If you got your recent tax assessment, I am sure you have a little sticker…
It is no secret that rent in Denver and throughout the state has increased. A one bedroom in 2010 leased for 800, fast forward to 2021, that same one bedroom is now leasing for 1646 a month, a 106% increase. The legislature has taken up the fight with hb21-1117 that will reverse a 1981 Law that prohibits local governments from implementing their own rent control measures. The “income restricted” housing bill is a game changer for real estate. What is in the new legislation? 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?
Will this new bill pass?
I wrote about this bill a few months ago, as predicted it recently passed and cities are now scrambling to update their land use regulations to incorporate the new changes.
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. As a result, 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 must 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?
HB21-1117 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 clarifies that the existing authority of cities and counties to plan for and regulate the use of land includes the authority to regulate development or redevelopment in order to promote the construction of new affordable housing units. The provisions of the state’s rent control statute do not apply to any land use regulation that restricts rents on newly constructed or redeveloped housing units as long as the regulation provides a choice of options to the property owner or land developer and creates one or more alternatives to the construction of new affordable housing units on the building site. The bill clarifies that the existing authority of cities and counties to plan for and regulate the use of land includes the authority to regulate development or redevelopment in order to promote the construction of new affordable housing units. The provisions of the state’s rent control statute do not apply to any land use regulation that restricts rents on newly constructed or redeveloped housing units as long as the regulation provides a choice of options to the property owner or land developer and creates one or more alternatives to the construction of new affordable housing units on the building site.
To try to placate developers and property owners that this bill is not rent control (it is), they added the following language:
The bill also states that it should not be construed to authorize a local government to adopt or enforce any ordinance or regulation that would have the effect of controlling rent on any existing private residential housing unit in violation of the existing statutory prohibition on rent control .
HB21-1117 changes a 1981 law that prohibited cities from enacting laws to control rent. Look for cities like Denver to jump in full force with the implementation of this bill.
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 in Colorado
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 values in Colorado
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 in Colorado
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. This will lead to steep declines in values on certain properties 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 that the sitcom friends is 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.
Building costs increase:
Furthermore, “ the bill clarifies that the existing authority of cities and counties to plan for and regulate the use of land includes the authority to regulate development or redevelopment in order to promote the construction of new affordable housing units”
With an affordable housing mandate on every new project, it is undeniable building costs will increase. Take for example a developer is going to build a 20 unit condo complex in Denver or a resort town in Colorado. Assume the city says that 5 of these units must have affordable rent/ be deed restricted. The builder will discount these units to meet the affordable housing requirements and increase the costs of the other units, remember the cost of the project did not change, just the profit margin has to be spread over fewer units. The remaining units will be even less affordable for prospective local purchasers as the market rate units must subsidize the affordable housing.
To counteract the skyrocketing rents, the Colorado legislature has come up with a worn-out idea to implement rent control. Who does not want to see rent stay constant? According to the fiscal impact statement, there will be no impact on the state or cities.
Unfortunately, someone must pay. Everyone else will pay with the largest impact to lower income residents who are now priced out of market due to the increasing prices because of the decrease in new development and increasing costs that will be passed on to other buyers/renters. This bill “hollows out” the middle class.
There are fundamental reasons rents are rising; there are more people relocating and supply is not keeping up with the demand. Unfortunately rent control does nothing to address the fundamental issues causing rents to rise. The real solution is supply which rent control would decrease. Rent control is the wrong tool to fight the housing challenges facing not only in Denver but every resort community in the state and will have the opposite effect of increasing rents and prices on everyone else.
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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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