1025 Rent Survey With Rent Control

[Robert Anderson]

We do not have rent control in any of the areas I cover, so I have never appraised a residential income property that is subject to rent control. However, my inclination would be to provide two values--one assuming market rents and one based on existing tenants and actual rents. If both units of a subject duplex are vacant or at market rent levels, the two values would be the same. If one or both units have existing tenants with below market rents, then the second value would in all probability be lower.

When appraising commercial and industrial properties that are encumbered by long-term leases, it is an accepted practice to report one value for fee simple and one value for leased fee. Providing two values for a rent-controlled property would be similar.

I would have reservations with the use of actual rents that are substantially below market levels in the income approach. This could result in a distorted indicator of value if, for example, the tenants are very elderly. Tenants do move and that needs to be considered.

The intended use of an appraisal can impact how we appraise a property. Do any lenders have policies on how to handle rent-impacted properties?

 

[hastalavista]

Robert-

As I mentioned, I do not use the actual rents, but convert the subject and comps to market. Unlike commercial properties where the long-term leases can be analyzed, these are typically month-to-month rents.

I also am part owner of an apartment building in a heavily rent-controlled area (Santa Monica, CA). Actual rents are not the income consideration for the typical buyers (6-10 units) of these properties; they are anticipating market rents.

It’s interesting at the difference of opinions regarding the use of actual vs. market in rent control properties (2-4 residential). Again, my experience in the past is that when I used actual rents, my GRMs are all over the board, with the longer the tenancy, the greater the range.

By using market rents, all income analysis is based on an equal unit measurement; the GRMs I see using this technique are much "tighter" and seem to be more consistent with the Sales Comparison Approach.

Lastly, as I illustrated in my last post with the example of divergent rents for "controlled" vs. "non-controlled" properties and the resulting difference in Income Approach valuation, no one here has given a good contrary example.

 

[Robert Anderson]

Denis,

As I mentioned in my earlier posting, I have no experience appraising rent-controlled residential income properties and perhaps my earlier posting demonstrated my ignorance. But, just for the purpose of clarity, I will expand a bit on my earlier posting.

The point I was attempting to make is that the rents being received from existing tenants in a rent-controlled property can impact its value. Let me demonstrate by example.

You have two rent-controlled duplex properties that are located next to each other. These duplexes are identical to one another with one exception. Duplex A has two middle-aged tenants who work nearby and pay monthly rents of $1,000 each. This is exactly half of the each unit's market rent of $2,000 per month. Under the rent control ordinance, existing rents can be increased at the rate of inflation, which is currently running at 2 percent per year. Both units in Duplex B are vacant and are available to be rented at their market rents of $2,000 per unit. If one assumes a knowledgeable buyer, the price paid by an investor for Duplex A is going to be less than the price paid for Duplex B. And, if the market recognizes a difference in the market values of Duplex A and Duplex B then we as appraisers should do the same.

I do acknowledge the point made in your earlier example. Assuming a GRM of 290, and using my above example, the value of Duplex A would be $590,000 and the value of Duplex B would be $1,160,000. Clearly this is wrong because people do move even from rent-controlled properties, and owners do anticipate increasing rents. Still, it would be equally wrong to argue that both duplex properties have the same market value.

There is an unrelated but important point. If you have been assigned to appraise Duplex A for loan purposes, and if you do not consider the impact on value of the existing rents and rent control, I would argue that you have produced a misleading appraisal.

Bob Anderson

 

[hastalavista]

Bob-

I follow your line or reasoning. And as you pointed out in your example (as I did in mine), the difference in GRMs between your duplex A vs. B results in values of $590k vs. $1,160k using the Income Approach. We are agreed that the market does not react like that.

How my market reacts is this (as a rule, everything else being the same): If, using market rents as the unit of comparison for all comps, those that are vacant and can rent “at market” do sell at a price that reflects a higher GRM.
Let’s take another look at your example. In it, you provide rents, but not sales prices; I throw in two sales prices:


Duplex A: Rent Controlled, both units rent for $1,000- $2k/month. This property sold for $500k.
Duplex B. Vacant units, assume market rent ($2,000)- $4k/month. This property sold for $575k (a 15% premium- change it if you think that is not reasonable).

