The other side

by J. Wallace Oman

Now that the dreaded Proposition 98 has gone down to resounding defeat at the hands of California voters, rent control in California is safe for the time being. So I think it’s a good time to look briefly at rent control in San Francisco. I know many people who have said that they have grave doubts about the ultimate social benefits of rent control. Below is an interview on the subject with one landlord lawyer, Nils C. Rosenquest; actually, he represents both landlords and tenants, but I first met him as an opposing landlord attorney on a case about 25 years ago. (Full disclosure: we occasionally team up to represent tenants who are suing landlords.)

J. Wallace Oman: Nils, I understand that you have said that you think San Francisco landlords could well be in a very difficult place without rent control. Why do you say that? Most San Francisco landlords I know complain constantly about rent control and eviction control.

Nils C. Rosenquest: Contrary to the stated aims of the rent ordinance, there has not been a preservation of affordable housing but rather the perpetuation of ever higher-cost housing.

JWO: I guess that fact, if true and if caused by rent control, would make landlords happy. But isn’t it all relative? Given the outside market forces at work in San Francisco, with—to oversimplify the picture—lots of high-salaried young singles and wealthy empty-nesters moving in from the suburbs, how can you be sure that the loss of affordable housing and the gentrification would not have been even greater without rent control and eviction control? Hasn’t rent control acted as a damper, to slow down huge upward spikes in rents and to prevent mass evictions (even worse than the slew of Owner/Relative Move-in and Ellis evictions for the last decade)? I think of rent control with eviction control as a long staircase of steps of small rent raises over time, and here and there over the entire city, rather than an express elevator for large vertical rent raises everywhere at once.

NCR: I agree that rent control has acted as a damper on the unregulated swings that have taken place in other rental markets. This has protected tenants somewhat from volatile increases and larger dislocations in short periods of time, but it has also protected landlords from the same forces. I do not think the effect has been a smooth stair step, because it hasn’t acted that way. There have been dips and peaks in the eviction rate. However, rent control has provided a moderating force against, to paraphrase Alan Greenspan, “over exuberance.”

JWO: Just to clarify, we’re not talking about evictions for tenant fault now, such as nonpayment of rent, nuisance, breach of lease covenant, and so on, right? Those evictions have been happening at whatever rate the circumstances require. And as the rents rise, of course there are more evictions for nonpayment of rent, especially during the periodic economic downturns, like right now. But you’re speaking primarily about evictions of tenants who are not “at fault” via OMIs, Ellis Act evictions, and to a lesser extent, Permanent Removal/Demolition evictions?

NCR: Right, for the most part, I am speaking of all “no fault” terminations, which include evictions, uncontested 30- and 60-day notices, and negotiated move-outs. That said, economic circumstances also accelerate the rate of “fault” terminations. Where rents are higher or vacancy rates lower, landlords are less inclined to support underperforming tenancies than where rents are lower and vacancy rates higher. At the last downturn in the 1990s, many landlords carried tenants who were making partial or late payments to avoid increasing the number of vacancies in the building. Similarly, when rental rates dropped, many landlords agreed to rent reductions to keep their occupancy rates up.

JWO: Since rent control was enacted on June 13, 1979, many middle-income and low-income tenants have been forced from the city, I agree. But wouldn’t the gentrification have occurred much more quickly without rent control and eviction control?

NCR: As to the dislocation, I would assume so because the gold rush mentality of rental increases would have shoved huge numbers out in the beginning. But I cannot say the same thing would necessarily follow with gentrification. Gentrification does not result from increases in rental costs but from other factors. I don’t pretend to be an expert on development economics, but in my experience, gentrification reflects the costs of home ownership more than it reflects the costs of renting. At least in San Francisco, gentrification results from the conversion of rental units into owner-occupied units in a given area. Only after the real property values begin to rise do rents start to increase and a neighborhood moves “upscale.”

Rent control and low-growth planning policies have accelerated gentrification to the extent that they have increased property values and restricted the supply of both rental and owner-occupied housing. Gentrification fails to occur where owner occupancy does not become a significant component of the rental housing neighborhood.

