Rent Control coming to Colorado: your property taxes will skyrocket

Denver rent has skyrocketed.  A one bedroom in 2010 leased for 800, fast forward to 2018, that same one bedroom is now leasing for 1457 a month, a 79% increase.  The legislature has taken up the fight with SB 19-225 that will reverse a 1981 Law that prohibits local governments from implementing their own rent control measures.  Will this solve the “rent inflation” or make matters even worse?  What does this mean for property owners and renters?  Who wins and what are the unintended consequences as a result?

What has caused the skyrocketing rents?

Basic economics never fails, supply and demand have gotten out of balance.  On the demand side net migration to Colorado continues as the Denver metro is consistently a top destination for companies and subsequently their employees.  Unfortunately supply has not kept up for a few reasons.  First, it is expensive to build in Denver due to land costs, labor, and zoning/taxes.  As all of these items have increased builders have gravitated towards higher end properties since this is the only way for them to make a return on their investment.  Zoning and taxes have exacerbated the situation.  For example as taxes increase, rents have to increase to account for the taxes.  Furthermore, zoning has limited the number of new properties coming online.  All these factors have led developers to focus on higher tier properties further driving up the rent

What is rent control?

SB 19-225 would make drastic changes in Colorado law.  Currently cities/counties are not able to control rent on private properties.  Below is an excerpt from the Colorado legislature:

The bill repeals existing statutory language prohibiting counties or municipalities (local governments) from enacting any ordinance or resolution that would control rent on either private residential property or a private residential housing unit (collectively, private residential property). The bill authorizes local governments to enact and enforce any ordinance, resolution, agreement, deed restriction, or other measure that would stabilize rent on private residential property.

SB 19-225 changes a 1981 law that prohibited cities from enacting laws to control rent.  What cities in Colorado do with this power is the million dollar question.  I could see high cost areas like Boulder enact legislation to cap the current rents now on apartments at the cost of inflation (which is basically non existent now).

 

How has rent control worked in other cities?

Rent control is not widespread in the U.S. According to a recent study by the Urban Institute, 182 municipalities in the U.S. out of about 89,000 have rent control regulations, and all of them were in New York, New Jersey, California, Maryland, or Washington D.C.  The reason it is not widespread is that rent control doesn’t work and over the long term has the opposite effect.

Rent Control reduces supply:

According to the Brooking institute, a liberal leaning organization:

DMQ find that rent-controlled buildings were 8 percentage points more likely to convert to a condo than buildings in the control group. Consistent with these findings, they find that rent control led to a 15 percentage point decline in the number of renters living in treated buildings and a 25 percentage point reduction in the number of renters living in rent-controlled units, relative to 1994 levels. This large reduction in rental housing supply was driven by converting existing structures to owner-occupied condominium housing and by replacing existing structures with new construction.

Rent Control reduces value:

To calculate the value of a commercial property, you take the Net Operating income by the rate of return (cap rate).  With rent control the net operating income is reduced drastically (less rents) and therefore the property is worth less.  Furthermore without profit motivation and a built in tenant base property owners are considerably less likely to take care of the properties.  Cambridge is a unique study as they had rent control and passed legislation to remove rent control.  The impacts on the market were profound:

From December 1970 through 1994, all rental units in Cambridge built prior to 1969 were regulated by a rent control ordinance that placed strict caps on rent increases and tightly restricted the removal of units from the rental stock.  In November 1994, the Massachusetts electorate passed a referendum to eliminate rent control. 

Author, Palmer, and Pathak (2014) (APP), studies the impact of this unexpected change and find that newly decontrolled properties’ market values increased by 45 percent.  In addition to these direct effects of rent decontrol, APP find removing rent control has substantial indirect effects on neighboring properties, boosting their values too. Post-decontrol price appreciation was significantly greater at properties that had a larger fraction of formerly controlled neighbors: residential properties at the 75th percentile of rent control exposure gained approximately 13 percent more in property value following decontrol than did properties at the 25th percentile of exposure. This differential appreciation of properties in rent control–intensive locations was equally pronounced among decontrolled and never-controlled units, suggesting that the effect of rent control had been to reduce the whole neighborhood’s desirability.

The economic magnitude of the effect of rent control removal on the value of Cambridge’s housing stock is large, boosting property values by $2.0 billion between 1994 and 2004. Of this total effect, only $300 million is accounted for by the direct effect of decontrol on formerly controlled units, while $1.7 billion is due to the indirect effect. These estimates imply that more than half of the capitalized cost of rent control was borne by owners of never-controlled properties.

Rent Control increases taxes:

It is well established that rent control reduces values but nobody is talking about how rent control will increase everyone else’s taxes.  As property values decline, so does the amount of property taxes collected as taxes are based off values.  With steep declines in values caused by rent control to not only the apartment owners but entire neighborhoods, how will local governments continue to provide the services now.  Either services will be cut (which never happens) or taxes will need to be increased on all property owners to make up for the lost revenue due to the decline in values.

 

New York Case Study:

When I think of rent control, the first city that comes to mind is New York (hopefully everyone remembers the sitcom friends based in rent-controlled apartments).  So how has NY fared as a result of their rent control ordinance?   Not so well.  According to the NY Daily: Median apartment rents in the city have increased 75% since 2000 — a rise 31 points greater than in the rest of the country, according to a report released by the city controller’s office. Over the past decade, 400,000 affordable housing units renting for $1,000 or less have disappeared, Stringer said.

 

To counteract the skyrocketing rents, the Colorado legislature has come up with a worn-out idea to implement rent control.  Who doesn’t want to see rent stay constant?  Unfortunately, someone must pay.  This is a giant transfer tax from not only apartment owners but everyone in the neighborhood around these rent control units as property values decline.  If you own real estate, you are more than likely impacted as being near a rent control property substantially reduces your property value and on the flip side will increase your property taxes.   The real solution is supply which rent control would decrease.  Unfortunately, rent control is the wrong tool to fight the housing challenges facing not only Denver but every resort community in the state.

Resources/Additional reading:

 

1. https://www.nydailynews.com/new-york/nyc-rents-soar-incomes-decline-article-1.1765445
2. https://www.westword.com/news/one-bedroom-rent-in-denver-rose-79-percent-in-under-a-decade-11072121
3. https://www.denverpost.com/2019/04/15/colorado-rent-control-regulations/
4. https://www.brookings.edu/research/what-does-economic-evidence-tell-us-about-the-effects-of-rent-control/
5. https://fair.org/extra/brookings-the-establishments-think-tank/

 

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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