FISCAL YEAR MARKET-RATE APARTMENT RENT SCHEDULE

Transcription

1 May 12, 2017 TO: SUBJECT: CONTACT: CADA Board of Directors May 19, 2017, Board Meeting AGENDA ITEM 6 FISCAL YEAR MARKET-RATE APARTMENT RENT SCHEDULE AND RENT INCREASE/LEASE METHODOLOGY Diana Rutley, Property Manager RECOMMENDED ACTION Staff recommends that the Board adopt a resolution approving: 1. FY Market-Rate Apartment Rent Schedule 2. Lease Term Rent Premiums 3. Rent increase Methodology BACKGROUND With the exception of actions taken to comply with the affordability mandates set forth in its enabling legislation, CADA must charge market rates for its apartments. Accordingly, a market-rate apartment rent schedule is prepared at this time each year for implementation in the next fiscal year. The rents on the market-rate rent schedule are the rents charged to new residents as units become vacant and are placed on the market. To encourage resident loyalty, reduce turnover and assist with budgeting CADA assigns its lowest rates (the market rent) to a 12-month lease term and caps rent increases at a fixed percentage. Residents who commit to renting for at least a year will pay the lowest rates, while residents who choose shorter-term leases pay a premium for the flexibility. ANALYSIS I. FY Market-Rate Apartment Rent Schedule For FY staff recommends an overall percentage increase to the Market Rents of 5.2%, which increases the average monthly rent $47, from $884 to $931 per month, as detailed on Attachment 1: FY Proposed Market-rate Rent Schedule. The market rents for CADA s apartments are based on several key factors: A. Market Data Supplied by Industry Professionals and in the News B. CADA s Years of Experience as a Multi-Family Housing Provider C. Market Demand for CADA Properties D. Vacancy and Turnover Rates at CADA s Properties

2 E. Improvements Made at the Properties in the Past Year F. Market Rents of Similar Non-CADA Units in the Downtown Rental Market CADA sets market rents for all of the 750 apartments it manages. Although 187 of the units are rented to low income households who pay a below-market rent, the units are scattered throughout most of CADA s properties and fluctuate as residents move in and out. Rents for the 61 CADA apartments at Biele Place and Somerset Parkside are governed by financing agreements with HCD or CalHFA. Market rents for those units are only set for those occasions when a resident of the property is receiving a Section 8 Housing Choice Voucher subsidy and HUD is paying the Fair Market Rent. The market rents apply to all of the units that are not in an affordable program. To adjust the market rents for FY 17-18, staff applied a fixed percentage increase of 5% (rather than a fixed dollar value) to the market rents to reflect the rent changes in the downtown Sacramento rental market in the past year, and then made adjustments to account for improvements at specific units, to more accurately reflect market demand for particular units, or to charge a comparable rent or rent per square foot for similar units within the same property or another property within CADA s portfolio. This resulted in increases to the market rents ranging from 4.4% to 6.8% (an average of 4.9%) for all but 21 apartments. The increases for the remaining 21 units range from 6.9% to 33.6% (an average of 11.3%) and are a result of kitchen and bathroom upgrades, the installation of central heat and air in several apartments, market demand and corrections that needed to be made. These are the rents at which apartments will be placed on the market as they come vacant. i Please refer to Attachment 2: FY Exceptions to the Market Rent Increase Averages for specific information. The rents for CADA s property at 1320 N Street were not increased at all due to upcoming development on the site (Development Site 21). Table 1 illustrates the average rent and percentage increases by unit size proposed for FY Table 1 Average Rent and Percentage Increases by Unit Size Unit Type FY FY Average Average Avg. Rent Avg. Rent Increase $ Increase % Range 1 Rooming House $450 $470 $20 4.4% 4.4% Studios $747 $782 $36 4.7% 4.5% to 5.9% 1 Bedroom $840 $883 $44 5.1% 4.7% to 6.5% 2 Bedroom $1,286 $1,367 $80 6.2% 5.0% to 6.8% 3 Bedroom $1,238 $1,313 $75 5.9% 5.0% to 5.8% All Units Avg. $884 $931 $48 5.2% 4.4% to 6.8% While CADA s market rents must stay consistent with market conditions, CADA strives to neither lag behind the rental market, nor lead the market. It is common in the multi-family industry for private property managers to accept a 5% vacancy factor and raise rents when the vacancy is less than 5%, and hold rents or offer more concessions with a vacancy factor of more than 5%. Multifamily real estate market experts often use the term "equilibrium" to describe occupancy levels around 95 percent. At that rate, an apartment development is generally full enough for its owners to keep rents where they are, but no higher. 2 CADA follows a similar practice, but historically, it has accepted a 3% i The rent paid by existing residents is set in accordance with CADA s annual rent increase limits.

