How Rent Control Policies Could Impact the Single-Family Market

When all is said and done, 2019 may be remembered as the year of rent control.

California, New York, and Oregon passed new statewide legislation in 2019 under the guise of rent reform, and Illinois is considering following suit. With the nation’s housing deficit now running at more than 1 million units, and rents continuing to rise in many markets across the country, the clamor for rent control has only increased in recent years.

“Since 2017, 14 states and the District of Columbia have attempted to expand rent control either through the legislature or via the ballot box,” says Jim Lapides, vice president, strategic communications at the National Multifamily Housing Council, a trade association that represents apartment groups. “Those 14 states and the District represent more than half of the existing rental apartment homes in the country.”

But while rent control is typically seen as a policy area that mostly applies to multifamily apartments, what’s different in 2020 is that single-family homes have now been sucked into the debate as well. Both the California and Oregon laws apply to single-family homes in some form while they were typically exempt from past rent control measures.

The push toward single-family inclusion in rent reform measures comes right at a moment when the number of single-family homes built to rent is on the rise. NAHB estimates nearly 1 in 20 new single-family homes—or 5%—today are built-to-rent houses. As both millennials and downsizing baby boomers have displayed a penchant for renting either out of necessity or by choice, a growing share of single-family rentals has been one of the hallmarks of this housing cycle, with 39% of the nation’s rental stock now single-family homes, according to Harvard’s Joint Center for Housing Studies.

In other words, rent control is no longer just a multifamily issue.

“Given the rising count of single-family rental units and the small but growing share of single-family built-for-rent construction, rent control policies are a risk for the single-family market as well,” Robert Dietz, chief economist at NAHB, wrote in the October issue of BUILDER. “Moreover, by distorting market signals of the relative prices of renting and owning a home, rent control can also negatively affect demand for for-sale housing.”

On the Radar, Nationwide
The intersection of the resurgence of rent control regulations, coupled with the rise in single-family rentals, has certainly gotten the attention of single-family rental operators. “We are sending out a communication to all of our non-California investors telling them California is the third state to create statewide rent control,” says Doug Brien, a former NFL placekicker turned real estate investor who launched single-family landlord Starwood Waypoint Residential Trust, which has since merged with Invitation Homes.

Now, as CEO and co-founder of Oakland, Calif.–based MYND Property Management, which manages both multifamily and single-family units for owners, investors, and builders, Brien oversees a single-family rental portfolio of more 4,500 units and finds the inclusion of single-family homes that are owned by corporations in California’s rent control legislation particularly concerning. “A lot of policy and trends emanate from California, so this is definitely something investors nationwide should be aware of,” Brien says.

Major single-family public home builders, such as Lennar and Toll Brothers, have recently entered the built-to-rent market, and other companies, including American Homes 4 Rent, Invitation Homes, and NexMetro, have staked their business models on renting out both new and existing single-family homes.

The numbers illustrate the trend. Five million single-family homes were added to the U.S. rental stock since the Great Recession, mostly from existing homes, according to NAHB’s Eye on Housing blog, and there are now 18.2 million single-family rentals, according to the Joint Center for Housing Studies of Harvard University. Moreover, in the 10-year period from 2005 to 2015, 56% of the gains in rental housing stock were due to the increase of for-rent, single-family homes, according to NAHB, though the Harvard numbers note that increase slowed dramatically after 2015 as multifamily units gained. Indeed, while NAHB notes that built-to-rent single-family homes now account for 4.9% of all newly built single-family homes, compared with a historical average of 2.7%, that share is actually down slightly from 2013, when it was 5.8%.

Penciling Out
The story behind those numbers is easy to understand when told by the likes of Jerry Ellenburg, CEO of Tampa, Fla.–based ERC Homebuilders, a built-to-rent real estate development company that’s undertaking a “soft” IPO with the aim of raising $50 million to develop and wholesale mini-neighborhoods of affordable single-family homes to investors who want to rent them out. A former mobile home communities operator, Ellenburg started buying distressed single-family homes in the wake of the 2007 housing bubble and subsequent financial collapse with the goal of adding improvements and then flipping them at a profit.

“You could buy these homes at good prices, fix them up, and then sell at a nice profit,” Ellenburg recalls. “Then, starting in 2013 or so, we noticed partnerships coming in to buy the homes, and one of them was owned by Blackstone. But it was still very disorganized, with all those homes spread out geographically. So around 2015 or so, guys like us got the idea of building homes for those partnerships in a contiguous location, as a closer cousin to traditional multifamily, where you build 80 homes in a single neighborhood, and sell them, wholesale, to those groups.”

