The attached video blog is a variation on the analysis I’ve recently been providing to clients, potential investors, and others wanting to better understand the rapidly-changing landscape of housing shortages throughout Sonoma County. What is presently happening in Santa Rosa is truly a microcosm of developments occurring all over California, as our state emerges from “The Great Recession.”
Not all readers or viewers will understand my left-field reference to Star Trek’s “Kobayashi Maru.” To offer a concise explanation: the Kobayashi Maru is a very complex challenge, for which there is no readily-apparent answer.
Housing Shortage in Sonoma County
Since 2008, there has been no significant development of new housing in Sonoma County. According to some reports, the number of new housing starts are at low levels not seen in 45 years. Additionally, housing sale values, after plunging precipitously to their lowest levels in 2010, have rebounded by nearly 75%. Many recent housing purchases have been by investors – not just purchasing multi-unit complexes, but also many single-family homes.
Vacancy factors are likewise at low rates not seen in more than ten years. The local vacancy rate, depending on the data source, is somewhere between 1.5% and 3.0%. Under either calculation, this is the statistical equivalent of “full occupancy.”
Many factors have influenced recent rent increases. Investors purchasing multi-unit buildings expect to capitalize their investment and generate the desired cash flow. In some instances, pre-existing rents for those purchases may have been measurably below market value prior to the sale. Even for properties not subject to recent changes in ownership, there have been dramatic increases in rent values, affecting single family homes, condominiums and other types of housing.
As San Francisco has become the hottest rental and sale market in the nation, that impact has expanded to outlying communities. Santa Clara, the East Bay and Marin Counties first felt the effect, but it is now extending to even more distant areas, including Sonoma County. The low vacancy factor noted above has the direct impact of increasing average rent values across the board.
Throughout the years between 2000 and 2010, rents remained fairly stable, increasing only incrementally. In the three years between 2012 and 2014, average comparative market rents increased by 30%. Arguably, rents are increasing by an even more rapid rate in 2015. In a lot of instances, landlords have not – had not – been adjusting rents methodically over the course of the past decade. Many owners stayed firmly below market rent, in some cases with significantly low margins. As recent rent escalations have become “newsworthy,” landlords who had been keeping rents low have now realized that it’s past time to institute their own rent increases. While most investment owners have generated only moderate increases, there are numerous examples of landlords who have increased rent by more than 40%.
While the inherent market value of housing has increased dramatically, employee income has not kept pace. In the Great Recession, many local jobs were lost. While Sonoma County job growth has improved since 2010, a significant number of those recently-added jobs have been in leisure, hospitality and other moderately-compensated industries. Likewise, wage increases for established employees in all industries have not kept pace with the extraordinary increases in home sale and rent values.
There have been a few recent, high-profile articles in the media about landlords and investors who have exemplified a “ham-handed” approach to tenant relations. In Santa Rosa, an investor bought a 10-unit complex, and immediately raised rents by nearly 50% on the existing tenants, even though there were apparently clearly-visible habitability issues afflicting the property.
In Healdsburg, a buyer purchased a 21-unit apartment building, evicted all of the long-term tenants, and advertised for investors to share in his goal of turning the property into a more “refined” residential complex. While these instances are truly the exception rather than the rule, they have become public examples of “bad landlord behavior,” and held out as a justification of the need for cities to get involved in regulating local housing
Lack of Affordable Housing
In many instances throughout Sonoma County, a rental property that might have been listed at $1,500 in 2010 could easily be worth $2,100 now, if vacant. Let’s presume that a “reasonable and responsible” landlord wanted to increase rent somewhere above the present price but below today’s market value. A rent increase to $1,800 would not capture the present value, but would still result in a rent adjustment of 20%, amounting to $300 more each month. Even such a “moderate” increase would have a monumental impact on existing tenants. In this scenario, the tenants would be required to recalculate their annual budget, and reassign $3,600 yearly from other obligations, applying it directly to rent. It is difficult to ignore the impact such adjustments would have on most renter households.
Also, given the hot sale market, many owners of investment properties are frequently choosing to market their units for sale. The impact of this decision is frequently even more dramatic for tenants. If the property sells to an investor and the tenant remains in place, the new owner will often be financially motivated to substantially increase rent to offset the new actual costs of ownership, including the adjusted mortgage and property tax rates. Alternately, if the new owner is an owner-occupant, the existing tenant would be displaced, and forced into the present rental market. Whereas they might previously have been paying $1,500 monthly, they could now be competing to rent the similar unit for $2,100.
Circumstances have forced numerous tenants to actually leave Sonoma County, because rents have increased beyond their means, and/or simply due to the lack of alternate affordable housing.
Landlord vs. Tenant
These circumstances have a clear and dramatic impact on residents throughout Sonoma County. At numerous City Council meetings in both Santa Rosa and Healdsburg, elected officials have sustained a barrage of vivid testimonies, examples of tenant hardship and suffering. Additionally, tenant advocacy groups, like the North Bay Organizing Project, have been rapidly coordinating efforts to rally those most impacted by recent rent spikes. NBOP and other groups are strong advocates of rent control and other “stabilization” options to minimize impact on tenants and those most at risk. However, minimizing negative impacts on TENANTS will potentially create significant negative impacts on OWNERS.
