By Adam Pagnucco.
With a strict rent control bill coming out of the council’s Planning, Housing and Parks Committee and worries about a structural budget deficit pervading county government, the two issues are threatening to converge in a toxic way. That’s because rent control will damage the tax base.
Let’s start with county revenues. Property taxes are usually the number one source of revenue for the county, accounting for nearly a third of all money in county budgets. Property tax receipts depend on valuation, rates, exemptions and credits. When valuation declines, other factors equal, receipts will decline.
In Maryland, assessments of real property are issued by the State Department of Assessments and Taxation (SDAT). The state uses three approaches to establish valuation: “Recent sales of similar properties; replacement cost, less accrued depreciation; and in the case of rental or commercial properties, a fair and reasonable capitalization of income.” That means that rental properties with high incomes get higher assessed valuations. The converse is also true. The state revalues properties on three year cycles and owners may appeal their assessments.
By capping rents, rent control definitely reduces property incomes. The bill pending before the council has an allowable rent increase of 3 percent plus the CPI and a hard cap of 6 points. That’s lower than the allowable increase in Takoma Park last year (which was 7.3%), a place that has not seen any new multifamily buildings since it instituted rent control over forty years ago.
On the issue of how rent control affects property valuation, let’s revisit a 2012 MIT study on rent control’s repeal in Cambridge, Massachusetts in 1995. Among its findings, the study reported:
Pooling administrative data on the assessed values of each residential property and the prices and characteristics of all residential transactions between 1988 and 2005, we find that rent control’s removal produced large, positive, and robust spillovers onto the price of never-controlled housing from nearby decontrolled units. Elimination of rent control added about $1.8 billion to the value of Cambridge’s housing stock between 1994 and 2004, equal to nearly a quarter of total Cambridge residential price appreciation in this period.
Two things to note here. First, the numbers apply to events of 20-30 years ago. They would be much higher in today’s dollars. Second, Cambridge’s population of 118,488 is roughly one-ninth of Montgomery County, MD. The impact of rent control on property valuation could be MUCH larger here.
Rental property assessment appeals could be triggered in two ways. First, anyone owning an existing property under a new rent control law could appeal as soon as allowable under state law. Second, in the unlikely event that anyone constructs a new building, rent control would kick in under the county bill after 15 years. That could also provoke an appeal.
I asked my sources in the real estate industry about whether rent control would lead to assessment appeals. Here is what a few of them said.
Source 1:
“The assessment for operating commercial properties (which would include apartments for this purpose) is usually based on an income approach. (The income capitalized to determine a value someone would pay to obtain that income stream, i.e., buy the building.) The owner must report to the State its income and expenses, from which the cash flow and cap rates can be analyzed.
So every owner who has their income limited for the future would argue for a lower assessment. And, because they may not be able to recoup the suppressed values upon natural turnover the State will not be able to argue that at the end of lease X, if the tenant moves out (just for innocent reasons), the rent can be increased to whatever is market value and thereby increase the income (because the Council was worried that landlords would not extend leases in order to make a unit vacant in order to raise the rent to market, so that under the bills, even upon vacancy, rent cannot be increased except in accordance with the new caps). [Editor’s note: the council has not yet decided vacancy control.]
Just as every office building owner should have been appealing their assessment during the pandemic and also now, every apartment owner should be doing the same thing, once the bill passes. And remember that we will not have the regulations to determine what is a “fair return” until sometime after the bill is passed. (There was some discussion about that issue at the end of the worksession, but it was a little hard to follow.) In past recessions, when office markets were hit hard, people did successfully appeal assessments with a corresponding significant impact on the County.”
Source 2:
“Not a theory, that’s how it works.
If the net operating income drops 20% so does the value, caps rates being equal. The income approach (NOI) is how we establish valuations for office buildings and multifamily. Widely accepted by the assessors.
Office buildings occupancies and NOI are widely down 25% nationally and expected to get worse in ‘24 so office building assessments and tax revenues will decline by as much. Multifamily was the growing tax base. With rent control those valuations will decline – so too will tax revenues. The only asset class holding its weight is single family. It alone cannot make up for the looming office and multifamily valuation declines.”
Source 3:
“Perhaps a corollary to that may be that the reduced income stream will devalue properties when they trade which will also lower assessments.”
Source 4:
“It will be open season for appeals.”
How much lost revenue for the county are we talking about? That’s hard to know but let’s start with a few numbers.
1. According to SDAT, the county had an assessable base of $11.4 billion in apartment buildings in July 2022. But that doesn’t cover all rentals, some of which will be included in the residential assessable base of $142.8 billion.
2. According to the U.S. Census Bureau’s American Community Survey, Montgomery County had 405,755 housing units in 2021. Of those, 133,185 were occupied by renters. That means a third of the county’s housing stock is rental property. That’s a LARGE part of our total assessable base.
3. A 2015 study by Towson University claims that rent control in Montgomery County would eventually produce an annual loss in property tax revenue for the county of $36 million a year. That number is hard to evaluate because it’s uncertain whether it is based on a model approximating the county’s current legislation, and one thing to know about rent control is that the details matter a lot. For whatever it’s worth, this study predicts total tax revenue losses reaching more than $100 million a year.
Rent control will cost the county money in other ways besides assessment appeals. If multifamily buildings covered by rent control trade at discounts, recordation and transfer tax receipts will fall. If multifamily construction falls or ceases, impact taxes collected for the capital budget will fall. And if property development declines, the total assessable base will grow at a slower rate, reducing future property tax receipts. It may be impossible to calculate the costs of all this and the county’s fiscal impact statements on its rent control bills did not even try.
No one knows how much money this will cost the county. And no one in government seems to be talking about it. But with billions of dollars of valuation at stake, it could cost A LOT.
With assessable base bleeding on the floor and ever-mounting county spending bills coming due, is there anyone reading this who does not believe that the county will eventually respond with more tax hikes? And if they do, guess who will pay them?
That’s right. You will.