Policies Getting out of Control - July 2019 - Urban Development ...
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July 2019 Policies Getting Out of Control John P. Kim Gaurav Mathur US Real Estate Analyst Real Estate/REITs and Special Projects Associate BMO Capital Markets Corp. BMO Nesbitt Burns Inc. jp.kim@bmo.com gaurav.mathur@bmo.com (212) 885-4115 (416) 359-7072 This report was prepared in part by an analyst(s) employed by a Canadian affiliate, BMO Nesbitt Burns Inc., and who is (are) not registered as a research analyst(s) under FINRA rules. For disclosure statements, including the Analyst’s Certification, please refer to pages 17 to 19. 19:00 ET~
Policies Getting Out of Control
Why this report?
With multiple rent control measures ongoing, we wanted to address key questions including:
Why is rent control increasingly being considered by states and municipalities, despite
evidence this will likely worsen the affordability crisis?
How does rent control affect the supply-demand dynamics in markets under consideration?
What is the potential financial impact of current proposals?
Which REITs are most impacted from proposed regulation?
BMO Edge. We leveraged our broker relationships to understand bottom-up market dynamics, and
analyzed current and proposed legislations in each market to frame our thesis.
BMO Takeaways
The BMO Bottom Line: Rent will likely remain an issue. While U.S. rent growth has closely mirrored household income
Rent control will likely be growth over the past decade, some major cities are highly unaffordable, asset value growth
has widely outpaced income growth, and income disparity has widened.
an issue in the foreseeable
future, as asset values and However, it is not a long-term solution: Under rent control restrictions, developers are dis-
income disparities increase. incentivized to build affordable rental units and tend to build high-end apartments and condos.
Developers and investors are hesitant to commit capital for new projects amid policy
Rent control will likely uncertainty.
significantly curb the
Near-term cash flow impact may be benign: Major markets with rent control will likely remain
construction of new units tight in the near term as deliveries slow, lowering vacancy and increasing market rent growth
and constricts supply in the (assuming vacancy de-control is allowed). Toronto’s annual rental growth has been 3.3% since
market. 2006, outpacing New York, with 1.1% vacancy – well below New York and San Francisco.
Current rent restrictions Annual Rent Cap Impact: Running rental caps assuming installed in 2000, annual rent increases
based on CPI+7% would of CPI+5% (or higher) would have been benign (Policies Getting Out of Control
Most economists tend to agree to disagree more often than not – so when the vast majority of
economists agree on a policy, it is noteworthy, in our view. On the subject of rent control, economists
are near unanimous in concluding that it is a policy with detrimental outcomes. In a poll of 464
economists published in the May 1992 issue of the American Economic Review, 93% of U.S. respondents
agreed that “a ceiling on rents reduces the quantity and quality of housing available” leading Paul
Krugman of the New York Times to conclude that rent control is “among the best-understood issues in
all of economics, and – among economists, anyway – one of the least controversial.”
Despite this view among economists, rent control has resurfaced as a solution to address skyrocketing
rents and a growing housing shortage for policymakers, as tenant groups across North America and
Europe have mobilized to demand rent control legislations. At the other end, landlords and investors are
vehemently opposing rent control regulations as they argue that such measures will essentially curb the
supply of new units in the market. Earlier this year, Oregon joined the states of California, Maryland,
New Jersey, New York, and the city of Washington D.C. as markets with some rent control or rent
stabilization policies on the books. Another three states—Colorado, Illinois, and Washington—are
considering similar statewide measures. Currently, 37 states prohibit or ban rent control outright.
Exhibit 1: Current and Proposed Rent Control Measures
State/City Current/Proposed Rent Control Measures Investor Outlook for Multifamily Assets Upcoming Deadline
Oregon • Imposed state-wide rent control; Maximum increase is 7% + • Investors and developers remain cautious. • Bill passed through
CPI (for All Urban Consumers, West Region); Does not Investment sales are expected to remain both Houses.
apply to buildings that are less than 15 years old, nor to constant.
government-subsidized rents.
California • Bill limits rent increases at 7% + CPI, not to exceed a total • Investors are not yet concerned about rent • Active bill to pass
increase of 10%; does not include new projects built in the control initiatives and investment sales are through both
last 10 years or landlords with ten or fewer single-family expected to remain constant. Houses by mid-
rental properties; September deadline to pass both houses September 2019.
of the legislature.
New York • Passed rent regulations which include ending vacancy • Investment has slowed as investors remain • Bill passed through
decontrol, ending the vacancy bonus, and limiting MCI rent cautious over the uncertainty on rent both Houses.
hikes. Towns and cities across the state can form their own regulation rules across the state.
rent control regulations which will be permanent in nature.
City of • Bill limits rent increases when a rent control apartment is • Strong capital inflows and high demand for • Bill passed through
D.C. vacated, to 10% of the rent if the previous tenant occupied assets among a broad spectrum of both Houses.
the unit for 10 years or less, or to 20% if the previous tenant investors.
occupied the unit for more than 10 years.
• Current rent control laws encompass any rental property
built before 1975; Maximum increase CPI+2%, limit to 10%.
New • No on-going dialogue regarding rent control measures. Of • Investment activity is slow as investors are • No upcoming
Jersey the state's 565 municipalities, more than a 100 have local seeking higher-yielding assets amid high deadlines.
rent-control laws. Rent increases vary between 3%-4%, CPI valuations and compressed cap rates.
and/or an assortment of conditions.
Maryland • No on-going dialogue regarding rent control measures. Few • Investors are focused on value-add • No upcoming
cities have rent stabilization laws that limit how much strategies. deadlines.
landlords may charge or the frequency of rent increases,
generally between 1.6%-2%.
Source: State legislatures, CBRE, JLL, Cushman & Wakefield, BMO Capital Markets Research
In June 2019, Berlin’s senate voted in favor of a rent freeze on Berlin homes for five years (with the
exception of already subsidized public housing and newly constructed apartments). This would impact
an estimated 1.5 million of the city’s 1.9 million homes.
