Communities around the country continue to push toward instituting rent control laws,
creating an environment of political uncertainty that is driving many multifamily investors out of those markets. But there are investors who have opted to take on the challenge of buying rent-controlled properties, believing that if handled correctly, such properties offer great opportunity.
To have success with rent-controlled properties, it’s critical to have a firm grasp on the ins and outs of what makes rent-controlled properties unique, understanding the market the property is located in, the nuances of that city’s rent-controlled regulations and the property itself.
What makes rent-controlled properties attractive to those companies who are active in the space?
For starters, prices on rent-controlled properties are generally lower, with average cost often times somewhere between $100,000 to $150,000 less than a non-rent-controlled property.
The bid process also tends to be less competitive, helping investors steer clear of getting involved in a price war for properties. There’s also very little institutional money currently involved with rent-controlled properties, so most of the competition for properties comes from mom-and-pop investors.
Spending less on the acquisition of a rent-controlled property gives the investor a surplus of capital that they might not have with a non-rent-controlled building. That surplus can be used to fund capital improvements that are often a necessity when purchasing rent-controlled properties, which can be older and in some cases in need of repair.
Even if the property has been well-maintained, instituting a capital improvements plan helps ramp up the process of converting the property to a market-rate building.
In addition, many cities allow landlords to temporarily increase rents at rent-controlled properties, usually for a period of 60 to 72 months, to help recover costs caused by making major improvements to the property.
In Los Angeles, property owners can apply to have 50 percent of those costs reimbursed by tenants, but to be eligible the improvements must primarily benefit the tenant and can’t be part of routine repairs. Things like a new roof or siding put on the building, new carpet or drapes, and upgrades to common areas like the pool or laundry room would likely be covered.
While being in a rent-controlled building is something virtually all renters would sign up for, there is a misconception that tenants living in rent-controlled units never leave. It’s simply not true.
While rent-controlled buildings don’t typically turn over as quickly as buildings where tenants are paying market rate, there is turnover at rent-controlled properties, albeit at a slower rate.
And a slower turnover rate isn’t necessarily a negative. For example, having units turn over at a reduced rate reduces the hassle and costs associated with finding a qualified new tenant for a vacant unit.
In most cases, slower turnover also means the majority of the units are occupied, providing the building’s owner with a predictable, steady stream of revenue, no matter what the state of the market is.
Also, in Los Angeles, owners of rent-controlled properties are entitled to raise rents by a maximum of three percent a year. While prices for units at market-rate properties are dictated largely by the state of the market, there are times when that means rents drop.
So rent-controlled properties actually provide owners with a recession-proof revenue stream, providing a level of consistency market-rate buildings can’t guarantee.
With less turnover and smaller annual rent increases, investors who consider getting involved with rent-controlled properties need one critical attribute—patience.
The ideal buyer of a rent-controlled property is a company that buys to hold. To be successful investing in rent-controlled properties generally requires the company to have a long-term view of each property.
Preparing to invest
Prior to acquiring a rent-controlled property, it’s critical to do your homework on the market, the building and its tenants.
As a rule, most companies that invest in rent-controlled properties stay away from acquiring properties where a significant number of existing tenants have lived there for five years or where rents are more than 50 percent below market value. Both are signs that the building is going to take too long to turn.
Buying rent-controlled properties in markets they know and understand can help investors navigate through the challenges and restrictions associated with that particular market.
Investing in rent-controlled properties isn’t for everyone, but for those who take the time and make the effort to understand the complexities associated with owning such properties, they can be a strong supplement to your portfolio.
Henry Manoucheri is chairman and CEO of Universe Holdings, a privately-held multifamily investment, ownership and management firm focused on value-add and off-market transactions. Universe has been investing in rent-controlled properties for the last two decades.