Despite a nationwide push by the Trump administration to decrease regulations in all facets of the economy, many municipalities and states are moving in the opposite direction—especially regarding commercial real estate. While these restrictions may be well intentioned, they may create unintended negative consequences for both investors and consumers.
Perhaps the most significant of these new regulations is the rent control law enacted in New York state earlier this year. Although rent control laws in New York City date back at least to 1943, the new law includes significant new restrictions that are expected to stay in place for a long time.
Gov. Andrew Cuomo signed the rent control bill, known as the Housing Stability and Protection Act of 2019, on June 14. The law makes it harder for apartment owners to increase rents and eliminates rules that allowed units to become free of any rent control. The new regulations dictate the rents of about 1 million apartments, amounting to about half of the apartments in New York City.
Some provisions include:
- Landlords can no longer increase rents by more than 20 percent when tenants move out.
- Landlords can no longer deregulate an apartment from price controls if its rent exceeds $2,774 a month or if the occupant’s yearly income exceeds $200,000.
- Rents below the legally permitted rate are now frozen as long as existing tenants occupy the unit, and rent increases due to capital improvements are capped at 2 percent annually.
- Newly constructed buildings are classified as stabilized and, therefore, subject to the new laws; they can’t be classified as exempt “affordable housing.” (“Affordable housing” is defined as dwellings that cost their residents less than 30 percent of their income.)
- With new building taxes of as much as 30 percent of gross income, tax abatements are much less attractive because these programs regulate rents.
- Condo/co-op conversions now require that 51 percent of existing tenants buy their apartments before they can be converted, further complicating and limiting a traditional exit strategy.
For current renters, the new provisions will probably be positive. In most cases, their rents won’t increase as long as they stay in place.
For people who want to become renters and landlords—especially in the long term—the effects might not be so good. In fact, some landlords, investors and CRE professionals in New York City predict that the state’s new rent control law will have a negative impact on valuations for assets that have a high concentration of rent-stabilized units—and especially those with revenues very close to their operating expense levels.
According to RERC valuation experts, properties that have below-market rents will be affected the most; valuers are anticipating 1 percent to 2 percent income increases into perpetuity. Cap rates for some New York City apartments, which have been as low as the 3-4 percent range, are expected to rise into the 4-5 percent range, which could cause initial value to decline by 25 percent or more. After the impact of the new rent controls fully kicks in, the next buyers will have to factor these value losses into their calculations. Down the road, it won’t be as attractive to buy or develop apartments.
- Investors have become skittish and many transactions have been canceled.
- The new law limits the recovery for capital improvements, and many landlords will decide to make minimal improvements to their properties.
- Investment demand will likely dwindle, further reducing the prospects for capital investment. This in turn will create the unintended consequence of lower quality living for consumers.
In light of these developments, appraisers and investors will have to look at properties on a case-by-case basis, and sometimes a unit-by-unit basis. The fear is that regulated stock will deteriorate and tenants will move to market-rate projects that continue to maintain their properties.
Ken Riggs, CFA, CRE, MAI, FRICS, CCIM, is president of RERC, a SitusAMC company.