3 vacancy factor to remain consistent with CADA s approach of neither leading or lagging behind the market. We also do not follow the practice of some property managers of changing the market rents often throughout the year to whatever level will keep vacancy rates within the acceptable industry standard of 5%. Instead, CADA follows the practice of setting not-to-exceed rents on an annual basis and holding these maximums for the year. The rent schedule proposed for FY 17-18, with its average 5.2% increase to the market rents, follows ten years of market-rent adjustments totaling 17.35%. Rents in Sacramento reportedly increased 36% during the same 10-year period. 3 In order to arrive at the rents proposed on the Market-Rent Schedule, staff reviews articles and quarterly research reports by professionals in the property management industry regarding the state of the rental market and the economy and compares the data to CADA s experience. Staff believes that the rent schedule proposed for Fiscal Year is appropriate, and also reflective of the following market data and factors specific to CADA: A. Market Data Supplied by Industry Professionals and in the News: Sacramento leads the nation in double-digit rent growth, which has been sustained for well over a year - for a total of 7 quarters of rent growth above 9%, through April Downtown is the 4 th most expensive neighborhood in the Sacramento region, with average rent of $1,732. At the end of December 2016, Sacramento recorded the largest year-over-year rent increase of 12.2%, with average rent city-wide jumping from an average of $1,063 per month in December 2015 to $1,193 per month in December The rent growth is primarily due to a lack of new construction and strong market fundamentals. Sacramento occupancy is at an all-time high of 97.4%, with a 2.6% vacancy. Sacramento s population is growing at a rate above the national average, but with a median age below the national norm. The younger population is known to prefer renting which is placing added pressure on a limited number of vacant units. Sacramento is experiencing a large influx of bay area residents particularly the millennial cohort - who are in search of less expensive housing. Sacramento is #5 in the State for job growth, which has pushed rents up for all asset classes, but particularly in the renters-by-necessity group who primarily rent Class B and C units. Market forecast for the year ahead: The strong market fundamentals that currently exist in Sacramento are predicted to continue, perhaps with some moderation, throughout the remainder of 2017 and into 2018: o Sacramento rents will continue to grow through 2017, in the 6%-7% range. o Continued migration of residents moving to Sacramento from the Bay Area combined with a lack of new units will continue to be the principal drivers for higher rents. o Low vacancy will support continued rent growth. o As newly constructed units are delivered, occupancy will drop in 2017 to the mid 96% range as market forces pursue equilibrium. Please refer to Attachment 3: Rental Market References May 2017 for specific quotes and citations for the articles staff reviewed in order to derive this year s Market Rent Schedule.

4 B. CADA s Advantage as a Multi-Family Housing Provider CADA s almost 40 years of experience as a multi-family housing provider gives us an advantage over many other property management companies in the downtown rental sub-market. With its government agency transparency and reporting requirements, the public feels an extra level of security renting from CADA, and is confident that CADA will make good public policy decisions. In addition, CADA is unusual in that has so many full-time staff in the neighborhood who are able to offer a quick response to residents needs 24-7, and because it provides a 12-hour nightly courtesy patrol by a professional security company. C. Market Demand for CADA s Properties The proposed rent schedule takes into consideration the varied nature of the housing CADA provides. Mostly high-demand Class B or C properties, which range from years old and years old, respectively, 4 CADA s inventory ranges from modest rooming house rooms and small studio and one bedroom apartments built in the 1940 s, to rehabilitated Victorians and more contemporary flats and townhomes. Although many of CADA s properties are much older than the Class B and C age ranges noted, they have the advantages of location, architectural charm and superior service history which mitigate the much lower rents that CADA might otherwise achieve at many of its older properties. 5 The superior location of CADA s properties provides renters what they want most: livability, energy efficiency and walkability to nearby shopping, work and transit. 6 D. Turnover and Vacancy Rates at CADA s Properties CADA experienced 24% turnover at its residential properties in the past twelve months, approximately 12% less than CADA s average most years of 37%, through This year s turnover figure continues the decline of resident move-outs as it follows two years of historically low turnover at CADA s properties: 31% in FY , and 27% in , respectively. The national average is reportedly 54%. 7 While there is value in reducing turnover costs, there is a point where lower turnover isn t always necessarily a good thing. Operators with high turnover have more opportunities to push rent growth. 8 CADA s average vacancy factor for the past year was just 2% (with a corresponding 98% occupancy), a little better than the average 2.6% vacancy for Sacramento in Historically, CADA recorded an average occupancy of 97% for the calendar years 2000 through 2016, with dips to 95% and 96% in 2008 through 2012 (attributable to the recession and its aftermath), and spikes to 98% in 2007 and In conclusion, these two factors suggest that CADA s rents need to be increased. E. Improvements Made at the Properties in the Previous Year In the past fiscal year CADA renovated the kitchens and bathrooms of several apartments by adding updated finishes and fixtures, and installed central heat and air systems in several apartments which previously did not have that feature. The new market rents reflect the increased value of these improvements. Please refer to Attachment 2: FY Exceptions to the Market Rent Increase Averages for specific information.