US Real Estate | Page 2 July 23, 2019Policymakers are recognizing the need for solutions which can immediately protect renters from
unsustainable rent increases, and in their view, rent control is a crucial first step. Times may change, but
the hard truth remains that the apartment market is complex and answers, such as rent control, only
worsen underlying issues, in this case a dearth of new rental construction.
The commonality between the cities/states with rent control is their expense. There are multiple factors
for why these cities are expensive, including other regulations that mirror rent control’s arbitrariness.
Rent control essentially makes housing more expensive by taking units off the market via high
occupancy rates and low turnover. We note that rent control causes the same misfortunes as other price
controls, i.e., it leads to underproduction of the units that are regulated, and allows for price gouging for
the units that aren’t.
Exhibit 2: Rent Control Policies Do Not Do Enough to Restrict Rising Rents Among Expensive Cities
New York D.C Los Angeles San Francisco Boston Toronto Vancouver
Current Vacancy 2.2% 6.2% 3.9% 3.7% 4.7% 1.1% 1.0%
5-Yr Vacancy Avg. 2.8% 6.5% 4.1% 4.7% 5.2% 1.3% 0.9%
Current Monthly Rent US$2,787 US$1,808 US$1,902 US$3,087 US$2,289 C$1,467 C$1,650
5-Yr Rent Growth CAGR 2.4% 2.3% 4.0% 3.4% 3.4% 3.2% 4.7%
Cap Rate 4.5% 5.1% 4.4% 3.6% 4.8% 3.5% 3.0%
Current Transaction
US$284,049 US$196,984 US$181,593 US$121,620 US$315,974 C$228,128 C$341,173
Value/Unit
5-Yr Median Household
4.1% 3.2% 4.3% 7.6% 4.1% 0.9% 1.4%
Income Growth CAGR
Source: CMHC, CoStar, CBRE, ESRI
Why is rent control gaining steam?
On one hand, the rent control debate is surprising to us given new supply historically has been an
effective suppressant to rental growth. Additionally, over the past decade, median household income
growth has grown fairly consistently with multifamily rent growth. As shown in the chart below, the
growth in median household income mirrors that of the average monthly rental growth seen over the
past 10 years, with average rental growth of 2.3% CAGR slightly outpacing median household income
growth of 2.1% CAGR.
Exhibit 3: Rent vs. Household Income Growth
Avg. Monthly Rent Median HH Income
1.50 1.46
1.40
1.31
1.30 1.26
1.20 1.23
1.10
1.00
Forecasted
0.90
0.80
3Q14
1Q20
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
1Q15
3Q15
1Q16
3Q16
1Q17
3Q17
1Q18
3Q18
1Q19
3Q19
3Q20
1Q21
3Q21
1Q22
3Q22
Source: CoStar, BMO Capital Markets Research.
US Real Estate | Page 3 July 23, 2019Furthermore, driven by the low unemployment rate of 3.7%, CoStar estimates a divergence in the
growth rates between the two, with income growth of 5.2% CAGR vs. 1.4% for rents. As a result, we
estimate the national rent to median income ratio at 25.1%, a moderate increase from 24.8% in 2009.
However, there are a number of markets where rent affordability has reached heightened levels,
resulting in political pressure to limit rental growth. The most unaffordable markets, in our view, are
New York (45.7% rent to income), Miami (36.0%), Los Angeles (33.3%), San Francisco (30.5%) and
Boston (30.3%) – all major coastal urban markets where housing stock is not keeping up with demand.
Exhibit 4: Rent to Median HH Income Ratios – U.S. and Major Markets
50% 1Q09 1Q14 1Q19
45% 45.7%
40%
36.0%
35%
33.3%
30% 30.3% 30.5%
27.3% 27.0% 26.4%
25% 25.7% 25.9%
22.1% 25.1%
22.9% 22.8%
21.6% 21.5% 21.7%
20.9% 21.4%
21.3%
20% 19.7% 19.6% 20.4%
19.1% 18.5% 17.9%
15%
10%
Source: CoStar, BMO Capital Markets Research.
We believe another reason rent control is increasingly being discussed is that values for apartments and
homes have significantly outpaced rental growth. Over the past 10 years, while income growth
averaged 23%, apartment values have increased 118% to $114.7k per unit; while home prices have
increased 54%. However, this is largely driven by lower interest rates and capital flows into real estate,
and a 10-year timeframe ignores the period in which asset values declined significantly.
Exhibit 5: Rent vs. Household Income Growth vs. Home Price and Apartment Values
Avg. Monthly Rent Median HH Income
1.50 Median Price Per Unit S&P/Case-Shiller
1.40 1.38
1.30
1.24
1.20
1.24
1.10
1.00
0.90
0.80
0.70
0.60
Source: CoStar, BMO Capital Markets Research.
US Real Estate | Page 4 July 23, 2019As shown in the chart above, if we look back 11 years to 2008, apartment values have increased a more
reasonable 36%; home prices 24%.
Still, we believe sentiment is pervasive that disparity between the haves (owners) and have-nots
(renters) is increasing. Income disparity has become a bigger issue in recent years. As shown in the
chart below, since 1979, the before-tax incomes of the top 1% of America’s households have increased
more than seven times faster than bottom 20% incomes.
Exhibit 6: Growth in U.S. After-Tax Income, 1979-2015
300% Top 1% Bottom 20%
250% 233%
200%
150%
100%
50% 32%
0%
-50%
Source: Congressional Budget Office.
There also have been cases in which multifamily owners have converted rent-controlled units to market
rate units through investment and conversion, under prior regulations. In New York City, the stock of
rent-controlled units has steadily increased, as owners have converted to market rate units, or condos.
According to the New York City Housing and Vacancy Survey, in 2017, the percentage of market rate
apartment units was 64% vs. 36% that were rent controlled, stabilized or subsidized. This compares to a
50%/50% split in 1996.
Exhibit 7: Market Rent Units Have Increased to 64% of Stock, as Rent-Controlled Units Have Been
Converted
4.0 Rent Stabilized Rent Controlled Subsidized Market Rate
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1991 1993 1996 1999 2002 2005 2008 2011 2014 2017
Source: US Census Bureau New York City Housing and Vacancy Survey, Bloomberg.