For example, I would compare San Francisco neighborhoods like Bernal Heights, SOMA and the Mission with the gentrification attempts in downtown Oakland and Jack London Square. While the San Francisco neighborhoods reflect sharp increases in rates of home ownership and owner-occupancy, it does not appear that the same effect has occurred in Oakland, even though Oakland has had rent control in some form for a considerable time. So there has been less gentrification in these Oakland neighborhoods.

Also, with a restricted supply of rental housing, rent control has provided higher rates of return to landlords while shielding them from uncontrolled market volatility, competition, tenant mobility, and higher capital and maintenance costs. In other words, without rent control, the profits would not have been as consistent and healthy as they have been. San Francisco landlords obtain a premium from rent control.

JWO: Can you, for example, make a direct comparison between equivalent residential rental properties in San Francisco County, which has rent control, and San Mateo County, which does not have rent control?

NCR: Taking a snapshot of rentals on Craigslist in the Bay Area, San Francisco rents are still significantly higher than rents in unregulated areas. For example, where San Francisco one-bedroom units rent from $1,500 to $2,300 per month, in San Mateo they rent at $1,450 to $1,500 per month, in Mill Valley and Corte Madera at $1,350 per month, and in Santa Rosa from $900 to $1,100 per month.

The regulated market, even in a downturn, has commanded higher rentals than the unregulated market.

In addition, I believe that landlords in unregulated markets spend a greater share of revenue on building maintenance and capital improvements (well, except those engaged in rent skimming or slum housing) than unregulated San Francisco landlords spend. For example, landlords who compete with San Francisco housing at the same price points generally have to offer greater services and amenities, such as parking and updated full kitchens, not to mention recreational facilities and other amenities.

JWO: Again, can you give some specific examples?

NCR: I don’t have any statistical examples but, anecdotally, ads for rentals outside San Francisco describe far more incentives and amenities than are included in San Francisco units. They include such things as parking, dishwashers, pet-friendly policies, and a month of free rent—all incentives not shouldered by San Francisco landlords.

Conversely, as evidence of cost savings, I have seen more building department notices of code violations in San Francisco, particularly with regard to deferred maintenance, than I have seen in other, non-rent-controlled counties. Experienced landlords in non-rent-controlled areas often utilize regular schedules for capital replacement and improvements, practices which I have not seen as frequently with San Francisco landlords. These examples suggest that San Francisco landlords do not invest in maintenance and improvements to the same extent that landlords outside the area do.

I want to add that in San Francisco, both rent control and restrictive zoning have discouraged the building of affordable housing while encouraging lower density uses of existing housing. This topic by itself could fill a whole article. I served on the board of a major affordable housing group for many years and marveled at the difficulty in providing affordable housing. Rent control, particularly eviction control, discourages private landlords from participating in affordable housing programs like Section 8, while restrictive zoning and NIMBY attitudes block affordable housing development in many neighborhoods. For the private sector, when the San Francisco Board of Supervisors amended the rent ordinance to delete the Section 8 exemption, the board killed the incentive for private Section 8 housing in the city. I doubt any knowledgeable landlord would accept Section 8 with the double regulatory burden now loaded on it. Much as I personally think Section 8 should be improved and expanded rather than diminished, I usually advise my San Francisco landlord clients to terminate Section 8 whenever possible.

As to the nonprofits, most of their programs provide affordable housing to certain target populations, such as the chronically homeless, the disabled, the elderly and low-income families. Nonprofits house people who, for one reason or another, are no longer able to compete for the available general rental housing, because most government funding in San Francisco responds to the “squeaky wheel” principle. While these programs provide housing to populations who might be rendered homeless otherwise, they do not provide broad-based affordable housing to many segments of the population who are employed but earn less than six figures a year, such as new teachers, nurses, office workers and retail workers. These people do not have a government agency willing to assist with rental housing, and rent control has, by and large, failed these people.