5 F. Market Rents of Similar Non-CADA Units in the Downtown Rental Market CADA s goal is to have market rents that are within market range when compared to similar apartment properties. A review of the rents that others are charging in the downtown submarket confirms that there are properties in the area with rents above and below CADA s proposed average rents and that CADA s overall increase to the market rents is low in comparison to the double-digit rent growth that has been occurring in Sacramento over the past two years. II. Lease Term Rent Premiums In addition to setting annual market rents, CADA also asks the Board to approve its lease term premiums and rent increase methodology, as set forth below: Since the inception of leases at CADA in FY 09-10, staff has asked the Board to approve the premiums charged for the different lease terms, with the current year s market rent always assigned to the 12-month lease term. Both new and existing residents who don t wish to sign a 12-month lease - either at move-in or upon expiration of an existing lease - pay a premium for signing a shorter lease term to compensate for the cost of re-renting the apartment within a potentially shorter period of time. The premium for a 6-month lease term is currently 3% above the 12-month lease rate, for both existing and new residents. The premium for a month-to-month term is 5% above the 12-month lease rate for existing residents and 20% for new residents at the time of move-in. Because the rent differential between a 12-month lease and the shorter lease terms is fairly small in terms of dollars with the existing 3% and 5% premiums, many residents choose to sign a 6-month or month-to-month lease in order to have the flexibility that a shorter term provides. However, because the turnover expenses associated with shorter term leases are more costly for CADA, staff proposes to encourage more residents to sign 12-month lease terms by increasing the premiums charged for the shorter lease terms, as follows: 6-month lease term: Staff proposes a 10% premium for both existing and incoming residents, instead of the current 3% that is charged to both. A resident who now pays $900 a month for a 1-year lease term and $927 per month for a six-month lease term would instead pay $990 for a six-month term. Month-to-month term: Staff proposes to increase the premium charged to existing residents from 5% to 20%, the same rate that is currently paid by new residents who choose to rent month-to-month at move-in. CADA assumes that a resident who signs a short-term lease is not planning to remain for a year or more, so raising the premium for the shorter terms will help CADA to be better-prepared financially for the turnover expense when it occurs. While the maintenance expenses for the turnover of an apartment that has only been occupied for two months should generally be low, it is the vacancy loss and cost of re-leasing the apartment that can be especially costly. For example: A 225-unit apartment community with a 40 percent turnover rate (7.5 moves a month), an average rent of $650 per unit and an average per-unit turnover expense of $1,800 is spending $162,000 annually on turnover, or about 9 percent of the gross rent