New York
On June 14, 2019, state lawmakers and Governor Andrew Cuomo approved the largest overhaul of New
York’s rent laws and signed Bill S6458, the “The Housing Stability and Tenant Protection Act of 2019,"
into a law. The Bill was signed shortly before the current laws were set to expire on June 15. Moody’s
Investors Service viewed the new laws as a credit negative for owners and lenders, including those who
finance through CMBS loans and commercial real estate collateralized loan obligations (CRE CLOs).
US Real Estate | Page 5 July 23, 2019Exhibit 8: Rental Growth Has Begun to Increase in a Constrained Market Amid High Wage Growth
4% Wage Growth Avg. Asking Rent Growth
3%
2%
1%
0%
2011 2012 2013 2014 2015 2016 2017 2018
Source: Bureau of Labor Statistics, Costar, BMO Capital Markets Research
The new law bars landlords from increasing preferential rents to the legal maximum for the tenure of
the tenancy. The law also ends provisions that allow landlords to increase rents up to 20% every time a
regulated apartment turns over (vacancy bonus) and repeals provisions that allow apartments to be
deregulated after rent exceeds $2,733.75 per month (vacancy decontrol). The new law also allows
municipalities and counties outside of New York City with multifamily vacancy rates below 5%, to opt in
to rent-stabilization.
Additionally, the law imposes restrictions on how quickly landlords can recoup costs from major building
improvements. The new bill allows landlords to increase rents 2% annually, from 6% under previous
provisions, to pay for major building-wide improvements. Notably, the new law does not include rent
roll backs and thus allows for some room for landlords to raise cash flows. The new law is applicable to
towns and cities across the state, and allows them to fashion their own rent control regulations which
will be permanent in nature. Prior laws were only applicable to the city of New York and a few other
localities. Under the new law, rent increases for rent-stabilized units will still be capped at certain
percentages by the City’s Rent Guidelines Board, which, since 2009, has permitted increases that have
averaged 1.75% (or 3.86% for leases of two years). The most recent order, effective through September
30, 2019, allows increases of 1.5% for one-year leases or 2.5% for two-year leases.
Exhibit 9: Sensitivity Table: New York City Average Multifamily Rents at Various Rent Caps
New York Avg. Monthly Average Asking Rent at:
Year Asking Rent 2.75% 2.50% 2.00% 1.75% 1.50% 1.25% 1.00% 0%
2000 $1,983
2001 $2,050 $2,037 $2,032 $2,022 $2,018 $2,013 $2,008 $2,003 $1,983
2002 $2,073 $2,060 $2,055 $2,045 $2,040 $2,035 $2,030 $2,023 $1,983
2003 $2,064 $2,052 $2,047 $2,037 $2,032 $2,027 $2,022 $2,014 $1,975
2004 $2,095 $2,082 $2,077 $2,067 $2,061 $2,056 $2,047 $2,035 $1,975
2005 $2,137 $2,124 $2,119 $2,108 $2,098 $2,087 $2,072 $2,055 $1,975
2006 $2,246 $2,182 $2,172 $2,150 $2,134 $2,119 $2,098 $2,075 $1,975
2007 $2,435 $2,242 $2,226 $2,193 $2,172 $2,150 $2,125 $2,096 $1,975
2008 $2,499 $2,301 $2,282 $2,237 $2,210 $2,183 $2,151 $2,117 $1,975
2009 $2,330 $2,146 $2,128 $2,086 $2,061 $2,036 $2,006 $1,975 $1,842
2010 $2,303 $2,121 $2,103 $2,062 $2,037 $2,012 $1,983 $1,952 $1,820
2011 $2,356 $2,170 $2,152 $2,103 $2,072 $2,042 $2,008 $1,971 $1,820
2012 $2,386 $2,198 $2,179 $2,130 $2,099 $2,068 $2,033 $1,991 $1,820
2013 $2,438 $2,246 $2,227 $2,173 $2,136 $2,099 $2,058 $2,011 $1,820
2014 $2,499 $2,302 $2,282 $2,216 $2,173 $2,131 $2,084 $2,031 $1,820
2015 $2,593 $2,365 $2,339 $2,260 $2,211 $2,163 $2,110 $2,051 $1,820
2016 $2,650 $2,417 $2,390 $2,306 $2,250 $2,195 $2,136 $2,072 $1,820
2017 $2,685 $2,449 $2,423 $2,337 $2,280 $2,225 $2,163 $2,092 $1,820
2018 $2,742 $2,501 $2,474 $2,384 $2,320 $2,258 $2,190 $2,113 $1,820
2019F $2,815 $2,567 $2,536 $2,431 $2,361 $2,292 $2,218 $2,134 $1,820
% Difference (8.8%) (9.9%) (13.6%) (16.1%) (18.6%) (21.2%) (24.2%) (35.3%)
Source: Costar, BMO Capital Markets Research.
In our view, prior rent control laws encouraged the construction of rental housing and also allowed
landlords to have enough funds to maintain their rental units, while enabling rent growth. Stricter
measures on rent control will acutely affect the supply of new units in a market which is struggling with
a housing shortage. The new rent reform legislation also effectively shuts down reinvestment because it
eliminates the resources landlords need to upgrade and maintain their apartment buildings.
US Real Estate | Page 6 July 23, 2019Exhibit 10: Supply Pipeline Remains Constrained in the Near Term Exhibit 11: Investment Levels Have Slowed Amid Investor Caution
Inventory Growth Net Absorption
Transaction Volume ($M) Cap Rate (RHS)
Avg. Asking Rent Growth (RHS) Avg. Vacancy (RHS)
30,000 4% $20,000 7.0%
25,000 6.5%
3% $15,000
20,000
6.0%
15,000 2% $10,000
5.5%
10,000
1% $5,000
5,000 5.0%
0 0% $0 4.5%
2011 2012 2013 2014 2015 2016 2017 2018 2019e 2020e 2021e 2022e
2011 2012 2013 2014 2015 2016 2017 2018
Source: CoStar, BMO Capital Markets Research Source: CoStar, BMO Capital Markets Research
Our conversations with CRE brokers indicate that investment in the multifamily market has slowed as
investors remain cautious over the uncertainty on how towns and cities plan to frame new rent
regulation rules. This caution is expected to continue over the near term.
