Rent Control-projected Rent $ Question

[Pat Nikolewski]

I did a report for a 4 unit property in the rent controlled Los Angeles area. A reviewer has questioned the projected rental amount that used..which is market rent. Reviewer says I can only show the projected rent at a 3% increase. I have done quite a few of these and this is the first time any issue has come up regarding the rental amount.

Maybe I have been doing it wrong....but I have always shown projected rent at market from a sale value and it is common to pay existing tenants relocation.

 

[moe cohen]

Pat
It depends on your town's rent control ordinance. If the rent control ordinance is strict you usually can not raise the rent more than the prescribed amount and can not get the tenants to vacate. In such a case you are actually appraising the leased fee estate.
The leased fee estate may be substantially below the fee simple. It is justified to project a rent increase as defined by the ordinance. You may also be right if indeed you can relocate the tenants but that is not permitted under most rent control ordinances.
Moe

 

[Tawfik Ahdab]

What if there is no lease, Moe? What if it's month to month? If so, it's not a leased fee estate, and market rent would apply.

However, given the rent controls in place, and the fact that the tenant cannot be evicted so that the landlord can find someone to pay market rent, it's important to note that the owner's estate is like a leased fee estate because the tenant's interest is very much like a leasehold estate having positive value due to the spread between the lower contract rent and the higher market rent.

Technically, the operating income statement should consider market rents and not contract rents. However, without a doubt, that is misleading because the owner is not as of the date of the appraisal either receiving, or able to receive, market rent.

For this reason, I would use contract rents with an explanation such as I gave above. In addition, I would use a 0% vacancy rate. Further support for your unorthodox use of contract rent for income and the no-vacancy estimate may be adduced by noting the behavior of tenants of rent-controlled housing, who move out of such housing only when they have to, not really when they want to, and are entrenched due to a legal advantage conferring property rights essentially akin to leasehold.

By the way, I had no guidance in this analysis expect for my own knowledge of appraisal theory and procedure, so I may be wrong. I wouldn't offer these comments if I didn't think they could be useful, and I searched The Appraisal Of Real Estate index for rent control but found nothing on the subject. There is very likely specialized literature on this topic but I don't know of, or have access to, it.

Most importantly, if you use market rent, then explain why you didn't use contract rent in light of the rent controls in effect, and if you use contract rent, explain why you didn't use market rent. Ideally, you would produce an operating income statement using both scenarios.

Lastly:

it is common to pay existing tenants relocation.

This is not a customary real estate expense. It becomes a real property expense only because of the distorting effect of rent controls. So while it is common in the affected market area, it is still not recognized as an operating expense proper.

 

[Tina]

Seems to me (again like Tawfik, no guidance except my "common sense" and some experience with 'affordable housing projects') that the property is not capable of commanding 'Market Rents', therefore, I would use contract rents. I guess the controlling factor is how the "Rent control ordinance" reads.



TB

 

[Jim Onderisin]

I don't have one with me to look at, but it seems to me that in the 1025 multi-family form and the operating income statement, there is some direction given by Fannie Mae for this situation. I may be mistaken, but doesn't it say in there somewhere to use actual rents, unless market rents are lower? For the operating income statement, this makes a lot of sense. If actual annual rents are $10,000 and estimated annual expenses are $20,000, then the property owner must have sufficient income to cover the difference. This is part of the lender's assessment of the default risk.

 

[Tawfik Ahdab]

Jim, thanks for bringing this up. A careful review of the 1025 operating income statement form shows that it does indeed state: "Income should be based on current rents, but should not exceed market rents."

Note that this conforms with appraisal theory only in case of a leased fee estate. Where a month-to-month lease applies, this instruction is not compatible with normally-accepted appraisal theory and practice.

Here's your supplemental standard at work.

 

[Pat Nikolewski]

Thanks to all for your input. Not what I really wanted to hear cause I dn't like conceding to the reviewer....but that does seem like that is where this is going.

My only other offering of advice was from a friend with a background in lending and he said actual rents were the only thing he would want to see on the report.but thought he was being a "lender" as there is a lot of things they would rather see......all in all a learning experience I guess.
(aren't they all?)

A phone call to the "Office of Rent Control" just to confirm what I already almost know will be my last attempt to redeem my pitiful self.

 

[Ann O'Rourke]

I do appraisals in Oakland California, a city with complicated rent control regulations, including restrictions on removing tenants and increasing rents.
Berkeley CA had very strict rent control laws in the past. I also worked there.

I look to the market to tell me what investors are doing with that particular property type and location. Do they invest based on market rents, assuming they can somehow raise the rents. Or, do they base their decision on actual rents. Or, do they not even consider the rents at at all (very common on 2 unit properties).

For larger apartments, say over 20 units, I always use actual rents as that it what investors do. If the rents are above market (common in this area due to rent declines) I forecast (and use) market rents.

In my report, I provide market rents to let the reader know how different the actual (and projected if over market) rents are from market rents.

A few years ago California passed a law requiring vacancy de-control - cities can't keep rents the same rent level forever if there is tenant turnover.

 

[George Hatch]

Complex assignment.

I haven't done apartment appraisals in that area in a long time, so I really don't remember all the ins and outs of those rent control ordinances. But I was under the impression that the only way a landlord could actually "evict" a tenant from a rent control unit was to convert it to owner occupancy or (I think) do a substantial rehab on the entire property. Relocating a tenant who has a protected rent would not be a cheap, easy or even reliable proposition because even one holdout could really gum up the process. I could be wrong about all that though, because as I said, I'm not current in that area.

Nevertheless, if your assignment is to value the subject property in it's "As Is" condition and the requirements for converting the contract rent to market rent includes significant effort, time, costs and risks, your income/expense analysis would have to adequately cover all of these bases. If it costs $3,000 in relocation costs for each tenant (and I can imagine the payoff being a lot higher than that) and there are also rehab costs and lost rent scenarios in the analysis, simply applying a GRM to a monthly market rental rate is going to present a very inaccurate and misleading picture of that income stream. And that doesn't even cover any legal costs or risks associated with stubborn holdouts, of which there always seem to be a few.

Then to top it all off, your appraisal would be based on hypothetical conditions and the resulting value opinion would be subject to completion of all of these conditions. So your "As Is" value is still probably going to be based on how the typical buyer would actually handle this situation rather than a simple market-based GRM equation.

 

[moe cohen]

Twafic
Inb most towns here, a landlord is required by law to register each year their rents with the rent control office regardless of having or not having a lease. The rent registration statement is an important part of my appraisal of a large rent controlled building. The rent registration establishes the rent for future tenants . In towns where there is a rent decontrol or a lax "capital Improvement" provision the market will tell you that the leasehold estate is close to the fee simple. In markets where the ordinance is very restrictive you will find a substantial difference.
This becomes extremely important in cases of condemnation where we have to value the leasehold estate. The court will in most cases determine the landlords interest based on the lower rent controlled rents.

Moe