6 potential. If that apartment community reduced turnovers by just one per month, it would save more than $20,000 in annual turnover expenses. A property with a lower average rent is going to experience similar if not higher turnover costs, so the percent of revenue required to support this expense will be higher. 10 Accordingly, most experienced landlords feel it makes good business sense to charge a premium for the shorter lease terms that is more reflective of the associated higher costs. In CADA s case, doing so would also reward residents who have committed to rent for 12-months by creating more of a differential between the rent they pay and the rent paid by a neighbor who has only committed to rent for a few months. III. Rent Increase Methodology for Continuing Residents Finally, staff is also asking the Board to approve a 5% rent increase for continuing residents in FY 17-18, plus an additional amount that may be necessary to bring a resident s rent to within 2% of the new market rent for a 12-month lease term, not to exceed a 10% increase, in total. 11 The new rent would go into effect at the beginning of the resident s next lease term, or in the case of month-tomonth residents, on July 1st. 12 CADA s annual rent increase limit for continuing residents has generally been 5% per year, with some exceptions, as noted in Table 2: FY Rent Increase Percentages and Resident Rent Increase Limits. Table 2 FY Rent Increase Percentages and Resident Rent Increase Limits Fiscal Year Market Rent Increase Continuing Resident $ Increase Fiscal Year Market Rent Increase Continuing Resident % Increase % 10% % 3% % 10% % 3% % 5% % 3% % 5% % 3% % 5% % 5% % 5% % 5% % 5% % 3% % 5% % 3% % 5% % 5% + In Fiscal Year , a 10% rent increase was imposed to continuing residents to reduce the disparity between the market rents and their rents. In the years that followed, the increase percentage was mostly capped at 5%, with exceptions in FY s and 08-09, when an additional 1% was added for every 10% (or portion thereof) that a resident s rent was below market; several years during the recession when the increase limit was set at 3%; and more recently, the past two years, when the increase cap was again reduced to 3%, reflecting staff s concern about the swift and dramatic increases in apartment rents that have been occurring in the Sacramento area. There are currently 330 market-rate residents who are paying a below-market rent (as of April 30, 2017), ranging from less than 1% below market to 23% below market, a result of the years when the increases to the market rents exceeded the CADA rent increase limit, or the resident received a rent concession at move-in. The difference between the rent a continuing resident pays as compared to what a new resident pays is called a loss to lease. While it is a common practice in a soft rental

7 market for landlords to allow continuing residents to pay a lower rent than new residents moving in, it is practically unheard to accept a high loss to lease figure when market conditions are strong. For just this group of residents who are paying a below-market rent, CADA s loss to lease figure for the month of April 2017 was $8,473 (approximately $100,000 per year). If the Board approves the rent increase limits as proposed, the loss to lease figure will be reduced to $53,000 in FY Rent increases will range from less than 1% to 5% for 97 residents and from 5.1% to 10% for 232 residents. 13 The rent increases will be limited for ten residents in this group who will continue to pay a rental rate that ranges from 2.8% to 13.7% below market until their next lease renewal. If we instead cap the increases at 5%, the loss to lease figure would increase to $113,000 in FY With a 6.2% increase to the Consumer Price Index between February 2015 and February 2017, 14 the increased costs of maintaining CADA s older properties, the high loss to lease figures, the 10% to 12% rent growth recorded for Sacramento in the past year and CADA s low vacancy and turnover rates, staff believes the proposed rent increase methodology is sound. Additionally, issuing higher rent increases to residents with a larger gap between their rent and the market rent helps to achieve parity among the rents paid by CADA s continuing residents. CADA s CONCERNS FOR THE YEAR AHEAD As CADA considers the year ahead we believe the following issues deserve our attention: Workforce Housing: Much like the period of The Great Recession, that had a big impact on people s ability to afford their homes, this current period of time now being called The Housing Crisis - is having a similar impact on people s ability to find housing they can afford. Staff is concerned about that workforce cohort mentioned earlier who are often priced out of housing to such an extent that it ultimately has an impact on the ability of a community to meet the needs of its residents, and in the year ahead will be exploring ways in which it might be able to help this group meet its housing needs. As John Powell explains in his article for National Real Estate Investor: 15 It is critical for people to have the option to live near where they work, particularly those workers who are most essential to the local economy. Vital employees include teachers, emergency service workers, nurses and retail clerks [and restaurant workers, CADA would add], many of whom find that most existing and newly constructed housing is simply priced beyond their reach. Especially in urban cores and near employment centers, land and development costs are very high, thereby forcing people to live further away from jobs and significantly increasing their commuting times and costs. When people can afford to live closer to their jobs, entire communities reap the benefits. Commute times and traffic congestion ease, neighborhoods are more diverse and provide the opportunity for families to live and grow in one place over time, and economies strengthen by helping employers attract and retain essential workers. Ensuring an adequate supply of good quality, well-located and affordable workforce housing is critical to the health and well-being of all communities and should be an important component of our national housing policy. A writer for the Sacramento Business Journal explains the workforce housing problem this way: 16