Exhibit 12: Rental Growth Has Begun to Increase in a Constrained Market Amid High Wage Growth
4% Wage Growth Avg. Asking Rent Growth
3%
2%
1%
0%
2011 2012 2013 2014 2015 2016 2017 2018
Source: Bureau of Labor Statistics, Costar, BMO Capital Markets Research
According to CoStar, in 2018, the median price per unit increased 5.9% and average asking rents
increased 2.1% annually, while vacancy fell to 2.4%. Rents are expected to increase in the near term as
the supply of new units is expected to slow. Currently, 55,306 units are under construction and we
estimate that no new development projects will be initiated in the near future.
California
In California, 15 of 478 municipalities have voluntarily passed rent control, and larger efforts to
strengthen the statewide rent control policy have failed. Last November, voters shot down Proposition
10, a ballot measure that would have overturned the Costa Hawkins Rental Housing Act, which
weakened rent control policies statewide when it was passed in 1995.
The rent control discussion is back on the front burner in California as lawmakers passed AB 1482, a
statewide rent-control bill, which caps annual rent increases to 7% plus the consumer price index (CPI),
not to exceed 10%. The bill does not include new projects built in the last 10 years or landlords with 10
or fewer single-family rental properties. The limits have an expiration year of 2023, a concession that
generated enough support to push the bill through the Assembly. The bill now has a September
deadline to pass both houses of the legislature.
The concern, among landlords and investors alike, is that additional rent control measures will impact
the supply of new units negatively and will stall new construction. With 82,785 units currently under
construction, we believe that the supply of new units will decrease as deliveries get delayed, predicated
on a slowing economy and the rise of rent control measures. According to CoStar, most of the supply
under construction is concentrated in cities such as Los Angeles (~25,000 units), Santa Clara (~15,000
units), San Diego (~11,000 units), Orange County (~8,700 units), and San Francisco (~7,600 units).
US Real Estate | Page 7 July 23, 2019Exhibit 13: Supply Is Set to Decrease in the Near Term Exhibit 14: Investors Are Still Bullish in the Direct CRE Market
Inventory Growth Net Absorption
Avg. Asking Rent Growth (RHS) Avg. Vacancy (RHS) Transaction Volume ($M) Cap Rate (RHS)
35,000 8% $30,000 7%
30,000 $25,000 6%
25,000 6%
5%
$20,000
20,000 4%
4% $15,000
15,000 3%
$10,000
10,000 2% 2%
5,000 $5,000 1%
0 0% $0 0%
2011 2012 2013 2014 2015 2016 2017 2018 2019e 2020e 2021e 2022e 2011 2012 2013 2014 2015 2016 2017 2018
Source: CoStar, BMO Capital Markets Research Source: CoStar, BMO Capital Markets Research
Most landlords expect rental growth rates to increase given that supply pipelines are expected to remain
constrained in the near future.
Exhibit 15: Sensitivity Table: California Average Multifamily Rents at Various Rent Caps
California Avg. Monthly Average Asking Rent at:
Year Asking Rent CPI+7% CPI+6% CPI+5% CPI+4% CPI+3% CPI+2% CPI+1% CPI
2000 $1,201
2001 $1,296 $1,296 $1,296 $1,296 $1,290 $1,278 $1,266 $1,254 $1,242
2002 $1,291 $1,291 $1,291 $1,291 $1,285 $1,273 $1,261 $1,249 $1,237
2003 $1,271 $1,271 $1,271 $1,271 $1,265 $1,253 $1,242 $1,230 $1,218
2004 $1,275 $1,275 $1,275 $1,275 $1,269 $1,257 $1,245 $1,233 $1,222
2005 $1,319 $1,319 $1,319 $1,319 $1,312 $1,300 $1,288 $1,276 $1,255
2006 $1,395 $1,395 $1,395 $1,395 $1,388 $1,375 $1,358 $1,332 $1,297
2007 $1,469 $1,469 $1,469 $1,469 $1,462 $1,449 $1,428 $1,388 $1,339
2008 $1,509 $1,509 $1,509 $1,509 $1,502 $1,488 $1,467 $1,425 $1,375
2009 $1,443 $1,443 $1,443 $1,443 $1,436 $1,423 $1,403 $1,363 $1,315
2010 $1,413 $1,413 $1,413 $1,413 $1,406 $1,393 $1,373 $1,335 $1,287
2011 $1,435 $1,435 $1,435 $1,435 $1,428 $1,415 $1,395 $1,355 $1,307
2012 $1,475 $1,475 $1,475 $1,475 $1,468 $1,454 $1,434 $1,393 $1,344
2013 $1,529 $1,529 $1,529 $1,529 $1,522 $1,508 $1,486 $1,436 $1,372
2014 $1,587 $1,587 $1,587 $1,587 $1,580 $1,565 $1,538 $1,472 $1,393
2015 $1,689 $1,689 $1,689 $1,689 $1,668 $1,637 $1,594 $1,510 $1,415
2016 $1,768 $1,768 $1,768 $1,768 $1,737 $1,688 $1,627 $1,527 $1,416
2017 $1,834 $1,834 $1,834 $1,834 $1,801 $1,750 $1,681 $1,562 $1,435
2018 $1,899 $1,899 $1,899 $1,899 $1,865 $1,813 $1,741 $1,611 $1,465
2019F $1,948 $1,948 $1,948 $1,948 $1,914 $1,860 $1,786 $1,653 $1,500
% Difference -- -- -- (1.8%) (4.5%) (8.3%) (15.2%) (23.0%)
Source: Costar, BMO Capital Markets Research
Exhibit 16: Rental Growth Continues to Outpace Wages as Rental Supply Remains Constrained
8%
Wage Growth Avg. Asking Rent Growth
6%
4%
2%
0%
2011 2012 2013 2014 2015 2016 2017 2018
-2%
Source: Bureau of Labor Statistics, Costar, BMO Capital Markets Research
Our conversations with CRE brokers indicate that investors are not yet concerned about recent rent
control initiatives and that transaction spending is expected to grow at the same pace. In 2018, the
median price per unit increased 13.5% on an annual basis. In the same period, rents grew 3.6% across
the state.
