Rents are NOT high … when compared to Home Prices.

Rent Should be Tied to Current Home Prices

Yes, rents have increased substantially over the past few years, but so have home prices. The cost to rent something has to be tied to the current value of the object. You can’t expect rents to remain low while home prices have spiked? Rents in the Bay Area actually reflect a poor return on investment if home prices are not increasing.

Let us look at real world example. Buy a single family home in Redwood City for $1,500,000. The fair market rent is around $4,500/month.

  • Income = $4,500×12 = $54,000 Year
  • Prop Taxes = $16,500
  • Insurance = $ 1,200
  • Water = $1,500
  • Gardener = $1,800
  • Prorated Repairs = $8,000 (roof, water heater, fences, flooring, painting between tenants, etc.)
  • Net Income = $25,000/Year

Return on investment (ROI) = $25,000 ÷ $1,500,000 = 1.7 %
This is the return purely on the rent, it’s a better ROI when home values appreciate and worse when values decline. These numbers are based on the owner not having to pay to service any debt on the property. Of course a duplex or other greater multi-unit property should give better returns than a single family home.

Rentals have a low Return on Investment

Landlords are investors, they own an asset and expect a return on it. Purely looking at rent, a Bay Area landlord is only getting 1.7% return when the S&P has averaged an 11% annual return over the last 20 Years. With stocks there is no call at 10pm to unclog a toilet, no having a property vacant because a tenant moved out unexpectedly, no threat of liability from a tenant suing etc. If the landlord wants to have a property management company assist them, it will cost them 6% of the gross rent; this will reduce their ROI to 1.5% without reducing liability.

When properties are appreciating in value, the ROI is much higher, but the cost to rent the asset should reflect the asset’s current value. If I had put a $100 in the bank 50 years ago to be paid 3% interest annually, after 50 years I don’t expect to still be paid interest based on $100, I expect to be paid 3% interest based on the $447 that has accumulated in the account. Rental housing is an investment and rents need to reflect the current market value of the asset.

Rent Control is One-Sided

Majority of rent control proposals protect the tenant against rising rents, but property owners gets zero protection. There are several proposed laws coming up that would increase property taxes or make it easier for communities to raise property taxes. Tenants will be allowed to vote on them, so if the laws pass, then shouldn’t landlords then be allowed to charge tenants for some of these extra property taxes? After all, such taxes will go to pay for schools and other services the tenants will partake in? If property owners cannot have a modest return on investment then why suffer the headaches of owning property? Why not just put the money in the stock market? No liability or clogged toilets!

What about when the economy falters and rents decrease? The landlord in a rent control community is limited in raising the rent, but if rents drop then is the tenant obligated to stay on and pay the same rent as before? No, when the lease expires, tenants will either try to renegotiate a lower rent or move to a cheaper place.

The Long Term Landlord

A responsible landlord should be concerned with their tenant’s comfort and safety, but these things cost money; plumbers, roofers, etc. are not cheap in the Bay Area. It should not fall upon an individual to be responsible for providing society affordable housing. Many landlords are just individuals that purchase property to receive some income when they retire. If rent control makes it difficult for them to be a responsible landlords (keep tenants safe and happy) and still get some retirement income, then they may not be interested in owning property. Why would they? They’re better off selling it all and buying stock that pays good dividends or some bonds that pay interest.

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