I’m a real estate investor, and I love San Francisco’s rent control. Here’s why:
Rent control restricts the amount an apartment’s rent can be increased per year. Escalations are regulated until turnover, when the apartment’s rent can be marked to market. This dynamic creates favorable conditions for investors:
- Tenant turnover decreases as long-term residents with below market rent create long term homes
- Supply is artificially constrained by reduced turnover
- Market rent growth accelerates with reduced supply
Favorable Upside vs. Downside
I value safety of principal and liquidity more than excess returns, and I’m weary of an economic correction that negatively impacts multifamily rents. The purchase of apartment units that are rented far below market can provide downside protection in a market retraction.
Example: Suppose a unit is rented for $1,000/mo while the market supports a rental rate of $2,000/mo. Conventional wisdom suggests that the occupant will remain in the unit at current rents during a retraction that reduces average market rent by 50%!
After the Tech Bubble, the average rent in San Francisco dropped 25%, compared to 5% in the Great Recession and 8% between 2016 and 2017.
Real estate valuations rarely reflect the downside protection created by apartments leased below market. Capitalization rates for apartment buildings with below market rents are similar to those that have near market rents. In such situations, periodic turnover of below market tenants can create significant upside for investors.
Case Study: Russian Hill Multifamily
A recent offering for a multifamily building in San Francisco sheds light on the economic benefits of rent control. With 21 units, the building’s current annual gross rents are $257,758, while the market supports gross rent of $591,780. Among the 21 units are 17 that are leased greater than 40% under market. Given the downside protection provided by the rent controlled units, a 20% market correction would only reduce the current gross rent by 9% ... downside protection!