Oregon
In February 2019, Oregon became the first state in the US to implement universal rent control (Bill SB
608). The new law prohibits landlords from raising rent by more than 7% plus CPI for All Urban
US Real Estate | Page 8 July 23, 2019Consumers, West Region on non-subsidized buildings, with exemptions for the first 15 years of
occupancy. For 2019, the rate stands at 10.3%. The law also severely restricts when landlords can evict
renters without cause.
Investors feel that rent restrictions create an incentive for developers to maximize profits by building
high-end apartments rather than affordable housing units, and some developers may opt not to build at
all. According to House Speaker Tina Kotek, “30,000 housing units must be built per year to meet the
state’s current housing deficit and to build for the future as more people move to Oregon.” Also, since
the new eviction rules give landlords less control over their property, they will have an incentive to
demolish existing affordable housing and use the land for other commercial purposes.
Our conversations with CRE brokers indicate that, in the near term, new supply is expected to continue
to outpace demand. In 2018, the median price per unit increased 18.4% and average asking rents grew
2.8% annually. Even when rent growth peaked in 2015, the average rent increase was 8.4%, still under
the level allowed in this legislation currently. Studios continue to make up the predominant unit type in
new construction, in response to the trend of young people moving to Oregon.
Exhibit 17: Sensitivity Table: Oregon Average Multifamily Rents at Various Rent Caps
Oregon Avg. Monthly Average Asking Rent at:
Year Asking Rent CPI+7% CPI+6% CPI+5% CPI+4% CPI+3% CPI+2% CPI+1% CPI
2000 $796
2001 $831 $831 $831 $831 $831 $831 $831 $831 $824
2002 $838 $838 $838 $838 $838 $838 $838 $838 $831
2003 $822 $822 $822 $822 $822 $822 $822 $822 $815
2004 $816 $816 $816 $816 $816 $816 $816 $816 $809
2005 $828 $828 $828 $828 $828 $828 $828 $828 $821
2006 $859 $859 $859 $859 $859 $859 $859 $859 $846
2007 $905 $905 $905 $905 $905 $905 $905 $897 $875
2008 $936 $936 $936 $936 $936 $936 $936 $928 $903
2009 $910 $910 $910 $910 $910 $910 $910 $902 $878
2010 $900 $900 $900 $900 $900 $900 $900 $892 $868
2011 $917 $917 $917 $917 $917 $917 $917 $909 $877
2012 $940 $940 $940 $940 $940 $940 $940 $932 $899
2013 $975 $975 $975 $975 $975 $975 $975 $962 $919
2014 $1,010 $1,010 $1,010 $1,010 $1,010 $1,010 $1,009 $986 $933
2015 $1,095 $1,095 $1,090 $1,080 $1,070 $1,060 $1,048 $1,014 $951
2016 $1,164 $1,164 $1,159 $1,147 $1,125 $1,104 $1,082 $1,037 $962
2017 $1,202 $1,202 $1,197 $1,184 $1,162 $1,140 $1,117 $1,067 $980
2018 $1,236 $1,236 $1,231 $1,217 $1,195 $1,172 $1,148 $1,097 $1,008
2019F $1,272 $1,272 $1,267 $1,253 $1,230 $1,206 $1,182 $1,129 $1,037
% Difference -- (0.4%) (1.5%) (3.3%) (5.2%) (7.1%) (11.3%) (18.5%)
Source: Costar, BMO Capital Markets Research
Exhibit 18: New Supply Will Outpace Demand in the Near Term Exhibit 19: Cap Rates Remain Stable Amid Investor Caution
Inventory Growth Net Absorption
Avg. Asking Rent Growth (RHS) Avg. Vacancy (RHS) Transaction Volume ($M) Cap Rate (RHS)
10,000 10% $4,000 7.0%
8,000 8%
$3,000 6.5%
6,000
6%
4,000 $2,000 6.0%
4%
2,000
$1,000 5.5%
0 2%
(2,000) 2011 2012 2013 2014 2015 2016 2017 2018 2019e 2020e 2021e 2022e 0% $0 5.0%
2011 2012 2013 2014 2015 2016 2017 2018
Source: CoStar, BMO Capital Markets Research Source: CoStar, BMO Capital Markets Research
With nearly 210,000 units, Portland is Oregon’s largest apartment market by a large margin. The two
next largest, Eugene and Salem, each have about 25,000 units.
US Real Estate | Page 9 July 23, 2019Exhibit 20: Rents Have Begun to Rise Amid High Employment and Net Positive Migration
10%
Wage Growth Avg. Asking Rent Growth
8%
6%
4%
2%
0%
2011 2012 2013 2014 2015 2016 2017 2018
Source: Bureau of Labor Statistics, Costar, BMO Capital Markets Research
According to CoStar, with 11,225 units currently under construction, the market still has some room to
expand. While investors and developers are cautious, the 15-year exemption for new construction in the
legislation can potentially help alleviate concern that would prevent future development. While there
are a few worries about a slowdown, in our view, high employment and positive net migration should
ensure this market remains strong in the near term.
City of Washington D.C.
In the city of Washington D.C., nearly 80,000 apartments are rent controlled. Rent control laws
encompass any rental property built before 1975, owned by a landlord who has five or more rental units
in the city. Publicly subsidized units are not covered under the current law. Landlords can increase rents
in rent-controlled apartments by CPI plus 2% annually. However, rental increases cannot exceed 10%
annually. For tenants who are elderly or disabled, the maximum increase is the CPI alone. Also, rents for
these tenants cannot increase by more than 5%.
When a rent-controlled apartment becomes vacant, landlords are permitted to raise the rent beyond the
rent control limit. Before renting to the next tenant, they can raise the rent either 10% or to a level
comparable for similar units. However, landlords in the District cannot increase the rent to more than
30% of the rent charged to the previous tenant. This is referred to as an “allowable vacancy increase”.
