How Statewide Rent Control Will Affect the South Bay Real Estate Market

Rent control is now a reality for the residents of California as the recent passing of AB 1482 has become the hottest topic in real estate.

If you missed last week’s blog post,”The South Bay Real Estate Market is Now Rent-Controlled,” be sure to check it out here for some of the main points. If you would like a deeper dive into the nitty gritty of AB 1482, take a look at the full bill here.

So, after a weekend to review and gather my thoughts on how this new law will affect landlords and tenants, I now present to you my unscientific thoughts on how things will shake out.

For those of you that know me, I choose to be a tenant for my personal residence and a landlord for my investments (both rent-controlled and non-rent-controlled property). As a result, I think I bring a unique angle to both sides of the table.

My Brief Two Cents

In short, how will statewide rent control affect the South Bay real estate market?

It will have very little, if any.

You read that right. In terms of affecting property owners, tenants, and the value of income property investments, I do not think there will be a meaningful impact on markets that did not have rent control prior to the passing of this bill.

The Medium Version Opinion

In comparison to the tenant-friendly Rent Stabilization Ordinance (RSO) laws in the city of Los Angeles, the new state law is a piece of cake for landlords, but a step in the right direction for tenants.

For this post, I will use the city of Los Angeles’ RSO to compare some of these new laws and provide some perspective of what other Los Angeles area tenants and landlords have been accustomed to.

At the end of the day, there are three factors that landlords and tenants need to focus on with this new law:

1. Rent caps
2. No-fault evictions & no-fault just cause evictions
3. Relocation assistance

Rent Caps

The new law states that rent increases can be no greater than 5% + essentially the cost of living (aka inflation). Roughly speaking, rents will be capped at about 7.5% annually.

You rarely ever see rent increases of greater than 7.5% from landlords if they plan on keeping the same tenants in their building.

The city of Los Angeles has allowed for 3% rent increases for years and just this year approved 4%.

The new statewide law essentially allows for double of what the largest city in the state deems acceptable for rent hikes.

In theory, state lawmakers are giving landlords much higher rent increases than most rent control laws in bigger cities while protecting tenants from egregiously high rent with just a 60-day written notice.

That all said, the rent cap seems reasonable for both landlords and tenants.

No-Fault Evictions & No-Fault Just Cause Evictions

The no-fault evictions and no-fault just cause evictions are the biggest item in this new bill.

If you do not understand this legal jargon, let me break it down for you…

No-fault evictions essentially mean that a tenant cannot be asked to move unless they are at fault. The obvious reasons for an eviction would be non-payment of rent or violating the terms of a lease.

No-fault just cause evictions allow for a landlord to remove a tenant from a unit legally, even if the tenant is not at fault based on what is considered a “just cause” for a landlord to vacate a unit.

In a nutshell, the language surrounding no-fault just cause eviction standards are very very weak when compared to the city of Los Angeles’ laws.

In Los Angeles, there are only 12 legal reasons to evict a tenant. Outside of those reasons, you can never ask a tenant to move.

So for instance, in the city of Los Angeles you could have an underpriced unit that has a market rate of $2,000 a month that a tenant has lived in for the past 30 years at only $500 a month. Loosely, if you were to invest $75,000 to gut and remodel the unit, the tenant could move back into the newly remodeled unit and would continue to only have to pay $500 a month.

That is Los Angeles…but not the case with the new rent control laws passed by the state. Please read the below language, per the bill:

• No-fault just cause includes…
  • “Intent to demolish or substantially remodel the residential real property.”
  • “For the purposes of this subparagraph, ‘substantially remodel’ means the replacement or substantial modification of any structural, electrical, plumbing, or mechanical system that requires a permit from a governmental agency, or the abatement of hazardous materials, including lead-based paint, mold, or asbestos, in accordance with applicable federal, state, and local laws, that cannot be reasonably accomplished in a safe manner with the tenant in place and that requires the tenant to vacate the residential real property for at least 30 days. Cosmetic improvements alone, including painting, decorating, and minor repairs, or other work that can be performed safely without having the residential real property vacated, do not qualify as substantial rehabilitation.”

This is a massive loophole for landlords to remove their under market tenants, improve their units substantially, and then rent them at market rates.

As mentioned in the “rent cap” section, a majority of landlords do not wish to increase rents beyond 7.5% annually.

But, if a landlord or apartment flipper has an outrageously low rental rate (which is normally a long-term tenant in an old building), they can make plans to “substantially remodel” a unit with a very low hurdle by pulling permits and doing work that takes longer than a month.

With the new law, you will more than likely see landlords and flippers pulling more permits for remodels that would have normally been done without the permit, just so that they can take advantage of the loophole within this new bill.