Using actual rents, Duplex A has a GRM of 250.00
Using market rents, Duplex B has a GRM of 143.75
Now, that’s a 106 range. On my rent controlled duplex, that’s a $200k variance.

But, if I use market rents for Duplex A, then I have a GRM of 125.00

Now, that’s a range of 18.75, or a variance of $75k.

OK, let’s make up data on the subject- let’s say it has one vacant unit (will use market rent of $2,000), and one unit rented at $1,250 ($3,250/month). Using actual rents and GRMs based on actual rents, I have an income value range of $467k to $813k. Not very meaningful in trying to determine a pinpoint value. What If I use the average of the two actual rent based GRMs? Then I have 196.88, resulting in a value of $640k. That’s $65k more than my full market rent property sold for.

Now, what happens if we substitute market rents for all properties- comps and subject? Well, it means I have a range of $500k to $575k. Exactly what the properties sold for. What happens if I use the average market derived GRM (134.38). That results in an Income Approach value of $538k. A little more consistent with the sales range, and makes good sense, since I have one vacant unit and one rent controlled unit in my subject. Also, it is consistent with rent controlled properties selling at a lower GRM vs. “at market” vacant properties.

My point is that by converting to market rents, it allows a basis of uniform comparison. This uniform comparison has resulted (in my market) of a tighter GRM range, and a tighter income valuation range that is more consistent with the Sales Comparison range.

In regards to being “misleading” by using market rents, I humbly disagree. The existence and influence of rent control is disclosed and analyzed, and the use of market rents results in a reasonable and credible value.

 

[Robert Anderson]

Denis,

We are on the same page and are just approaching the issue differently. In your example, I would probably first estimate the value of the subject assuming market rents. Utilizing the data you provide and based only on an income approach, this value would of course be $575,000. I would then estimate the adverse impact on value of the below-market rents. Just to play around with figures, I derived a GRM for below-market rents from the two duplex sales, applied this to the subject's below-market rent differential of $750, and came up with a deduction for below market rents of $28,125. This would yield a value for the subject is $546,875.

The exact approach that I would employ in an actual appraisal would vary, depending on the provisions of the rent control ordinance and the sales and income data that was available. In your example, there are two great sales for use in the sales comparison approach, and they clearly tell even a beginning appraiser that they need to be approximately midpoint between $575,000 and $500,000. The very important point is to recognize and reflect in the opinion of value the adverse impact on value of the below-market rents.

As to my "misleading" appraisal comment, I suspect that many appraisers would use market rents and GRM's and report a value of $575,000 for the subject. Given the intended use of the appraisal, this would in my opinion be misleading. This comment was a general one that was not directed at and would not apply to you.

Bob Anderson

 

[hastalavista]

Bob-

Agreed (and I didn't meant to sound as if I took the misleading statement personally; I didn't ).

I think the "proof in the pudding" would be this: To go back retrospectively and pick out a 2-4 in a rent controlled area (the heavier, the better: Like Santa Monica down south) and see how using Market Rents for all comps/subject changes the income analysis? But, who really has the time or inclination to do that! :lol:

We all hear how AVMs are going to take over the residential appraiser's jobs. 2-4 income properties are an area where the residential appraiser can specialize in, have market expertise, and not worry about an AVM being used.
The biggest and most significant valuation mistakes I find in my review business consistently occur in the 2-4 reports- typically because the appraiser does not know how to analyze the rental data, reconcile the GRMs, and conclude a reasonable and credible income approach value.

 

[Ted Wegener]

Would you pay as much for units with very low locked low rents as you would for a unit that was vacant. or had rents at or near market?

Sometimes tenants in Santa Monica and Los Angeles stay in the apartment for decades and dont move because of the low rent.


I remember protests a few years ago in Santa monica on the news by landlords with leashes around their necks being led around by mock tenants.