Rent control is a tenant's dream come true: what could be better than paying $400 in rent for a property worth $600,000? It's not so great for the property owner who can't charge what her property is worth. Aside from "don't buy a property that's rent controlled," here's what all real estate investors and landlords need to know about rent control.
What is Rent Control?
Rent control is usually a local regulation that restricts how much a landlord can charge for rent on a given property, regardless of what neighboring properties rent for, or what the property value might be. This law may impose limits on how often rents are increased, when they may be increased, and by how much.
Also known as a "rent ceiling," few cities in the United States have rent control laws. In California for example, cities like Los Angeles and San Francisco have these laws in place. So does New York City.
In the state of New York, it’s known as the War Emergency Tenant Protection Act. It was created during World War II to avoid war-related shortages in rental housing.
The rules differ by municipality, state and country. In San Francisco, rent control has two components: strict rules for evictions and price control. Increases are tied to the area’s Consumer Price Index (CPI). New York goes one step further with by adding a vacancy control law. Landlords are capped when it comes to rent increases on vacant units ready for new tenants.
Ontario, Canada, also has strict rent control laws. The provincial government sets the yearly allowable rent increase. The 2015 rate was capped at 1.6 percent. In 2014, the increase was a measly 0.8 percent. If a landlord wants to increase the rents by more than the allowed percentage, they must apply to the Ontario Landlord and Tenant Board for permission, which is difficult to get. Landlords may, however, set the rent as high as they like for vacant units and new tenants.
Most other areas in the United States don’t have rent control laws. This allows landlords to set rent as they see fit. If demand for housing goes up significantly, so can the rent.
What Right Do Tenants Have?
In areas with rent control, tenants’ rights are quite strong. The onus is on the landlord to increase rents regularly, and in accordance to regulations.
Rent control often prohibits landlords from increasing rents retroactively. In other words, if a landlord hasn’t raised the rent in many years, they cannot catch-up. Use it or lose it.
This can create big problems for inexperienced or absentee landlords who don’t stay on top of increases. Landlord-tenant acts tend to be quite strict in rent control areas. Landlords can’t evict a tenant because the rent is now too low, but they can’t raise it either. Eventually, the landlord is forced to pay out of pocket since expenses are higher than the income.
Selling a building with poor rental income is also a big problem. Even under new ownership, rent control prevents the new landlord from raising the rents. Landlords have limited options to rectify the situation.
How to Best Handle Rent Control as a Property Owner?
The first step is to be well informed. Rent control laws are quite rigorous, and can limit the income potential of a rental property. In rent controlled areas, the rental income is a big part of the property’s market value. On paper, a fourplex may be worth $500,000 for example, but if rents total only $1,500 per month, no investor will buy it. If the same building was generating $9,000 per month in rent, investors would be lined up around the block to hand in their purchase offers. You don’t want to be the chump who overpays and is stuck with a cash flow negative property.
The second step to being a landlord in a rent control area is to stay on top of rental increases. If the market can support the full increase, landlords likely should raise their rents. Owners may decide it’s not worth losing a great tenant over a few dollars per month, but they should take the time to make an informed decision. If market rates take off, they risk being left behind.
Third, landlords need to find out what their options are. With enough time and patience, it may be possible to salvage a bad situation. Take income properties in Ontario as an example. Rent control means landlords can’t increase rents more than the annual government set percentage, which tends to be quite low. Evicting a tenant in Ontario is also quite difficult, and it can’t be done to increase rent.
However, there is one possible option for the right landlord who plans to live in one of the building’s units. Once the tenant’s lease agreement term has ended, the landlord may be able to evict the tenant for personal use of the unit. It could also be used by a member of the owner’s immediate family. According to the landlord-tenant act, it must become their primary residence and be done “in good faith”. If the tenant thinks the property owner is not acting in good faith, they have up to 12 months to file a complaint. Eventually, if the landlord wishes to move out, they can rent the unit to a new tenant at market rate.
In some rent controlled areas, owners can turn the apartments into condomiums and sell them, instead of continuing to rent them. This can recover the true market value of the property, and prevent further losses for the landlord, but it actually drives local rents higher by reducing rental housing supply. Therein lies the problem inherent in all arbitrary interventions in market pricing: forced pricing creates an entire cascade of unintended consequences.
Likewise, what incentives do landlords have to improve the property, or offer better amenities? None. Landlords of rent controlled properties are incentivized in the opposite direction: to spend as little as possible on maintaining their buildings, because the rent will be unaffected regardless.
Carefully research what is legally allowed before trying to salvage a rent controlled building, and speak with an attorney to better understand the requirements. It’s also wise to contact the local landlord and tenant board to make sure all rules are being followed.
Would you become a landlord in a rent controlled area? Any advice for those thinking of buying their first property in this type of market?