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Friday, April 25, 2014

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Cascade: No. 73, Winter 2010

Preserving the Small Rental Housing Sector

Editor’s note: The Federal Reserve Board of Governors held a series of meetings this year with industry experts and other stakeholders to focus attention on the challenges faced by renters. One of these forums highlighted the importance of small multifamily rental properties (two to 50 units) and outlined options to preserve and improve this vital sector.

Small multifamily rental properties are a crucial and often overlooked part of America’s rental housing. These properties, made up of duplexes, triplexes, and other small buildings, are home to more than two-thirds of all renters. About 70 percent of lower-income renters live in small multifamily rental properties, which are primarily privately owned and are concentrated in the northeastern part of the nation.1 Small rentals are often family owned and are largely self-managed. Management and maintenance functions are often performed on a part-time basis by landlords who live in the buildings.

Challenges Faced by the Small Rental Property Sector

The small rental property sector faces a number of challenges, many of which are being exacerbated by the current housing crisis. The largest of these challenges consists of major inventory losses due to deterioration and lack of replacement. More than half of small rental buildings are over 30 years old, and much of the inventory is in need of substantial repair. Small rental properties have much higher inventory-loss rates than other types of real estate. Many units are located in distressed areas with high rates of foreclosure and abandonment. Foreclosure of small rental properties negatively affects the tenants in the building as well as the owner. New rental properties are not being built.

Production of new small rental properties has declined significantly over the past few decades.2 Much of the housing production market has focused on new single-family houses or larger multifamily rental buildings. Public programs favor larger rental projects, and local land-use ordinances often prohibit this type of construction. With these and other barriers, it is easier to build single-family or large apartment building housing. Therefore, small rental properties do not get replaced.

Many individual owners do not have the resources to preserve and improve small rental properties. These properties generally generate less operating income than other types of rental housing. In addition, rent is often not sufficient to cover the costs of upkeep, especially given the deferred maintenance costs and energy inefficiencies often associated with this older stock. Owners are often burdened with heavy debt loads and high property taxes.3 Added to these issues are local regulatory requirements that significantly add to the cost of rehabilitation, often making it an unattractive option for owners.

Another difficulty in preserving small rental units is the limited number of financing tools available for this sector. The cost of obtaining capital for construction or repair is often significantly higher than for larger buildings. This discrepancy is due to differences in scale, uncertainty about management, unclear resale values, and deteriorating property conditions.

Options for Preserving Older Multifamily Rental Properties

Some options exist for retaining this housing stock. One idea is the provision of training programs for landlords to help educate owners about responsible and efficient management practices and resources. Another idea is to encourage the repair of properties by reforming local rehabilitation ordinances. A third idea, which would benefit localities, is the creation of a central local database that provides details about property conditions. Such a database would enable localities to target limited resources for maximizing preservation of small rental properties.

Investment incentives are needed to stimulate the construction and preservation of small rental properties. Fostering new investment would likely require public subsidies. Undoing local regulatory barriers for this type of construction would also be necessary in many locations where Not in My Backyard (NIMBY) rules have thwarted efforts to preserve and increase rental supply.

A real estate investment trust (REIT) may help expand access to capital for the small rental sector.4 In this model, owners would be able to trade their individual properties for shares in the REIT. Aggregation into a pool structure would create sufficient scale to lower costs, improve property management, and access federal resources. Perhaps most important, this structure would lower the cost of capital (to the levels received by larger apartment owners) so that the REIT would have access to better terms on debt. The REIT would also create an equity source that could be used to foster construction of new rental units.

Conclusion

Rental housing is more vital than ever given that the housing crisis has exacerbated what had been an already large affordability gap. Demand for rental housing will increase in coming years. The population is projected to surge 33 percent by 2030. As a result, there will be increasing pressure to accommodate this population growth in a fiscally and environmentally sustainable manner.5 Small rental properties will serve an increasingly vital role in providing affordable market rate housing. Using available policy options could help this at-risk housing sector.

  • 1William Apgar and Shekar Narasimhan, “Enhancing Access to Capital for Smaller Unsubsidized Multifamily Rental Properties,” Joint Center for Housing Studies, March 2007.
  • 2Alan Mallach, “Small Rental Properties: A Case of Malign Neglect,” presentation to the Federal Reserve Board of Governors, April 28, 2009.
  • 3Alan Mallach, “Small Rental Properties: A Case of Malign Neglect,” presentation to the Federal Reserve Board of Governors, April 28, 2009.
  • 4Shekar Narasimhan, “Panel: The Critical Role of Smaller Rental Properties,” presentation to the Federal Reserve Board of Governors, April 28, 2009.
  • 5Doug Bibby, “A New Housing Policy: Making the Case for Rental Housing,” presentation to the Federal Reserve Board of Governors, April 28, 2009.

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