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Rent Control: A Cautionary Tale by – Dean Sherry, President of Duke Property Management

Posted on 01. Sep, 2018 by in all

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[AOA:  The following will not happen to you when we defeat Proposition 10!]

 One afternoon, a few years ago, I received a call from a guy inquiring about my company’s property management services. His said his name was Will Wright (name changed for privacy reasons) and that he owned a fourplex in Santa Monica, CA near Santa Monica College (SMC). He lived in one of the units and each unit was comprised of a one bedroom/one bath mix with all the fixings, including washer/dryer combos, central HVAC, modern appliances and parking!  He’d been saving up money to travel and wanted a management company to look after his property.

He also sounded like a good guy who needed help and I could already guess why, which was confirmed when he told me all three of his tenants had been students at SMC in the late 70’s, and have never left, and therein lies the issue. Although he occupied one of the units, it was still a fourplex so it wasn’t exempt from rent control and I could sense that the long-term effects of strict rent control policies have taken its toll on him.

I thanked Will for his inquiry, but told him I normally don’t take on a property under such circumstances and it wasn’t because I didn’t like him or Santa Monica- it was a simple matter of economics. I own the business and needed to stay profitable otherwise I’ll go out of business. I make my management fees on a percentage of the monthly rents collected and his rents were so far below market that I’d have to charge him a 10% management fee just to break even! However, I don’t know why, but something compelled me to take him on as a client anyway, it just felt like the right thing to do.

Will grew up near the property and he recalled the joy of growing up in such a great place back when Santa Monica was still a quiet, mom-and-pop type of beach town. Life was just simpler back then and he didn’t have to worry about his future, until his future suddenly came crashing down upon him.

Will Becomes a Rental Property Owner

Just after his 18th birthday, Will got a letter in the mail that he was being drafted into the Vietnam War and was to prepare for duty in one month.  His grandfather, in response to this, had then taken out a loan and purchased a parcel of land near where Will grew up and told Will he was going to build him a little apartment complex so he won’t have to worry about money or a place to live WHEN he comes home.

Thankfully, Will did return home two years later with a Purple Heart award, an honorable discharge and a war wound which left him partially disabled. He moved into the place his grandfather had built for him and started managing the property while enrolling into SMC and slowly trying to acclimate back into a normal life.

Rent Control – The Beginning to an End

Will was a good, responsible landlord. He raised rents when he had to, but only then just enough to offset his increasing expenses. He was close with his tenants and things were going well at the property until 1979, when the City of Santa Monica adopted rent control.

The little mom-and-pop beach town Will had grown up in was growing up itself and more and bigger companies were moving into Santa Monica, which brought in more jobs and more renters, which meant that the development of commercial and residential properties doubled but still couldn’t keep up with the influx of companies and people. Eventually, the flood of money and people coming into the City had created a housing shortage and as a result, a natural spike in rents threw the Santa Monica rental market out of whack. The City had no choice but to enact rent control to stabilize the housing market.

At the lowest point in 2015, the City set the maximum allowable increase at .004% and for Will, that translated to about a $5 monthly rental increase per tenant that year, while the annual allowable pass-through fees remained disproportionately low.  He was being squeezed by the City on the revenue side and couldn’t keep up with the increasing operating expenses. The financial strain was affecting his psyche too and one day, it happened – the pipes in his building virtually all burst at once due to a high rate of corrosion from exposure to seawater, and created a massive flood and that was the beginning of the end for Will.

A couple weeks after the incident, I went to visit Will at his friend’s house.  We went over some of his options and I suggested perhaps taking the units off the market as per the Ellis Act but he said that was for rich guys who could afford to do that.  The time and energy it would take for him to recover was just too much. He had taken out another loan a few years back and now he was under so much water, and his cap rate was so low that he couldn’t even afford to sell it!

Suddenly, Will pulled an envelope out of his pocket, handed it to me and said; “Here’s an advance on your management fees”. He then thanked me for everything and told me that he loved Santa Monica, and always will, but the City has abandoned him as a property owner and so now he has to abandon it. Then, he turned around and just walked away.  “Wait, Will, where are you going? What are you going to do? What about the property?” He turned around to face me, smiled, and said, “I’m going back to Vietnam. Life is much simpler there.” “Oh and about the property, do you want to buy it?” I said, “um, no, not really”, to which he replied, “I didn’t think so. Let’s just say I’m strategically defaulting on my loan. It’s the bank’s problem now”. He then straightened-up tall, gave me a military salute, turned around and left.

I never heard from Will again. He just disappeared, defaulted on his loans and left the property in the bank’s hands. The tenants were now displaced and had to find new housing, and the bank eventually sold the property at a foreclosure auction to a local developer who no longer developed apartments due to shrinking profit margins, and ended up building a less-than charming four-unit condominium project. A large part of its reduced charm, aesthetics aside, was the selling price of the condos. Another four units that were way out of reach for those former tenants of Will’s or for many people clinging to rent controlled apartments. So, Unaffordable Housing replaced what could have been Affordable Housing had Will been allowed to raise rents to a fiscally sensible level.

In the end,Santa Monica’s strict rent control policy backfired on itself and added four more renters to the market while losing another good property owner.  Instead of win-win situation, we have lose-lose.

Will struggled to remain financially solvent simply because his tenants HAD been there since the 70’s and were still paying rents from the 70’s due to the City’s insistence on keeping the yearly allowance artificially low in the name of affordable housing.

The difference between the rent he actually collected and the rent he could have collected at market rate is called an owner’s “Loss to Lease”. The year I started managing Will’s property, his total Loss to Lease for that year was $45,000, which was about the same amount he could have used to re-pipe his building.

What are we to conclude from this? Well here’s where I net out: why CAN’T the City adopt a tiered rental increase system, instead of 3% across the board? In other words, those long-term tenants who pay the cheapest rent should pay a higher yearly increase than the newer tenants who are paying over-market rent. I think that seems like a good start to a more “fair and balanced” system.

Until economic fairness is added into hardline politics of rent control, we will continue to see owners who literally cannot afford to keep their buildings; and tenants left out in the cold and I’m pretty sure that wasn’t the intent of rent stabilization.

 Help Save Costa-Hawkins!

[AOA: Yes, this might not happen to you, but it sure will happen to many other owners, and the value of your building(s) will go right down with them if we do not win this battle against Proposition 10!  It will take a lot of money to win and I encourage you to contribute your share.  Over fifteen million dollars have already been raised by a coalition and it is going to take a lot more to win.  We are counting on you and other AOA members and friends to help win this one.  The opposition has been given millions of dollars from a big donor with socialistic ideas.  To counter this, professionals have been hired to run the campaign for our industry and they have to be paid along with the cost of the promotion.  Be sure to visit an AOA office and pick up your “Vote No on Prop. 10” lawn sign.  Please, please donate at least $100!  If you are able to do more, please do it now.  How about somewhere between $100 and $10,000?  See you at the big Million Dollar Trade Show! – Dan Faller]

What Else Can You Do?

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 The article was written by Dean Sherry, President of Duke Property Management. Dean can be reached at (310) 657-4256 or via email dean@dukepm.com. Please visit Duke Property Management’s website at www.dukepm.com.

 

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