JWO: I’ve heard it said that rent control favors the “haves,” long-time rent controlled tenants, and discriminates against the “have-nots,” new tenants. And landlords with rent controlled units in San Francisco universally complain about being a single segment of taxpayers who are required to subsidize the incomes of tenants via rent control instead of passing that subsidy cost onto society at large. But I suppose that landlords themselves pass that subsidy cost onto their new tenants, don’t you think?

NCR: They certainly pass that subsidy cost to the extent that high market rate rents are charged to new tenancies. It is fair to assume that a component of the market rate is the “subsidy” portion of long-term controlled lower rents–even where a lucky or “skillful” landlord may not have such a subsidy cost due to turnovers.

JWO: To go back to an earlier question, please explain your comment about the city discouraging higher density housing. Are you thinking of mergers of rental units and of condominium conversions?

NCR: For the most part, the only new housing consists of luxury rentals and condos, except for some nonprofit housing. Even those uses that could immediately expand lower cost rental housing stock, such as legalizing in-law units and zoning for marginally higher densities, have been defeated. Rental housing keeps disappearing via sales of buildings to TICs and from condominium conversions.

All of these restrictive zoning practices and reductions in rental housing stock combine to make what housing stock remains more expensive. It becomes a limited resource. Policies which prevent supply from responding to demand—like lower density, refusing to legalize in-law units while continuing to give a wink to their existence, “in lieu” fees in lieu of actually providing median income housing—create a long-term rental housing shortage and commensurately higher housing costs to residents. The nonprofit housing that currently exists helps the people housed there and offsets some of the pressure on the target populations, but does not significantly affect the supply of available rental stock.
As a general rule, one cannot lay all the increased housing costs in San Francisco at the feet of rent control, but the combination of rent control, unit mergers and loss of rental housing stock creates a permanent rental housing shortage. I’m afraid my politics are leaking around the edges of my economics here.

JWO: So, if the supply of residential housing is not keeping up with the demand for it, tell me about the demand.

NCR: “Vacancy decontrol” means that, when a unit becomes vacant, the rent can rise to whatever the market will bear. Since San Francisco’s vacancy decontrol discourages tenants both from moving from existing units (because they will face much higher rents if they move into vacant, “rent decontrolled” units) or from demanding increased services attendant with increased rents, landlords have traditionally enjoyed very low vacancy rates and very low turnover rates. They rarely face significant “empty unit” costs or high rehab costs to rerent empty units.
San Francisco tenants, who continually fear both displacement and higher rents, still will fight to keep apartments, even substandard ones, rather than move. These tenants will often invest in their own units by making repairs or improvements, or will simply tolerate declining conditions, rather than risk eviction. This practice protects landlords from maintenance and capital costs as well as higher vacancy rates.

JWO: I don’t know the exact statistics, but I think that units turn over about every three years, on average. Is that what you mean by “rarely facing empty unit costs”? And what are these “empty unit” costs and rehabilitation costs, and how large are they? How much higher are such costs for landlords in, say, San Mateo County?

NCR: I do not know the hard dollar costs experienced by most landlords. Logically, though, if units turn over more often in an unregulated area, such as San Mateo County, landlords incur rerental costs in higher frequencies than in San Francisco. Since tenants without fixed-term leases have no protection in such areas, they are more willing and more likely to move from an apartment.
Moreover, since San Francisco rent control already has encouraged stability, no landlord particularly cares about turnover costs and only focuses on turnover benefits. This means that a San Francisco landlord will nearly always obtain more rent from a new tenant than an existing tenant. The increase in rents from a new occupancy typically allows a landlord to recover any rerental costs over a relatively short period of time and then enjoy a higher profit on the unit. In an unregulated market, existing (“old”) tenants and new tenants pay approximately the same amount. So, replacing an old tenant with a new tenant in an unregulated area requires a landlord to spend money to fix up a unit that will not generate any more rent than it had previously. The landlord does not profit from the turnover, because the rent stays the same. The non-rent-controlled landlord incurs the rerental expense just to get the same money—or even less if you factor in the vacancy period.

JWO: Are there any other rent control benefits for landlords?