Exhibit 21: Sensitivity Table: D.C. Average Multifamily Rents at Various Rent Caps
City of DC Avg. Monthly Average Asking Rent at:
Year Asking Rent CPI+2% CPI+1% CPI
2000 $1,211
2001 $1,285 $1,276 $1,264 $1,252
2002 $1,288 $1,279 $1,267 $1,255
2003 $1,255 $1,246 $1,234 $1,222
2004 $1,247 $1,238 $1,226 $1,214
2005 $1,266 $1,257 $1,245 $1,233
2006 $1,323 $1,314 $1,300 $1,275
2007 $1,396 $1,382 $1,355 $1,316
2008 $1,433 $1,419 $1,390 $1,351
2009 $1,445 $1,430 $1,402 $1,362
2010 $1,490 $1,453 $1,410 $1,356
2011 $1,533 $1,495 $1,447 $1,378
2012 $1,567 $1,528 $1,479 $1,408
2013 $1,600 $1,561 $1,510 $1,438
2014 $1,629 $1,589 $1,538 $1,460
2015 $1,681 $1,639 $1,578 $1,483
2016 $1,714 $1,671 $1,595 $1,484
2017 $1,734 $1,691 $1,614 $1,502
2018 $1,770 $1,726 $1,647 $1,533
2019F $1,827 $1,782 $1,701 $1,570
% Difference (2.5%) (6.9%) (14.1%)
Source: Costar, BMO Capital Markets Research
In November 2018, The D.C. Council voted unanimously to move forward a bill (D.C. Law 22-223:
Vacancy Increase Reform Amendment Act of 2018) that would limit rent increases when a rent control
US Real Estate | Page 10 July 23, 2019apartment is vacated, to 10% of the rent charged if the previous tenant occupied the unit for 10 years or
less, or to 20% if the previous tenant occupied the unit for more than 10 years.
In our view, lowering the allowable vacancy increase will reduce the landlords’ ability to repair units in
between tenants. Higher vacancy increases, which allow property managers to collect more in rent, help
to subsidize the cost of other rent-controlled, below-market-rate units in a building.
We believe that concessions provide landlords flexibility to respond to the seasonal nature of rental
housing. For example, landlords may want to offer concessions during winter months, when there are
fewer move ins and outs. Concessions will also allow landlords to offer lower prices so that they can
compete, while preserving the ability to raise rent when the market fluctuates.
Exhibit 22: Increased Inflow of New Units in the Market Exhibit 23: Cap Rates Remain Compressed in the Current Cycle
Inventory Growth Net Absorption
Avg. Asking Rent Growth (RHS) Avg. Vacancy (RHS) Transaction Volume ($M) Cap Rate (RHS)
18,000 8% $9,000 7.0%
15,000
6% 6.5%
12,000 $6,000
9,000 4% 6.0%
6,000 $3,000
2% 5.5%
3,000
0 0% $0 5.0%
2011 2012 2013 2014 2015 2016 2017 2018 2019e 2020e 2021e 2022e 2011 2012 2013 2014 2015 2016 2017 2018
Source: CoStar, BMO Capital Markets Research Source: CoStar, BMO Capital Markets Research
Our conversations with the broker community indicate that the market will continue to see strong
capital inflows as it offers a wide range of investment opportunities for a broad spectrum of investors.
Cap rates continue to remain compressed in the current cycle. Developers and landlords are taking
advantage of strong demand and completions are expected to be elevated in the near term. According
to CoStar, 30,116 new units are expected to be delivered over the next three years.
Demand drivers, such as economic strength and a growing population of highly educated young adults,
have limited the impact of amplified deliveries on apartment fundamentals in Washington, D.C. Despite
the city’s ability to absorb an increased flow of new product and keep occupancy above 93%, the
market hasn’t managed to sustain meaningful rent growth.
Exhibit 24: Rental Growth Continues to Lag Wage Growth in Spite of Strong Economic Conditions
8%
Wage Growth Avg. Asking Rent Growth
6%
4%
2%
0%
2011 2012 2013 2014 2015 2016 2017 2018
-2%
Source: Bureau of Labor Statistics, Costar, BMO Capital Markets Research;
Note: Wage growth denotes the District of Columbia
Other U.S. States
Three states—Colorado, Illinois, and Washington—are considering similar statewide measures as Oregon,
and lawmakers in these states have begun to discuss rent control legislations. Escalating housing costs
have left more renters in these states desperate for relief.
Colorado: State lawmakers recently introduced Senate Bill 19-225, which attempts to lift a
statewide prohibition against local governments implementing rent-control policies. The four-
page bill, introduced in April 2019, does not offer specific rules on what can and cannot be
US Real Estate | Page 11 July 23, 2019done when it comes to rent control or rent stabilization. Rather, the bill provides counties and
municipalities the discretion to come up with their own rent-control solutions.
Illinois: State lawmakers introduced HB 2192, which proposes to lift the ban on rent control by
any municipality in the state. Following this, six regional rent control boards would be elected
which would determine regulations about rent stabilization rates and set registration fees
which would fund repairs and improvements. The bill also includes rent control and
improvement tax credits.
Washington: Lawmakers in Washington are considering a statewide rent control bill similar to
Oregon. At the moment, lawmakers have introduced an eviction reform bill (HB 1453) in the
House. The bill allows tenants more time to pay rent before the expensive court eviction
process can begin, extending the pay or vacate notice period from three days to fourteen days.
The Canadian Case Study
Post 1978, Canada’s apartment stock diminished rapidly due to a number of factors which include
amendments to tax legislations in the 1970s, the introduction of the condominium legislation, changing
demographics, the introduction of rent control, a high inflationary environment, and increasing land and
construction costs and high interest rates.
Rising costs and interest rates combined with a regulated rental market, in which rental growth had
been suppressed by controls, essentially increased investor equity and substantially lowered return on
equity. It thus became increasingly expensive, and uneconomical, to launch apartment projects.
As developers retreated from the purpose-built rental market, they turned their focus to condominiums.