Not only does that make those homes more efficient to manage from a rental perspective, but also the homes themselves can be built with durable finishes and low-maintenance landscape features that lend themselves to renting versus the higher-end options of traditional, for-sale single-family homes.

Ellenburg stresses two aspects that make the built-to-rent model work today: low interest rates so that homes pencil out and the ability to charge rents from $1,700 to $2,000. “This model is very interest-rate driven,” says Ellenburg. “It would not have worked 15 years ago, because the payment to service that debt would have been too high. We’re looking to build these things for $200,00 to $220,000 and sell them for $260,000 or so to keep the rent in the high teens, from $1,700 to $1,900 a month, but definitely below $2,000.”

With rents in the single-family market rising at a rate of 4.5% year over year, compared with 3% for apartments, it’s easy to see the attractiveness of the built-to-rent model. But with the specter of rent control rising over the sector, it could also dampen excitement about those prospects.

“The fun’s over here in California,” says Daniel Yukelson, executive director of the Apartment Association of Greater Los Angeles, speaking to the state’s rent control legislation, known as AB 1482. “Starting Jan. 1, those single-family homes owned by a corporation, REIT, or LLC that has a corporation as a member, are no longer exempt.”

For Ryan Gilbert, director of equity research who covers single-family REITs at brokerage BTIG, the result could be investors taking a much harder look at the numbers in the emerging real estate asset class that is built to rent.

“If rent control measures are put in place in current built-to-rent markets, investors and developers would have to take a much sharper pencil to those deals,” Gilbert says. “They’d need to take a closer look at their underwriting requirements to make sure it wouldn’t negatively impact the yield on their investment.”

Does Rent Control Work?
Proponents of rent control say something needs to be done now in the face of the United States’ ever-increasing cost of housing. “The housing crisis is reaching every corner of America, where you’re seeing high home prices, high rents, evictions, and homelessness that we’re all struggling to grapple with,” Assemblyman David Chiu, a San Francisco Democrat who authored California’s law, told The New York Times. “Protecting tenants is a critical and obvious component of any strategy to address this.”

But for economists, the return to rent control is a quick-fix reaction that doesn’t work because it fails to address the underlying cause of high housing costs: a fundamental shortage of supply. Rent control, they say, actually disincentivizes the construction of new housing since it limits developers’ returns and adds policy risk.

“There’s an old joke that if you gather three economists, you’ll find four opinions,” NAHB’s Dietz wrote in his recent BUILDER article. “This joke falls flat with respect to rent control, because this is one of the few topics where almost all economists agree.”

Dietz points to a 2018 paper by economists at Stanford University that found rent control policies in San Francisco in the 1990s caused the supply of available rental housing to decline by 15%.

Brad Dillman, chief economist at Atlanta-based Cortland, which owns and manages more than 60,000 apartment homes nationwide, says he definitely falls in Dietz’s camp. “Rent control doesn’t work,” Dillman says. “It carries with it a variety of unintended consequences.”

Those consequences include stifling the motivation for developers to build more housing stock. “It actually has the opposite effect,” says Sharon Lewonski, a real estate attorney at Atlanta’s Culhane Meadows and a member of the Urban Land Institute. “What happens with rent control is you basically take rental units off the free market, people in rent-controlled units never move, and you’re providing disincentives for new construction and new development.”

While 31 states still have laws prohibiting rent control at the municipal level, including Georgia where Lewonski is based, some cities are opting for inclusionary zoning, which requires a certain amount of affordable units to be included in new developments to receive entitlement approval.

“Some people think that’s another form of rent control,” notes Lewonski, who points to Atlanta’s recent passage of inclusionary zoning as the setup of a possible legal fight. “The bigger question is whether Atlanta’s inclusionary zoning ordinance is constitutional, based on the statewide ban against rent control legislation.”

Then, there are examples of economies flourishing when rent control is undone. One of the best known is Cambridge, Mass., where rent control was repealed in 1994. While rents there have continued to climb as the area’s Kendall Square has become a biotech hub, a study by researchers at MIT also said the end of rent control added approximately $2 billion in value to the local real estate market. In Toronto, vacancy rates rose to their highest level since 2015 following the repeal of rent control on new buildings in 2018, while nine buildings and 3,078 units came online, a 25-year high for annual completions, according to Bloomberg.

A better solution, housing advocates say, are incentive-based programs, such as the highly successful federal low-income housing tax credit, or, more recently, the federal Opportunity Zone (OZ) incentive, which is intended to stimulate economic development and job creation in distressed low-income communities by incentivizing long-term capital investment.

