Tenderloin Heights
by Jim Forbes
I have never been a big opponent of San Francisco's Rent Ordinance. Unlike the Residential Hotel Conversion Ordinance or the limits on Condo Conversions, I have often felt that the stabilizing of a tenant's rent—as long as there is no vacancy control and a reasonable chance of keeping abreast of inflation—is an acceptable evil in a place as sought after as San Francisco. In fact, I might even prefer it.
Of course, my reasons are all personal, or shall I say selfish. First, I am afraid of the risks of the free-market. With a building containing below-market rents there is security. I find there is less danger of a decline in income, and only upside if someone moves out. In a free market environment, in-place rents tend to mirror the market regardless of the tenant’s tenure, leaving rent vulnerable to going down as well as up.
Although the obvious argument is to keep one's rents slightly below market to create a secure income stream, try finding a building to buy where this already is the case. Most likely, an investor will start the game with market rents and only worry about the downside if the market enters a bearish trend long before unilaterally decreasing rents (and his or her income) to create security.
Historically in San Francisco, buildings have always had a large degree of under-market tenants, giving an investor a reliable base of income. Since prices for San Francisco buildings have not differed much from properties outside the city in equally desirable locations that are free of rent control, I would pick a San Francisco building every time. Although a more risk-oriented investor might scoff at my need for security, I am not alone. I have even seen people take this philosophy over the top and pay a premium for the under-market rent, even if it meant paying far more than the market gross they would have paid if all the tenants were at market.
I have still other reasons for liking rent control. First, I have always thought that if San Francisco did not have rent control, big Real Estate Investment Trusts (REITs) from Texas or Palo Alto would buy every building in town, driving up prices and leaving few opportunities for me.
Second (this one is really personal), I have always been afraid of cash. Cash can be spent, quickly and easily. Once spent, there is nothing left. On the other hand, to dispose of real estate is tough. Even in a highly liquid market like ours, to sell or refinance may take up to 60 days, meaning that by the time the cash is in hand the urge to squander it may possibly have passed. For an impulsive shopper like me, best not to have cash. Keeping it tucked away in real property is the best way to hold onto it.
My third reason is that rent control takes this forced regulating philosophy one-step further. If all my tenants paid me market rents at once, I would have too darn much disposable income, which I am certain I would spend on things I don't need. Rent control moderates my spending. When the gods of San Francisco real estate decide I deserve a raise, one of my low-paying tenants then moves out. There is nothing quite like the reward that comes at the end of a multi-year wait for a below-market apartment to come available. All this makes rent control worthwhile.
Fourth, I like rent control for it provides me with opportunities to invest. Now, don't get me wrong. I am not the type of investor who shakes, rattles and rolls his building until the low-paying tenants spill into the street, nor do I do owner move-in evictions. But I have nothing against a capital improvement passthrough petition or a PG&E passthrough to raise my income; nor do I look the other way when roommates suddenly appear or my tenants start using my units as their pied-á-terres.
Last, I like the inefficiencies that may arise when rent control collides with the rest of the economy, such as the potential convergence of the effects of rent control and rising interest rates. Now I don't see this happening anytime soon, but perhaps in two or three years if the economy gets going again, interest rates may climb two or three percentage points, putting adjustable loans at 8 percent or more rather than the current sub-6 percent.
For those investors who may have bought their buildings today, even with as much as 30 percent down, the cash flow of a few points today would suddenly go negative if they can't get their rents up. Even if the market for apartments climbs, rent control could keep a lid on increases, putting the squeeze on the landlord. As we found out in the last real estate recession of the early 1990s, negative cash flow gets old real fast. These bleeding buildings could become good buys for opportunistic buyers like me. I'll have rent control possibly to thank for that.
The opinions expressed in this article are those of the authors and do not necessarily reflect the view point of the SFAA or the San Francisco Apartment Magazine. The information within this article is general in nature. Jim Forbes is president of Urban Properties, a real estate investment and brokerage firm. He can be reached at 415-922-8998 .