The introduction of condominium legislation in all provinces in the late 1960s fundamentally
transformed the land market for multi-residential land use. Up until the legislation was passed,
apartments were viewed as a rental option. The introduction of this legislation allowed for options to
live in apartments and benefit from ownership, thereby changing the nature of rental demand.
Exhibit 25: Rental Stock in Canada Has a Long Way to Catch Up
80,000 12%
10%
60,000
8%
40,000 6%
4%
20,000
2%
0 0%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Rental Starts (# units) Condominium Starts (# units)
Rental starts as % of Population Change Avg. Rental Growth (%)
Source: CMHC, BMO Capital Markets Research
We analyzed Canada’s multifamily market dynamics in our recent note, “Canada Needs to Build With a
Purpose Never Witnessed Before”. We note that government regulations have further slowed the pace
of development of rental apartments than would otherwise have been the case.
In April 2017, the Ontario government announced its 16-point Ontario’s Fair Housing Plan (FHP), which
was in response to mounting pressure on policymakers to address declining home affordability.
Elements of the enacted legislation included: 1) the introduction of a 15% non-resident speculation tax
in the Greater Golden Horseshoe region (similar to a tax imposed in British Columbia, which applied to
the Greater Vancouver Area in 2016); and 2) expanded rent controls which will cover all private rental
units built on or after November 1, 1991.
US Real Estate | Page 12 July 23, 2019On November 15, 2018, the Ontario government released a “Plan for the People” which essentially
encouraged developers to build more purpose-built rental units by exempting new rental units from rent
control. They also decided to cancel the Development Charges Rebate Program thereby creating savings
of ~$100 million over four years.
Among major markets, Toronto and Vancouver are witnessing the largest crunch for rental stock, amid
high immigration and job growth. Renters in both markets are struggling to find product at a reasonable
rent. Developers have shown more intent in building condominiums units rather than purpose-built
rental units, given feasible project economics and a higher rate of return.
As shown in the charts below, Toronto has been a healthy multifamily market despite being regulated.
The city’s average annual rent growth has been 3.3% since 2006, outpacing New York but trailing San
Francisco, while vacancy rates have trended lower and were last recorded at 1.1%, well below the other
two markets.
Exhibit 26: Multifamily Average Rental Growth (%) Exhibit 27: Multifamily Average Vacancy Rate (%)
Toronto New York San Francisco Toronto New York San Francisco
1.5 4.7% 7.0%
1.4 6.0%
3.3%
5.0%
1.3 4.4%
1.7% 4.0%
1.2
3.0% 2.4%
1.1
2.0%
1.1%
1.0 1.0%
0.9 0.0%
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Source: CoStar, CMHC, BMO Capital Markets Research Source: CoStar, CMHC, BMO Capital Markets Research
We note that under the new rent control exemption for new units, the apartment market will soon face
a shortage of new units as developers will be less incentivized to build apartment units and maintain
them. Over the long term, we believe the existing apartment units will become more valuable, amid
shrinking supply, and REITs with exposure to the New York market will stand to benefit.
Currently, Canadian apartment REITs benefit from low supply, increased demand for apartment units,
high immigration and strong employment growth. The sector trades at a healthy 2019E P/AFFO of
~25.6x and 2020E P/AFFO of ~23.3x, compared to the entire REIT universe which trades at a 2019E
P/AFFO of ~18.9x and 2020E P/AFFO of ~17.9x (The BMO REIT Beat – June 28, 2019).
Europe: Taking a Hard Stance
Germany
In June 2019, Berlin’s government approved a plan for a five-year freeze on rents aimed at taming
soaring housing costs in the German capital. The legislation follows huge pressure from residents groups
– where 85% of people rent their homes – that the city has become unaffordable. The decision, awaits
final ratification by assembly members in October 2019.
Once fully ratified in October, the law would be retroactive to June 18, 2019. Rent increases on Berlin
homes would be banned for five years, with the exception of already subsidized public housing and
newly constructed apartments. This is not the first time that Berlin has seen rent control. Berlin already
has a fairly tight form of rent control, albeit one that is not well implemented. Across the city, a rental
authority assesses average rents for each micro-neighborhood, broken down further by apartment size
US Real Estate | Page 13 July 23, 2019and condition. No new lease is allowed to exceed 10% of this average price. The aim has been to
steadily pace rent increases, rather than halt them altogether.
Exhibit 28: Impact of Berlin’s 5-Year Rent Freeze on German Residential Owners
Deutsche Wohnen SE Vonovia SE
€ 50.00
€ 48.00
€ 46.00
€ 44.00
€ 42.00
€ 40.00
€ 38.00
€ 36.00
€ 34.00
€ 32.00
€ 30.00 01/02/2019
01/09/2019
01/16/2019
01/24/2019
01/31/2019
02/07/2019
02/14/2019
02/22/2019
03/01/2019
03/08/2019
03/15/2019
03/22/2019
03/29/2019
04/05/2019
04/12/2019
04/22/2019
04/29/2019
05/06/2019
05/13/2019
05/20/2019
05/28/2019
06/04/2019
06/11/2019
06/18/2019
06/25/2019
07/02/2019
07/10/2019
07/17/2019
Source: CMHC, BMO Capital Markets Research
Shares in German residential property groups with large portfolios in Berlin fell post the announcement
of the five-year rent control measure. For example, shares of Deutsche Wohnen fell 14% over the next
two trading days in Frankfurt. According to market sources, Deutsche Wohnen gets ~75% of its rental
income from Berlin. A cap would cut its funds from operations by between €15 million and €17 million
in the first year, or 3% of the total. Vonovia, Germany’s largest residential property group, fell 4.5% over
the same period, while Luxembourg-based Grand City Properties, which holds real estate predominantly
in Germany, dropped 6.3%. These two landlords get 10% and 14%, respectively, of their rental income
from Berlin.
France
In April 2019, the French government published a decree paving the way for Paris to reintroduce
citywide rent control. Paris first imposed rent control in 2015, in an effort to tackle the rapidly rising cost
of housing. The measure, however, was short lived. In 2017, a judge overturned the initiative on the
grounds that it should be applied throughout the region.
