Page 89 - AAGLA-MAY 2022

Member Update
and the northeast for places like Florida, Texas and the other southern states where the warm weather, business- friendly governments and laws, lower taxes and fewer regulations seem like a breath of fresh air. Reuters recently lamented that beset by COVID-19 and its fallout, many smaller local landlords are offloading their properties and selling to national institutional investors, and CNBC recently reported that at least 60% of single-family rental homeowners are owed back rent and are being forced to sell their rental properties to recoup losses. Finally, CBS News announced that as a last ditch effort to claw back tens of billions of dollars in unpaid rent, a national group of landlords is suing the Federal government for back rent.
However, even before COVID-19 rolled across the nation’s multifamily rental real estate investment market, landlords were seeing new rent control legislation start to encroach on their investment real estate portfolios, and squeeze owners’ profits. However, when COVID-19 arrived in the United States, cities across the country started expanding rent control laws and eviction moratoriums at an alarming rate, directly exposing landlords to financial peril. Legally speaking, the term “rent control” can be defined as any statutory rule that regulates the timing or frequency of increasing tenants’ rent, the services landlords must provide tenants, and the limited ability of landlords to evict tenants.
Today, multiple cities, states and jurisdictions are under some form of strict rent control regulation, including Washington D.C., Maryland, New Jersey, and New York. Most recently, the states of Oregon and California have enacted statewide rent-control laws that have greatly reduced landlords’ ability to raise rental rates. Cities like Santa Ana and St. Paul have both passed bills limiting rent increases to 3% a year. Seattle even passed a bill requiring landlords to pay the moving costs for tenants who can’t afford to stay in their homes, and the City of Los Angeles passed an ordinance that protects tenants from eviction for unpaid rent.
Perhaps no other region in the nation is more challenging for landlords than California’s Bay Area. For example, the City of Berkely has had one of the strictest rent control environments in the country capping not only rents, but also garbage and parking fees; Hayward limits rent increases at just 5% and rent increases following voluntary move-outs cannot be more than 5%; Oakland’s Rent Adjustment Program (RAP) limits annual rental increases to 30% in a five-year tenancy. Even more worrisome for landlords, cities like Portland and Oakland have recently created new restrictions that limit the ability of landlords to screen potential tenants, including:
• Prohibiting the use of criminal background checks
• Limiting the use of financial background checks
• Requiring landlords to accept of previously evicted tenants
• Limiting security deposits to 1.5 x month’s rent
Adding to these growing restrictive rental laws and regulations, landlords today must also face the reality of complicated and costly eviction laws and the soaring costs associated with repairs and maintenance.
Finally, many owners are recognizing that their rental property may not make as much financial sense as it once did. Why is this? Well, for several years now, property values in certain situations have risen faster than an owner’s ability to increase rents. The result is that the cash- on-cash return or “equity yield” gets compressed the higher property values rise. In some cases, this cash-on-cash return can be squeezed from a double-digit return to a low single digit return. Add to this the uncertain factors like inflation and unemployment, higher taxes, and a softening rental market, combined with city and government- imposed rent control and eviction moratoriums and more landlords are concluding that now might be potentially a good time to sell their investment real estate.
Enter the Delaware Statutory Trust and Passive Real Estate Investing
So why don’t rental owners simply take their equity positions and cash out? The simple answer because of the tax liabilities, including Federal Capital Gains taxes (15%- 20%), State Capital Gains taxes (0%-13.3% depending on the state he or she lives in), Depreciation Recapture Tax (25%) and the Medicare Surtax (3.8%) will now be due upon sale. These associated taxes could potentially take up to 40% of the asset’s sale price out of the seller’s proceeds. However, while it is true that a 1031 Exchange would allow owners to defer capital gains taxes, it is also true that they would most likely be limited to exchanging into another multifamily building or a single-tenant “triple net” building.
What’s the problem with these types of assets? Nothing, except investing in another multifamily building doesn’t offer the owner much diversification, and because the proverbial “3 T’s” consisting of tenants, toilets, and trash will still be involved, there will always be headaches and management expenses involved. A single-tenant net-lease property relies heavily on the quality of that sole tenant, and if that tenant fails, the investor’s income is likely to be reduced or eliminated completely (during COVID-19 there were multiple “triple net” tenants that went bankrupt or sought rental relief from their landlords). Also, triple net lease properties can be hard to locate, and conducting proper due diligence can be very difficult to accomplish within the time frame of 1031 exchange.
APARTMENT AGE • MAY 2022 89