NCR: Rent control has also helped boost the value of rental properties in excess of non-rent-control properties.

JWO: I agree that San Francisco landlords, despite all their complaining about rent control, generally seem to get very high prices for their buildings. These landlords have apparently made their wealth not on the monthly cash flow but on the long-term appreciation.

NCR: Yes, typically the value of a rental property is a function of its rate of return on income, whether expressed in the capitalization (or “cap”) rate, which is like the interest rate paid on a bank account, or as a gross multiplier on the total monthly rents received by the landlord.
Buyers in San Francisco settle for much lower initial rates of return, or even negative rates, than buyers in non-rent-controlled areas accept. For example, in San Francisco a building will sell at a gross multiplier of 14 times the rental income, as opposed to a multiplier of 10 or 12 times the income in other counties. In other words, rental property under rent control is more valuable than it is without rent control. That is not the result one would expect if landlords in San Francisco are truly suffering under rent control. It appears economically bizarre to assume, on the one hand, that rent control has damaged a landlord’s economic expectations, but on the other hand, that same landlord expects to sell to a new owner who will pay a higher price than the income stream can support.

JWO: Has the recent downturn of the housing market affected property values of these landlords much? If so, will that affect rents?

NCR: Not that I have seen. Property values are generally high. If anything, when other financial investments go sour, such as in a down stock market, the value of rental properties should remain strong or even increase as a hedge against the downturn in the financial sector. From everything I have read, rental rates are going to continue to go up barring some much larger economic problem.

JWO: Going back to your comment about landlords selling to new owners who will pay higher prices than the income stream can support, I fairly often see predatory landlording, where some landlord, almost always a new owner, and often a speculator or “flipper” who intends to sell as quickly as possible, has a business plan to evict all the long-term, low-rent tenants to raise the rents in those units and, thus, raise the market value of the property. These predatory landlords evict either by “aggressive enforcement” of rental agreement terms such as no-pet clauses or no-subletting clauses or by Ellis Act withdrawal of the properties to sell them to TICs.

NCR: I suspect flipping within six months is harder to do in San Francisco than elsewhere because eviction costs are higher and eviction proceedings are lengthier. You and your evil rabble-rousers—I mean colleagues­—are probably as much to blame for that as anyone. However, anticipating a high turnover over a one or two-year period is certainly “doable” and part of many business plans. One very large, prominent San Francisco management company in particular follows a business model that aggressively promotes turnover in newly acquired buildings.

JWO: Are some landlords faking their unhappiness with rent control?

NCR: I don’t think they are faking it so much as acting without contrary experience. San Francisco has been rent controlled for 29 years, and I doubt there are many small San Francisco landlords who have operated buildings without rent control. The dissatisfaction with rent control stems more from the landlords’ observation of “greener grass” for no rent control than from hard experience. Being a landlord in any market is hard work. It is more complex than many landlords realize, and I think some of the frustration vented on rent control is indicative of the difficulty of the business itself rather than rent control alone.

JWO: What would have happened, in your opinion, if Prop. 98 had passed in June?

NCR: I believe the law of unintended consequences would have written whole new chapters into all sorts of things. In the short run, it may have upped the termination rate, but in the long run it would have wreaked greater damage to city budgets, city planning and the rental market. It would be hard to predict its effects overall, but I can’t think of many good ones.

 

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The opinions expressed in this article are those of the author, and do not necessarily reflect the viewpoint of the SFAA or the SF Apartment Magazine. The information contained in this article is general in nature; consult the advice of an attorney for any specific problem. J. Wallace Oman is a San Francisco attorney specializing in tenant representation. Before that, for almost 20 years he was a staff attorney with the local, federally funded legal services program. He is a co-author of California Eviction Defense Manual, second edition (CEB California Continuing Education of the Bar 2008). He can be reached at walloman@aol.com. Nils Rosenquest is a San Francisco attorney who has been in private practice for 29 years. He has lectured on landlord-tenant law in several legal seminars and appeared on tenant attorney panels for the SFAA. Copyright © 2008 by J. Wallace Oman and Black Point Press. All rights reserved.