05 Sep Proposition 10 Oceanside, Vista, North County San Diego
Coming November 6 of 2018 is the a looming decision over Oceanside, Vista, and North County San Diego multifamily owners and investors, it’s Proposition 10. If you haven’t had the opportunity to review Proposition 10 in San Diego, I’m happy to meet and discuss how this can impact your Oceanside, Vista and North County San Diego multifamily investments.
What is Proposition 10?
Per the website calmatters.org which describes itself as a “nonpartisan, nonprofit journalism venture committed to explaining how California’s state Capitol works and why it matters” explains Proposition 10 as “bringing back rent control” and it would “allow cities to introduce new restrictions on market rents or expand existing rent control policies”.
What happens if Proposition 10 passes?
It would really depend on if cities start new rent control laws and/or further develop their existing laws. There are a few different view points depending on what side of the coin you are on. Some state that enacting rent control helps make housing more affordable by setting a limit on what owners can charge for renting out their apartment units. Other state that imposing rent control will only make rent more expensive than utilizing a free market system to self regulate the rental market. When rent is reduced, values of rental properties can decrease which can also decrease the property tax revenue. On the flip side, the less tenants are spending on rent, the more they have to spend on the economy and sales tax. Some cities won’t do anything, some will, only time will tell at this point.
What happens to the value of my Oceanside or Vista apartment building if Proposition 10 passes?
When rent is reduced, this generally makes your apartment building less valuable since the value is most often determined on the income the building generates. Generally speaking, more income, higher value, lower income, lower value. If interested in reviewing the value of your apartment building, visit here to discuss further.
Why are we discussing Proposition 10 at all?
Costa Hawkins Rental Housing Act and the housing crisis. Rents are higher than ever, I can really only speak for Los Angeles, Orange and San Diego County though I can only assume this is a common theme around the country. People are spending close to or over 50% of their income on housing which can only lead to major implications for the health of their personal finances thus increasing the likely hood for further debt which can then snowball into so many other issues. What the Costa Hawkins Rental Housing act did was set limits on what kind of rent control policies the cities could impose on their apartment building investors. For example, right now in Santa Monica, if a tenant lives a 2 bed 2 bath unit on 5th Street that has been in there since the 70s paying $900/month and getting only 1-2% increase each year in rent, the owner could now charge $3,000 for rent to the next tenant when the $900 tenant vacates, which at $3,000 would be the market rent for that area.
Let’s take a look at this example briefly to see what this rent increase means for the owner of this building. Let’s say it’s a 10 unit building, each tenant paying $1,000, for a gross income of $120,000 a year. Now this owner is probably fine with the $120k/year since they bought the building for $1,000,000 in the 90s. But now, once that $1,000 unit vacates and can now achieve $3,000 a month and the rest are still paying the $1,000, the gross income is now $144,000. Value before the market rate rent, $2,040,000. Value after that one unit is paying market of $3,000, $2,448,000, a $408,000 difference in value at 17 GRM!
Since the market is about as high or higher than the 2007 levels (depending where you are located) we saw before the great recession, more people want to be closer to jobs found in the major hubs like the Bay Area, LA, OC and San Diego Counties, more people equate to more demand, which means more upward pressure on prices. It’s really a mess, prices are going up faster than wages are growing. Gas continues to increase. Affordability in these more desirable places are really sinking. We are already seeing a little bit of an exodus to more affordable states like Nevada, Texas and Arizona, similar to how we did in the mid 2000s. Any of these trends sound familiar?
What are the arguments for and against?
Those in favor state that rents are just too high, people are getting pushed out of where they need to be to make money and either have longer commutes, need to relocate to suburbs, others states or worse get forced out on to streets.
Those against state if rents are low, investors can’t afford to maintain their existing units or make it worthwhile to build new housing. Most against suggest building more units is the solution to affordability.
Does rent control work?
From a common sense perspective, my opinion is, sort of, yes it can work. Though really depends on when you get into the unit. As for example above, the person was in the unit since the 70s paying $900/month, that’s a good deal considering their neighbor is paying $3,000. There unit probably still looks like it did in the 70s though if that’s your thing, you are getting a good deal. From my perspective, if that person bought a condo in the 70s or 80s at $300k, that condo would be worth $1M+ today, but that’s a whole other story. Though, if I can think of two of the most expensive places to live in the U.S. which I’ve lived in both, New York City and the West Side of Los Angeles, they are crazy expensive and they both have rent control!
So in theory, rent control works, sort of.
