Rent Control – A Cautionary Tale of the City of Santa Monica

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Rent Control – A Cautionary Tale of the City of Santa Monica

By Dean Sherry, President, Duke Property Management

Introduction and Update.  As I look back at this article that I wrote approximately  two-years ago about rent control, the same sad story is only getting worse for the mid-market “mom and pop” small owners.  However, one thing is strikingly different. Thanks to COVID-19, there is a natural market correction happening that, for some reason, state legislators are over-looking.

In my “little” world of property management, notices to vacate have just shot up and more units are becoming available which is driving down the price of rentals. Most of these renters who are abandoning their apartments are millennials who either are moving back with their parents, moving into smaller apartments or roommate situations, or are moving out the “big” City. 

The reason I wrote the article a couple of years ago, was to present the true story about how legislators attempt to create an artificial market correction, which has backfired on middle-market owners. Now that there is a natural correction happening, perhaps legislators can back off their ill-conceived “stop-gap” measures and let the market play out. Otherwise, I fear that the partisan and aggressive new laws being proposed will financially cripple the “mom and pop” owners and foreclosures will rule over forbearances.  I am seeing this all happen at an accelerated pace, and unless Proposition 21 is defeated, the ship will eventually sink.

My Cautionary Tale.  One afternoon a few years ago, I received a call from a guy inquiring about my company’s property management services. He said his name was Will Wright (name changed for privacy reasons) and that he owned a fourplex in Santa Monica near Santa Monica City College (SMCC) where he lived in one of the units.  Each of the units in his building were comprised of one bedroom / one bath units with all the amenities, including washer / dryer combinations, central HVAC, modern appliances, and parking!  He had been saving his money to travel and contacted me seeking a management company to look after his property.

Will 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 SMCC in the late 1970’s, had never moved out of his building, and therein lies the issue. Although he occupied one of the units, it was still a fourplex so it was not exempt from rent control and I could sense that the long-term effects of strict rent control policies had taken its toll on him.

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

Will grew up nearby the fourplex he owned, and he recalled the joy of growing up in such a great place back when Santa Monica was still a quiet, ”mon and pop” type of beach town. Life was just simpler back then and he did not have to worry about his future, until his future suddenly came crashing down upon him.

Just after his 18th birthday, Will got a letter in the mail that he was being drafted for 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 would not have to worry about money or a place to live WHEN he returned home from military service.

Thankfully, Will did return home two years later after having been awarded a Purple Heart, an honorable discharge and unfortunately having been wounded 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.

Will was a good, responsible property manager. 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, the year that 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.  As a result, development of commercial and residential properties more than doubled, but still available housing units did not keep pace with increased demand and the influx of companies and people.  Eventually the flood of money and people coming into the City of Santa Monica 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 Santa Monica set the maximum allowable increase at less than one percent at 0.004% and for Will that translated into about a $5.00 monthly rental increase per tenant that year, while the annual allowable expense “pass-through” remained disproportionately low. He was being “squeezed” by the City of Santa Monica on the revenue side and had difficulty keeping up with his 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 caused a massive flood.  That was the beginning of the end for Will.

A couple weeks after the flood incident, I went to visit Will at his friend’s house. We went over some of his options and I suggested perhaps he might consider taking his units off the market under the Ellis Act, but he said that was for rich guys who could afford to do that and to redevelop their properties. 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 could not even afford to sell his property!

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 he felt that the City had abandoned him as a property owner and so now he would have 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 condominiums. 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. As a result, “Unaffordable Housing” replaced what would have remained “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 displaced market list while losing another decent and honest property owner. Instead of “win-win” situation, Santa Monica created for itself a “lose-lose” scenario.

Will struggled to remain financially solvent simply because his tenants HAD been there since the 1970’s and were still paying extremely below market rents that were not much more than they had been during the 1970’s due to the City’s insistence on keeping the annual allowable increase so artificially low in the name of affordable housing.

The difference between the rent that Will 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 is where I net out: why CAN’T cities adopt a tiered rental increase system, instead of merely 3.0% or some other fixed amount 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.  Why CAN’T cities “means test” tenants so that property owners are not being forced to subsidize wealthier tenants?  There are just too many unintended consequences associated with rent control and any price controls.

Until economic fairness is added into hardline politics of rent control, we will continue to see property owners who literally cannot afford to keep their buildings; and tenants left out in the cold and I am certain that was not the intent of rent stabilization.

The above 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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