tion two: Ex­change out of the San Jose mar­ket into a nearby city that does not have rent con­trol. How­ever, those con­sid­er­ing op­tion two have a small win­dow of op­por­tu­nity. They need to move soon, while the mar­ket is still strong and values are still high — and be­fore other own­ers throw their hands up in frus­tra­tion and join the masses want­ing to sell off their San Jose rent con­trolled as­sets.

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