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November 2, 2018 Comments Off on What Repealing Costa-Hawkins Rental Housing Act Would Mean for California Multifamily Views: 1995 Bay Area, California News, Inland Empire, Los Angeles, Orange County, San Diego

What Repealing Costa-Hawkins Rental Housing Act Would Mean for California Multifamily

By Richard Sarkis, CEO and co-founder of CRE data engine Reonomy

If Californians vote to repeal the Costa-Hawkins Rental Housing Act this November, local commercial real estate investors may start looking to multifamily markets outside The Golden State.

Sarkis

Over the course of the last decade, a growing number of Californians have lamented the high and growing rent prices that have become unavoidable throughout The Golden State. Of California’s 39 million residents, nearly a third (31%) rent units in multifamily properties — many of which are becoming prohibitively expensive.

In fact, more than 3 million California households put more than 30% of their income toward rent, and nearly a third put over half of their income toward rent. Despite forking over large fractions of their income, 13.5% of California renters currently live in overcrowded spaces — defined as a living situation in which the number of residents in a unit exceeds the number of rooms in the unit — the second-highest statewide overcrowding rate in the country.

This widespread unaffordability is a direct result of California’s long-running housing shortage, as there simply aren’t enough units in the state to comfortably accommodate the number of California households. This shortage will only be exacerbated should the state’s population surpass 50 million by 2050, as forecasts predict it will.

The intuitive solution to this problem is to incentivize commercial real estate developers to build more multifamily units. Unfortunately, real estate has become so expensive in many parts of California — particularly in desirable regions like Greater Los Angeles and the Bay Area — that a number of developers have already started to pull back on their investment in multifamily assets in the state.

What’s more, if Californians vote to repeal the state’s decades-old rent control restrictions on November 6, the inevitability of lower returns may cause many developers to abandon multifamily assets in California altogether, effectively throwing the state’s housing crisis into hyperdrive.

Price Increases Bigger Than the Hollywood Sign

For simplicity’s sake, let’s zoom in on three prominent cities in the Los Angeles metro area: Santa Monica, Beverly Hills, and West Hollywood. According to Reonomy data, after dropping 25.4% between 2008 and 2009, the median sales price of multifamily assets in Santa Monica increased every year through 2016, with YoY growth rates ranging from 6.9% (between 2014 and 2015) to 32.4% (between 2012 and 2013). After a slight (10.0%) dip between 2016 and 2017, the median sales price has jumped back up 4.6% YoY through two quarters of 2018.

Meanwhile, the volume of multifamily transactions in Santa Monica has been unsteady. After increasing by 61.7% between 2009 and 2012, Santa Monica’s multifamily sales decreased by 36.1% between 2012 and 2014. Sales ticked up slightly in 2015 and 2016, only to drop again last year. All told, the number of multifamily sales in Santa Monica was only 6.1% higher last year than in 2009. What’s more, with the exception of 2009, the first two quarters of 2018 saw fewer multifamily sales than every other Q1-Q2 period since the turn of the century.

Similar trends are visible in Beverly Hills and West Hollywood. In the former, the median sales price of multifamily assets has increased (or stayed effectively level) every year since 2010, with the exception of 2014. At the same time, the number of sales was only 8.9% higher in 2017 than in 2009. In the latter, the median sales price of multifamily assets has increased (or stayed effectively level) every year since 2011. Sales volume was slightly higher (16.8%) in 2017 than in 2009, but it has seen YoY decreases every year since 2013 with the exception of 2015.

In short, since the Great Recession, the cost of multifamily assets in Santa Monica, Beverly Hills, and West Hollywood has grown more or less unchecked, compelling CRE stakeholders to take an unusually cautious investment approach. Those who have splashed out substantial sums for multifamily properties in these cities have passed the expense on to end-users in the form of higher rents — and in so doing have compounded the area’s affordable housing crisis.

What a Repeal of Costa-Hawkins Might Mean for California CRE

In theory, reigning in these skyrocketing rents is the impetus behind the recent push to repeal California’s Costa-Hawkins Rental Housing Act. Passed by a margin of a single vote in 1995, the Act set a variety of limits on cities’ abilities to implement local rent control legislation.

Among other things, Costa-Hawkins prevents cities from imposing rent controls on units built after February 1995, exempts all single-family homes and condominiums from rent controls, and reserves landlords’ rights to raise the rent on a rent-controlled unit to the market rate in-between tenants.

If Californians vote to repeal Costa-Hawkins this November, cities would suddenly find themselves with the freedom to impose a host of previously forbidden rent control measures, including placing rent caps on newly- constructed units. While a repeal won’t automatically trigger any specific rent control measures, it will undoubtedly create a great deal of uncertainty in multifamily markets throughout the state.

In truth, the economics of rent control are surprisingly unsettled, but a landmark study conducted by researchers at Stanford University recently demonstrated that, if nothing else, robust rent control pushes multifamily owners to consider other options. In fact, according to the study, “Rent-controlled buildings [are] almost 10% more likely to convert to a condo or Tenancy in Common (TIC) than [non-rent-controlled] buildings…and there is a 15% decline in the number of renters living in these buildings.”

In other words, when their multifamily assets are subjected to rent control measures, owners tend to find ways to reclassify their buildings, often reducing the number of units in the process. This further constricts supply, which in turn adds to the housing shortage, ultimately driving sales prices — and, by extension, rents — even higher.

An Uncertain Future

Combined with the price-driven slowdown in market activity illustrated by our data, the uncertainty brought about by a repeal of Costa-Hawkins could very likely convince CRE investors that multifamily assets in places like Santa Monica, Beverly Hills, and West Hollywood are simply too expensive — and too risky — to be viable.

And while a repeal is anything but certain — this is but the latest in a series of failed attempts to do away with the law, including one earlier this year — the mere fact of its being on the ballot may be enough to keep developers at arm’s length.

“These renter groups…have gotten more organized than they ever have been,” CRE investor Ben Lamson tells The Wall Street Journal. “I’ve started getting a little freaked out or a little scared or concerned that this [repeal] could really happen.”

If it does, don’t be surprised if investors like Lamson start looking to multifamily markets outside the state of California.

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