WHAT CAN HAPPEN NOW?
Costa-Hawkins Act of 1995
As mandated by this state law, many properties are automatically excluded from the “protections” of rent control. Single family units, condominiums, and government-owned or subsidized housing are all exempt from rent control. Additionally, ANY housing developments, whether single- or multi-unit, constructed after 1995 is likewise exempt.
Rent Control in Sonoma County
For those properties impacted by Costa-Hawkins, local legislatures can cap the amount of annual increases allowable on existing tenancies. Whenever a tenant in an existing rent-controlled unit vacates, the landlord would be permitted to reestablish rent at the prevailing market rent, but would once again be limited by annual increase limitations for the NEW tenant. In order to prevent landlords from methodically evicting existing tenants to allow for rent adjustment, many cities that instituted rent control have also implemented “just cause eviction” regulations. These regulations significantly limit a landlord’s ability to request any tenant to vacate a rent-controlled unit. Just cause eviction regulations could actually be implemented to affect ALL rental properties, not just rent-controlled units.
Rent Boards and Other Possibilities
To oversee this complicated process, cities approving rent control are required to create new bureaucracies, usually including a “Rent Board.” This department would arbitrate in disputes, make findings in instances where rent increases are in excess of the allowable amount, and rule in cases where a tenant requests a reduction in rent or alleges unjustified notice to vacate.
In addition to – or instead of – rent control, other “stabilization strategies” might be instituted. Some communities have required that landlords pay interest on security deposits. Another option has been the “Certificate of Registration,” wherein landlords are required to register with the city in order to “operate” their rental property. Some cities also require regularly-scheduled building inspections, performed by city officials and paid for by the property owner.
Rent Stabilization Efforts in Richmond, CA
On July 21, 2015, at a regularly-scheduled city council meeting, Richmond city officials passed an ordinance, becoming the first California city in 30 years to institute rent control. While the actual implementation will take effect in December 2015, the “base rent” upon which increases will be calculated was established as the rents paid by tenants on July 21, 2015. In other words, if an impacted landlord hadn’t increased rents prior to that 7/21 meeting, they would thereafter be prevented from doing so outside of the limitations of the rent control ordinance
Additionally, the implementation of rent control in Richmond will require the creation of a new bureaucracy, at an initially-budgeted cost of $2.2 million. This cost will be borne by ALL investment property owners – whether or not their properties are impacted by Costa-Hawkins. The City Council has initially stipulated that this cost CANNOT be passed through to tenants; it is solely the landlord’s obligation. Based upon the number of rental properties presently in Richmond, this amounts to a fee of $200 per unit, for the first year. Operating budget increases are likely, if not assured.
While Richmond’s particular situation is certainly rather unique and still being formalized, it is a vivid example of the severity of regulations that local municipalities could institute as a form of “rent stabilization.”
Call to Action: Needs of the Few vs. Needs of the Many?
As a professional property manager, I work for my individual clients, to whom I owe a fiduciary responsibility. My duty is to look after their needs and the needs of their properties. Accordingly, there are numerous instances where rent increases should be encouraged and instituted. The challenge becomes that, whether my clients have a property that would be impacted by Costa-Hawkins or not, the cumulative impact of dramatic rent increases throughout our community increases pressure on our City Councils to take remedial action. Tenant advocacy groups are doing their utmost to increase that pressure on elected officials. However, if I conversely recommend to my owners that they NOT increase rents – “for the greater good,”- they could still be negatively, and severely, impacted by actions of other landlords throughout the county. I would be remiss in my responsibility to my clients if I were to recommend that they keep rents unrealistically low, but if we decide to effect dramatic increases, we would likewise be potentially adding fuel to the fire – and hastening city officials’ implementation of stabilization ordinances that could affect ALL landlords, not just a few.
I have become actively involved and aware of the numerous meetings and developments transpiring in Santa Rosa, Healdsburg and beyond. This is a very complicated issue, requiring a mature, considered, and comprehensive solution. Decisions made today have the potential to affect many or most local investment property owners for the foreseeable future.
As a real estate investment owner in the midst of this tumult, what can – what should – you do? There are numerous ways you can have an impact. Be informed. Read the news, stay abreast of local developments and upcoming events. Attend local government meetings, and speak out. Support organizations like CAA which are working on your behalf throughout the state. VOTE. As developments in Richmond have proven, the makeup of your local government can dramatically influence how future problems are resolved.
I’ve said many times, “property management can be a complicated business. We’re here to simplify it.” This time, it’s probably not going to be simple. Please feel free to contact us at DeDe’s Rentals if you you’re looking for advice, ideas, information, or if you just want to express your opinion. Is this really a no-win situation? Not if we can help it.