A very big real estate story splashed across mainstream news recently, but got buried underneath (insert the sensational political headline you’re sick of) …
Associated Press, 2/28/19
Okay, we admit this is a government policy … so it’s political.
But politics is easy to laugh at when it’s happening in cyberspace. It’s a little less funny when it hits hard on Main Street.
For thousands of Main Street landlords in Oregon, politics just landed hard … right in their portfolio.
Of course, as is often the case, there’s more to the story than meets the eye.
So even if you don’t own property in Oregon … or won’t for much longer 😉 … there’s a lot to glean from this watershed legislation.
We could debate whether or not government should step into a “free” market and regulate the price of anything … from housing to healthcare to haircuts.
But it doesn’t matter if WE think they should or shouldn’t. They do.
And as a broken financial system keeps growing a wedge between haves and have-nots … we’re guessing more politicians will try to legislate affordability.
So like it or not (we don’t), rent control is something every investor everywhere should be watching out for.
Let’s take a look at how rent control works in the real world …
Real estate investors buy property to produce income and build long-term wealth. The more income a property produces, the more it’s worth.
In order to create more wealth, real estate investors need to create more income … which means creating more value that a tenant is willing and able to pay for.
The essence of real estate investing is using capital to acquire long-term cash flow. This is how real estate investors think.
Make sense so far?
Politicians, whom we’re guessing are NOT real estate investors, think investment starts and ends at acquisition.
Unless you’re Warren Buffet, paper asset investors don’t buy stocks with the intention of improving the cash flow.
You just buy, own, and sell. Maybe collect some dividends along the way.
But when value-add real estate investors buy properties in poor condition with lousy amenities …
… they’re excited about the potential to make further investments into the property AFTER the acquisition.
For example, a property without a washer and dryer might rent for $50 a month less than one with that amenity included.
So for perhaps $600 per unit additional capital invested, a landlord could acquire $600 per year cash flow.
That’s a good ROI. It’s also a nice amenity for the tenant.
You could say the same about covered parking, self-storage, a laundry room, a workout room, free wi-fi, and on and on.
Rent control caps the owner’s ability to create positive returns by improving properties. So guess what? They don’t.
So crappy properties stay crappy … because the incentive to improve them is removed.
And as nicer properties deteriorate, there’s not much incentive to maintain them above the bare minimum.
With profit potential capped on the revenue side … and no cap on the fixed expense side …
… as margins get squeezed, property owners have no choice but to cut services and defer maintenance.
So rent control makes both landlords and properties cheap. In a bad way.
And because there’s always more people on the low-end of the economic scale (part of the reason Oregon is doing this) …
… there will always be a line of people waiting to get into these “affordable” rentals … even though they’re crappy.
And with little market pressure on landlords to compete for tenants, there’s even less incentive to improve properties, add services and amenities, or lower rents.
But it gets “better” … or actually worse …
As property values decline … or stagnate relative to rising costs of labor and materials … incentives for developers to build new inventory declines too.
Rising values are what attract developers to create more supply … which is the answer to moderating rising values.
Yes, it’s sad when marginal tenants’ incomes don’t grow as fast as rents … or other inflating necessities.
But capping the property’s growth doesn’t pull the tenants up. It pulls the properties down.
It’s a bad scene. That’s why nearly every investor we know stays away from rent control areas.
But it’s also important to consider WHY this is happening …
The Fed dropped interest rates to zero for nearly a decade, then pumped trillions of dollars into the financial system … primarily to inflate asset values (stocks, bonds, real estate).
It worked … at least for some people.
Those paying attention, with both resources and financial education … snapped up the money, rode the equity train, and got much richer.
You might be one of them … or hope to join them. We hope you succeed.
You can’t blame people for playing the game using the rules and circumstances in their own best interests. But politicians do.
But the real issue is the financial policy wizards thought these now richer folks would then spend the money … and build businesses … and prosperity would trickle down to Joe six-pack and Larry lunch-bucket.
In many ways, it worked. The problem is the wealth didn’t allocate very evenly. It never does.
Certain markets got a disproportionate share of the goodies.
And even though Oregon wasn’t really on the list … it was nearby … and so became a collateral beneficiary /victim.
Lots of cheap money ended up in tech stocks, which blew up real estate values in tech hubs like Seattle and Silicon Valley.
As prices shot up, folks in those uber high-priced markets got pushed off the back of the bus … and gravitated to nearby “affordable” places like Oregon, Nevada, and Arizona.
Of course, the folks already in those nearby affordable areas end up competing with the new people who see everything as cheap … and easily bid things up.
It’s a regional variation of gentrification … with its roots in paper asset bubbles blown up by cheap stimulus money.
But politicians are notoriously myopic when it comes to “fixing” things … especially financial problems.
As Peter Schiff says, “Good economics is bad politics, and good politics is bad economics. That’s why you always get bad economics from politicians.”
Sadly, there are signs it could get worse as politicians try to contain the consequences of an over-financialized economy.
So even though we tout the opportunity to invest in affordable areas ahead of the crowds, it’s REALLY important to stay aware of the political climate.
If you bought into Oregon ahead of the migration …
… you’re now the proud owner of a property where the state government views you more as a public utility to be regulated than a free entrepreneur to be incentivized.
So you’ll either need to get out while the getting’s good … or not as bad as it could get … or start brushing up on your C-class property management skills.
Until next time … good investing.
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