Let’s say an apartment developer wants to build an apartment building to add more units. Their land price is $250/foot, it will cost them $300/foot to build (construction prices are increasing), not to mention the cost of tying up their money or cost of the loan over the year or two of construction. Let’s say the land they are building on is 14,000 square feet and the city will allow 17 units at 800 square feet each with subterranean parking that costs about $1M on top of their $300/foot, now we are are at:
Land Cost = $250/foot x 14,000 sqft = $3,500,000
Build Cost = $300/foot x 13,600 rsf + $1,000,000 subT = $5,080,000
Total = $8,580,000
Now, if they make these units affordable 1+1.5 townhomes let say, at $2,000 a month in rent
Affordable scenario 1:
$2,000 x 17 units x 12 months = $408,000 gross income
– less 3% vacancy = $12,240
– less 40% expenses = $158,304
= $237,456 NOI
= 2.76% cap rate
= Finished value at $700/foot = $9,520,000
Market rate scenario 2:
$3,250 x 17 units x 12 months = $663,000 gross income
– less 3% vacancy = $19,890
– less 40% expenses = $257,244
= 4.49% cap rate
= Finished value at $800/foot = $10,880,000
As you can see, if the developer tries to do the right thing by making affordable units, they can’t pencil out this investment on the simplest level with a 2.76% cap rate, especially when their loan is 5%. Sure, land cost could vary, construction cost, density bonus, whatever it is, you can still see why developers need build not only luxury units though, perhaps not build at all since it’s not worth it, the risk can outweigh the gain. Keep in mind, the developer is putting up a lot of cash and devoting a couple years to this project before they even begin to see a return, not to mention the city or the neighbors making it any easier on them to get a project built, for better or for worse.
Therefore, as the economist.com states “When prices are capped, people have less incentive to fix up and rent out their basement flat or build a rental property. Slower supply growth exacerbates the price crunch”.
A great example is in Santa Monica and LA, you see really either only high end apartment units being built or high end condos, either way, not only replacing the somewhat affordable structure that was existing prior, though making the new structure super luxurious to be able to either sell or rent for a profitable amount, thus further hurting the affordability in that area.
We could obviously go on forever on this subject in either direction and depending on what side you are on, the solutions are multiple, which ones are right and wrong depends on your perspective.
I’ll leave you with this excerpt from the Economist.com
“In places where demand for urban housing is rising (as in London, New York and Seattle), a more effective policy is simply to build more housing. The number of houses being built each year in Britain peaked in 1968 at 352,540 dwellings. Since 2008 there has been a particularly bad slump, while a restrictive “green belt” around the edges of London restricts growth. Meanwhile many developers sit on the land, watching its value grow. According to McKinsey, some 45% of land which is due to be developed in London remains idle. House-building rates are even lower in Germany, says Kath Scanlon of the London School of Economics. Restrictive zoning laws in places such as San Francisco (which also has rent control) could also be loosened, though locals might not like it. But in order to keep housing affordable, politicians will have to take on the NIMBYs, not just the landlords. “
Here are some links I used as resources so you can dig into the matter further.
“Here’s why Californians should vote NO on Prop 10:
• Proposition 10 will reduce availability of affordable and middle-class housing. Academic experts from the University of Southern California, U.C. Berkeley and Stanford agree that it would drive up rents, while discouraging new construction and reduce the availability of affordable and middle-class housing. Even the state’s nonpartisan Legislative Analyst has found that passage of Proposition 10 would both discourage new construction and result in existing rental units being taken off the market, reducing availability of rental housing.
• Proposition 10 will increase the cost of existing housing. Proposition 10 will cause homeowners to sell or convert rental properties into other more profitable uses, such as short-term vacation listing services like Airbnb. That would increase the cost of existing housing and make it even harder for renters to find affordable housing.
• Proposition 10 will cost taxpayers hundreds of millions of dollars per year, reducing revenues available for education and public safety. The Legislative Analyst also said that Proposition 10 would likely reduce the value of rental properties and single-family homes, driving down local property tax revenues by up to hundreds of millions of dollars per year. Driving down home values will hurt middle-class families and will also reduce the funding available for vital services like schools, public safety, road repairs, education, and fire safety.
• Proposition 10 will eliminate homeowner protections. Proposition 10 repeals protections homeowners have enjoyed for over 20 years, and lets the government dictate pricing for privately owned single-family homes, controlling how much homeowners can charge to rent out their home – or even just a room. Proposition 10 might even lead to bureaucrats imposing oppressive surcharges when an owner takes a home off the rental market and chooses to occupy it.
Please vote YES on Prop 5 and NO on Prop 10 on November 6th.” – https://www.car.org/difference/getinvolved/yes5no10
Contact me today to discuss your apartment building investments in Oceanside, Vista and North County San Diego – let’s get you setup to for the future.
Eric von Bluecher
Beachbreak Investments Inc.
12780 High Bluff Dr #130, San Diego, CA 92130