Pull a permit to update old electrical wiring, pull a plumbing permit for a new kitchen or bathrooms, or perhaps pull a permit to move or open a wall. These are all items a landlord would do anyway to get top of the market rents if they were to “turn” their building for higher cash flow and increase the value substantially.

Relocation Assistance

If a landlord wishes to complete a no-fault just cause eviction, they must pay tenants relocation assistance to help with the move by securing a new rental.

In the city of Los Angeles, relocation assistance for just cause evictions can run between $8,500 and $21,200 per tenant, depending on certain calculations.

The new state law requires landlords to pay one month’s rent of relocation assistance to tenants. So, if a tenant is paying $500 a month, they will legally receive $500 as relocation assistance for a just cause no fault eviction.

Just like the just cause no fault evictions, this part of the law is fairly weak when compared to other rent control laws like the city of Los Angeles.

**Side Note: I will opine on this part of the law…What were lawmakers thinking when they wrote this? In theory, the lowest rent tenants, who are probably at greatest risk, will get the lightest assistance. They should have required a rent survey or medium area income requirement to come up with a reasonable payment for all tenants, regardless of their rent rate.

When relocating foreclosed homeowners during the financial crisis, my investors would offer occupants one month’s rent and a security deposit that was fair for a local area rental.

The state lawmakers absolutely botched this part of the new bill.

Winners and Losers

So, who are the winners and losers from this new rent control legislation?

The Winners

• Landlords
  • Rent control is never a good thing for landlords, but this law is nowhere near as onerous as rent control laws in the city of Los Angeles and offers plenty of loopholes to continue business as usual.

• Subcontractors
  • If landlords want top of the market rents, they will be hiring electricians, plumbers, and other subcontractors en masse to pull permits and significantly improve their units.

• Lawyers
  • Since this is new legislation, there will be plenty of lawsuits to help define and clarify language in the new bill to set precedent on what is legal and not legal.

• Professional investors
  • This law further complicates residential income property ownership and management which is favorable to professionals. Professional investors will navigate the law just fine and will have no problems finding distressed buildings or opportunities to market to maximize the value.

• Problem Tenants
  • Whenever you add more restrictive rules and laws, problem tenants will take advantage of them. Bad tenants who would normally get a 60-day notice to vacate will now have more tools to stay in their units.

• Developers
  • Since property newer than 15 years old is not subject to rent control, there will be demand and incentive to build brand new buildings. If the state of California does not solve its housing supply problem, new buildings that can charge top of the market rents will be gold.

The Losers

• Under-market tenants
  • Unfortunately for the severely under market tenants that legislators are trying to protect, they are actually the biggest losers. The lower the rent, the lower the relocation fee, and the bigger the upside in rent for a landlord or investor. Rather than getting rent gouged with huge rent increases, tenants will be given notice and will have to find a market rate unit with very little assistance…which might be worse than getting a large rent hike for some. 

• City building departments
  • Now that landlords will be pulling more permits to remodel property and achieve market rents, city building departments will see their workload increase. This will be a challenge for understaffed and underfunded building departments and slow down construction for everyone.

• Anyone who purchased property between March and September of 2019
  • Just on the MLS alone, there were close to 3,000 income properties sold in Los Angeles County over this time period. Many of these buyers expected to be able to raise rents without a substantial remodel budget. Now, with the retroactive rent control date of March 15, 2019, many new owners will be stuck with property that does not earn the return they expected or properly budgeted for at the time.

• Mom & Pop Landlords
  • The little guys who may have spent a lifetime saving up for a triplex for their retirement or that want to live in one unit and rent out the others to make ownership affordable will be punished. Without deep pockets, most will likely get hurt in some way financially due to legal, remodel costs, or just not earning as much income as they expected due to lax management.

Conclusion

This is going to be a major topic and news story for California in the years to come. I am so interested to see how it will all turn out.

For now, both landlords and tenants can claim victory with the new law.

Landlords can celebrate the low relocation assistance fees and the weak just cause no fault rules that act as a major loophole for them to get units to market rate.

Tenants can celebrate because the biggest hurdle to rent control was making this first step. As the pendulum swings one way, it tends to continue its momentum even farther. Tenants will call it “progress” while landlords will call it a “slippery slope.” Regardless, the reality of the new law is huge for tenants in the future.

All in all, this new law is not a game-changer for residential income property at this time.

In fact, it will barely move the needle in either direction for values of what were once non-rent-controlled buildings.

I could be wrong, but when you dive deep into the law, it is hard to see how this new law will significantly change day-to-day business between landlords and tenants.

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