Why rent control is fueling 1031 exchanges

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If you want more evidence of real estate being all about location, look no further than to rent control legislation. Rent controls are usually put in place by politicians with good intention to protect the tenants housing affordability, hence designed to protect the little guy.

Admittedly, housing affordability has a soft spot for me as my own daughter have struggled with finding decent housing within a single parent budget.

Housing costs, for many, are totally out of reach, which is why I love to work specifically with such developments with investors and municipalities.

That said, it is not that simple.

The problem with rent controls

Rent controls, which are designed to keep affordability in check can often work in reverse.

Oregon, for example, recently signed a rent control bill into law intended to keep rents affordable.

However, the general principals of supply and demand are negatively affected with anything dealing with price controls.

To drive down price you have to drive up supply. Rent controls do the opposite. When you take motivation and profit away from property owners who are in the business of making money providing housing they are no longer motivated to provide more housing.  As a result they sell properties and move on to more profitable ventures that do not solve the general housing shortage.

The result is less supply and a larger problem of affordable housing. Or any housing in general.

It’s a simple case of basic economics.

3 reasons why rent controls devalue property.

1.     Supply and demand: as mentioned above rent controls actually slow down development of much needed housing inventory. If you drive down supply demand goes up. If demand is not met the housing problem worsens.

2.     Market conditions: Investors are cautious to invest in markets that have rent controls as the investment returns are unknown, and politicians, not property owners make the rules for the property owner investment.

3.     Values based on income: investment property values are based on income it generates. When an investor wants to increase the value of a property they want to improve property and increase rents. When rent controls remove this initiative, property values can suffer. That affect is not only pertinent for the investor, but average home owners as well.

In most cases landlords do not organically raise rents much higher than what the rent control of 7% allows for (such as in the newly passed Oregon bill). Landlords desire is to keep properties rented and maintain good tenants who renew their leases. However mandating what an investor can and cannot do typically always removes all incentives to invest in markets with these tight rules.
Rent control can lead to ill-maintained rental properties to make up for losses of tenant generated income as the landlord is less likely to keep the property up with improvements and repairs.

1031 exchange is the solution many investors turn to.

Strict landlord tenant laws prompt many investors to reposition their assets using 1031 exchanges to different markets where these strict laws are not in effect or to switch gears to different investment classes such as office buildings, storage faculties or perhaps single family investments.

Deregulation may be a better solution.

Personally speaking I cannot help but think if regulations strip incentives to create more housing and indeed results in a loss of inventory, then cutting back on regulations may result in more inventories.

Less strict rules on zoning, and/or boosting tax incentives, and/or fewer restrictions on construction to create affordable housing may be a better solution.

Would love to hear your thoughts and discussion in comments below.

Larry Arth is a real estate broker licensed in Florida. Thew views of the author may or may not be the views of HTBUSA. We are not attorneys or professionals, therefore this content is not to be considered as legal or tax advice, but mere opinion.