The specter of rent control is making a reappearance both in Los Angeles County and statewide.
Housing costs, including rents, have risen sharply in recent years, making it difficult for many to afford a home. While low-income people and seniors on fixed income are the ones feeling the most pain, according to Zillow, the average cost of renting is about 47 percent of the average paycheck.
The current economic climate sets the stage for populist efforts to reign in housing costs.
In early September, the Los Angeles County Board of Supervisors voted 4-1 in favor of instituting rent control in unincorporated parts of L.A. County. There will be a final vote in November before it takes effect.
Also in November, voters will be asked to vote on Proposition 10, which would give local governments the opportunity to impose rent control by repealing the 1995 Costa Hawkins Rental Housing Act, which limits rent control ordinances that cities can enact.
As anyone who has taken an introductory economics course can attest, the price of goods and services, including rents, is established by the marketplace.
As demand increases, prices rise. When supply relative to demand increases, prices decrease. When sustained demand relative to supply increases, ongoing inflation results.
Absent a monopoly or oligopoly where the market for a particular commodity is manipulated by suppliers, governmental price controls merely accelerate a shortage of that commodity.
This causes the available supply of the product to decrease and frequently results in a black market. Housing is unique because you cannot easily create a black market for it.
Our current Southern California housing market, including the rental component, is one where the demand for housing has sharply increased while the supply has not kept pace with that demand.
The millennial generation is forming new households at a time when it is increasingly expensive to construct new housing.
We experienced a similar phenomenon in the 1970s when the baby boomers also formed households in unprecedented numbers.
Since the 1970s the cost of constructing new housing has outpaced the growth of household income. Consequently, housing consumes a larger part of renters’ income than it did a generation ago.
Relative to the 1970s, it is extremely expensive to entitle a house. Increased permit fees, tougher building codes and environmental regulations are just a few of the factors contributing to cost increases.
The high cost of materials has also fueled increased housing costs.
In the 1970s, most new housing was constructed by locally owned companies who went to a local savings and loan association to finance their construction. Savings and loans have gone the way of the Dodo Bird.
Today, most new housing is constructed by companies with a national footprint.
Both the development and operation of rental housing is financed primarily by institutional investors. Much of that institutional money comes from pension funds who have participants like you and me.
When you invest your pension money, you need a return on that investment that is commensurate with the investment’s risk. If you don’t achieve that return, you won’t have enough money to retire.
Pensions and other institutional investors cannot afford to be charitable institutions.
Most institutional investors seek a 7 to 12 percent annual return on their investment and devote about 10 percent of their portfolio to real estate-related investments. If a particular real estate market cannot deliver the requisite return, investors will invest in other markets that are capable of doing so.
Real estate investment trusts (“REITs”) are huge players in multifamily housing nationally. Most multifamily REITs find they can receive higher returns by investing outside of California because it costs less to develop new housing than it does in California.
In order to deliver an identical return to the investor, the owner of a housing unit that costs $100,000 to build will have to charge higher rent than the owner of a unit that costs $80,000 to build.
Given the high cost of housing in parts of California, including the Santa Clarita Valley, rents are going to be high.
Local rental housing markets are not controlled by monopolies or oligopolies. Rather, marketplace forces are dictating where the flow of capital is directed. The marketplace is competitive.
If California enacts rent control, it will ensure that less capital will flow into its rental markets. That will further inhibit the supply of rented housing units.
A constrained supply will inevitably result in even higher rents, less affordability and increased housing shortages.
To solve the problem, we need to make difficult choices and address the factors increasing the cost of new construction.
Both the L.A. County supervisors and the backers of Proposition 10 have it wrong.
Jim de Bree is a semi-retired CPA who represented numerous real estate clients during his career.