“OZs are something that should, in theory, help more supply come to market,” Dillman says. “It incentivizes capital to move to those jurisdictions, and we’ve seen data that shows increased transactions in areas where that legislation went into effect.”

According to real estate data firm Reonomy, multifamily development in OZs is thriving, with 7.08% of multifamily properties transacting in the federally designated zones since legislation passed at the end of 2017, compared with 6.51% in non-OZs. Since 2018, 19.25% of all OZ transactions were multifamily properties—the second largest proportion of sales across all asset classes. And OZs are driving multifamily investment in unsung locales, such as Kentucky, Nevada, and Oklahoma.

“While multifamily properties in OZs seem to be appealing across the country, they are having an outsized impact in more tertiary markets,” says Sam Viskovich, vice president of marketing at Reonomy.

Meanwhile, as rent control continues to gain steam—the NMHC currently has a 15-jurisdiction watch list (see sidebar, “Mapping Rent Control Markets”)—single-family rental owners in California were not waiting for the new law to go into effect. “A real thing that’s happening is we have owners who are saying ‘The new law applies on Jan. 1, so let’s raise all our rents to the prevailing market rate while we can,’” MYND’s Brien says. “We’ll see how much that plays out [in 2020].”

Says Matthew Davies, president and founder of Harmony Communities, which owns and operates 24 manufactured home communities in California and Oregon, “This rent control move might, perversely, result in rents rising at a higher rate.”

Invitation Homes, which has 12,600 single-family units in California, notes that its average rent increase for the past three years has been lower than the state’s new cap on increases of 5%, plus inflation. “While we understand the intent behind this legislation, economists and housing policy experts have said the solution to affordable housing is more supply, not rent control,” writes Kristi DesJarlais, Invitation’s senior vice president of communications, via email. “Regrettably, AB 1482 is likely to exacerbate California’s housing problem by dampening new housing starts and investments, as experts have predicted.”

Is Rent Control, Like Home Building, Local?
While there’s plenty of concern among developers, builders, and rental groups about the move toward rent control in the past year, some purveyors of the single-family, built-to-rent model see the actions of California, New York, and Oregon as more akin to another 2019 hallmark: a big nothing burger. Why? Those are regions where rent control has always been in play, so developers—particularly those building single-family homes for rent—have already tended to steer clear of them.

“I’m not sure how robust of a trend it is,” says David Howard, executive director of the Washington, D.C.–based National Rental Home Council, whose members represent 230,000 single-family rental houses nationally. “Our members tend to have properties in the Southwest, Southeast, and the middle of the country, and less so in places like New York and California, which have a history of rent control practices. Home building is local. So obviously, you’re going to go to markets where there’s less of a regulatory impact on your ability to build and less of an impact on your return.”

That’s exactly what analyst Gilbert sees happening on the ground.

“From a yield perspective, it just doesn’t make sense for an institutional single-family rental investor to buy new construction homes in California and rent them out,” Gilbert says. “The big markets right now are Phoenix and cities along the Sunbelt. It’s happening in markets where rent control doesn’t exist.”

Indeed, when asked whether Toll Brothers is concerned about the trend toward increased rent control in areas like New York and California given its push into single-family, built-to-rent homes, a spokesman for Toll replied succinctly via email: “We aren’t doing single-family rental in either New York or California. But thanks for thinking of us.”

Another factor that’s creating a yawn from some is the fact that both Oregon and California exempt structures built in the past 15 years, in an effort not to curtail construction. Even Brien concedes that California’s rent control measure “could have been a lot worse.”

Ellenburg, who’s ramping up to build 1,000 built-to-rent units in Florida, is also not fazed by the places where rent control is happening for single-family homes. “Building in a suburb of Jacksonville is one thing. But building in a suburb of San Francisco is quite another,” says Ellenburg, a California native. “I can’t build them out there. I won’t take that chance, or risk having to collect $3,000 a month in rent to make it work. I’m going to be in Florida. I’m going to be in Tennessee. I’m going to be in Alabama and Georgia, where there’s a whole different culture that’s not about rent control.”

That may be the greatest irony of the current push toward rent control, especially as it entails built-to-rent single-family homes. Namely, the locales where economists say rent control typically discourages the development of more housing—high-barrier-to-entry markets along the coasts—are exactly the kinds of places the emerging asset class of built-to-rent, single-family operators, who want to pump out thousands of units to meet the country’s unprecedented demand for housing, are most likely to eschew.

“Single-family, built-to-rent operators are pushing into metros where there’s not rent control and where the hurdles to enact rent control are reasonably high,” says Gilbert. “The hallmark of those markets is that they are much more affordable than places like California.”