The decree brings into force legislation voted in November 2018 (the Elan law), which grants cities the
right to impose rent control. Limits will only apply to new leases, and the price of rent will be calculated
in euros per square meter, based on a property’s location. For example, a studio in the 6th
arrondissement (district), an affluent neighbourhood, will cost more per square meter than an
apartment of the same size in the 20th arrondissement, which is largely a working class neighbourhood.
Landlords will also be able to charge more than the mandated amount for special amenities, such as an
elevator or a sweeping view of the Eiffel Tower. There is growing interest among other mayors across
France to implement rent control initiatives in their municipalities.
Spain
In May 2019, the government of Spain published a decree in which landlords will have to negotiate
leases based on benchmark prices set for each property in neighborhoods tagged as most desirable.
That regulation follows a national law implemented in March that caps annual rent hikes at the rate of
inflation, currently 1.5%. The rules make exceptions for new construction and higher-end apartments.
Most investors feel that the new decree will curb the supply of new units. However, as per our
conversations, the decree will not affect long-term investors as the demand for apartment units is still
quite strong. The rules were written by the Government of Catalonia and allow similar controls in the
US Real Estate | Page 14 July 23, 2019region’s smaller towns. But few may embrace the measures equally, as the increases have been largely
confined to the biggest cities.
REIT Exposure in Current Rent-Controlled Markets
We analyzed apartment REIT portfolios by sub-markets and pin-codes, in our coverage and split them
into three segments – markets with rent control/stabilization measures, proposed markets with rent
control/stabilization measures and markets with no rent control/stabilization measure – to understand
where they stand should the rent control debate lead to an actionable law. As shown in the charts
below, AVB has the most communities with some rent control units; MAA the least. Communities with
rent control units tend to have lower vacancy rates, 4.1% vs. their all-market rate communities of 4.7%.
Exhibit 29: Apartment REITs: Communities With Rent Controlled vs. All Market Rate Units; %
Vacancy
# of Communities Rent Controlled # of Communities Market Rate
Vacancy % Rent Controlled (RHS) Vacancy % Market Rate (RHS)
100% 8.0%
90% 7.0%
80%
6.0%
70%
60% 5.0%
50% 4.0%
40% 3.0%
30%
2.0%
20%
10% 1.0%
0% 0.0%
AIV AVB CPT EQR ESS IRET MAA UDR
Source: CoStar, BMO Capital Markets.
Among U.S. Apartment REITs, MAA has the lowest exposure to markets considering rent control,
followed by IRET and Camden – thus we see less noise for these companies as rent control legislation is
discussed or implemented. Conversely, Essex has the maximum NOI exposure to markets where rent
control measures are being proposed, followed by Equity Residential and AvalonBay.
Exhibit 30: Apartment REIT NOI Exposure to Current and Proposed Rent-Controlled Markets
Rent Controlled/Stabilized Markets Proposed Rent Control/Stabilized Markets Market Rate
100%
90% 24%
80% 35%
45% 43%
70%
60% 77%
90%
50% 100%
40%
30%
20%
10%
0%
AIV AVB CPT EQR ESS IRET MAA UDR
Source: Company reports, BMO Capital Markets Research
US Real Estate | Page 15 July 23, 2019Looking at markets where rent control may be considered, we examine each apartment REIT’s exposure
to markets that have low-income population within a five-mile radius of each REIT’s communities, as
well as the median home price to income ratios, which measure housing affordability.
Exhibit 31: Apartment REITs: % of Units With Low-Income Exhibit 32: Apartment REITs: Home Value to Income Ratios Within
Population Within 5 Mile Radius of Communities 5 Miles of Communities, Current and Projected
Percent of PopulationIMPORTANT DISCLOSURES
Analyst's Certification
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Distribution of Ratings (July 22, 2019)
Rating category BMOCM US BMOCM US IB BMOCM US IB BMOCM BMOCM IB StarMine
BMO rating
Universe* Clients** Clients*** Universe**** Clients***** Universe~
Buy Outperform 48.9 % 20.8 % 62.8 % 50.0 % 60.9 % 57.7%
Hold Market Perform 47.6 % 11.5 % 33.7 % 46.7 % 37.5 % 37.5%
Sell Underperform 3.6 % 15.8 % 3.5 % 3.2 % 1.6 % 4.8%
* Reflects rating distribution of all companies covered by BMO Capital Markets Corp. equity research analysts.
** Reflects rating distribution of all companies from which BMO Capital Markets Corp. has received compensation for Investment Banking services
as percentage within ratings category.
*** Reflects rating distribution of all companies from which BMO Capital Markets Corp. has received compensation for Investment Banking
services as percentage of Investment Banking clients.
**** Reflects rating distribution of all companies covered by BMO Capital Markets equity research analysts.
***** Reflects rating distribution of all companies from which BMO Capital Markets has received compensation for Investment Banking services
as percentage of Investment Banking clients.
~ As of April 1, 2019.
Ratings Key (as of October 2016)
We use the following ratings system definitions:
OP = Outperform - Forecast to outperform the analyst’s coverage universe on a total return basis;
Mkt = Market Perform - Forecast to perform roughly in line with the analyst’s coverage universe on a total return basis;
Und = Underperform - Forecast to underperform the analyst’s coverage universe on a total return basis;
(S) = Speculative investment;
Spd = Suspended - Coverage and rating suspended until coverage is reinstated;
NR = No Rated - No rating at this time; and
R = Restricted - Dissemination of research is currently restricted.
BMO Capital Markets' seven Top 15 lists guide investors to our best ideas according to different objectives (CDN Large Cap, CDN Small Cap, US
Large Cap, US Small Cap, Income, CDN Quant, and US Quant have replaced the Top Pick rating).
Prior BMO Capital Markets Rating System
(April 2013 - October 2016)
http://researchglobal.bmocapitalmarkets.com/documents/2013/rating_key_2013_to_2016.pdf
(January 2010 - April 2013)
http://researchglobal.bmocapitalmarkets.com/documents/2013/prior_rating_system.pdf
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