8 As Sacramento becomes less livable for middle-market apartment tenants, workers may become harder to find for some kinds of businesses. This is already an issue in the Bay Area. And as consumers are forced to spend more of their incomes on rent, they are likely to have less disposable income for expenses such as dining out, potentially threatening sectors of the economy such as restaurants, which have been increasingly important to the region in recent years. The writer also quotes developer Lex Economou, who says, It s about finding a balance. We have to meet market demand. And right now, we re not. CADA may wish to modify its rent increase procedures in the future to address the unmet housing needs of these essential workforce wage earners (who earn between 60% and 120% of AMI). This topic will be the focus of a workshop CADA will hold later in the year. Downtown Housing Survey: CADA has partnered with the City of Sacramento, Midtown Association, Downtown Sacramento Partnership and R Street Partnership, to conduct a housing survey that asks those who work in downtown Sacramento to provide input on downtown housing options and opportunities to help inform agencies like CADA about the housing needs of different groups. The results of the survey, along with concerns about how to meet the housing needs of workforce wage-earners will be among the topics to be addressed at the workshop CADA will hold later in the year. CONCLUSION: Given that the multi-family outlook for the year ahead is still unknown, with some saying rent will continue to grow and vacancy will decrease even more, and others saying we ll see more moderation, staff believes the timing is especially correct for the market rent actions proposed herein and agrees with Anne Sadovsky, a professional speaker in the multi-family industry, who has this to say about timing: Because our business is cyclical, soft markets usually show up every 5-7 years. Therefore a strong market offers the opportunity to recoup losses, add amenities, take care of neglected repairs, and to upgrade the property over all. How? By increasing rents while the property is in high demand! Or, as my grandfather taught us early on, You gotta make hay while the sun shines. 17 In this spirit, although rent increases have, historically, been more difficult for CADA to accept than they might be for private landlords, CADA must prepare for the inevitable economic downturn now while it can, and raise rents in a measured way while the market clearly still supports doing so. And while staff believes that each of the proposed actions is appropriate and, more importantly, necessary for the agency to meet its legislative mandates and financial responsibilities, they do raise the bar for CADA in the years ahead. We must continue to provide superior customer service and care for our properties, never take our residents for granted, and never miss the opportunity to show our appreciation and say Thank You to them for making their home with us. POLICY ISSUES The recommended action is consistent with Government Code 8193(h) which requires CADA to establish a schedule of market rate rents for the units leased by the Authority from the Department of

9 General Services. GC 8193 states that until 800 newly constructed units are completed and occupied, CADA shall establish a schedule of rents designed to make available to low income households not less than 400 units at as close to affordable rents as practical in light of its budgetary needs and; that this schedule shall be designed to impose market rate rents for remaining units leased by the Authority from the Department [of General Services]. Please refer to Attachment 4: CADA Units Constructed and Occupied Since 1978, which provides a list of all of the newly constructed units, facilitated by CADA, which currently total 1,153. CADA met the benchmark of 800 newly-constructed units in 2014, with the opening of Legado de Ravel. While it is no longer required to make any market rate units affordable to low income households, staff continues to monitor the affordability of CADA s market-rate units. As illustrated in Table 3: CADA Market Rents Affordable to Very Low & Low Income Households, the proposed FY market-rate apartment rent schedule makes 646 units (86%) available to low-income households at affordable rents. This exceeds the 400-unit mandate by 246 units. Table 3 CADA Market Rents Affordable to Very Low & Low Income Households 18 (Per proposed Fiscal Year Market-rate Rent Schedule) Unit Size # Total Units 50% AMI 60% AMI 80% AMI % of CADA s units Affordable at 80% Household Size Room % 1 person Studio % 1 person 1-bdrm % 1 person 2-bdrm % 3 persons 3-bdrm % 4 persons TOTAL % STRATEGIC PLAN This action supports CADA s strategic plan goal of sustaining a balance of diverse housing opportunities. FISCAL IMPACTS Staff anticipates that the proposed actions will, over time, generate additional rental revenue which will help CADA to: Pay for the steady increases in the cost of maintaining its aging properties Pay for increases in utility costs Partially offset the reduction in rental revenue resulting from the removal of buildings and parking spaces to make way for development projects Achieve an equilibrium between vacancy and occupancy that is neither too high or too low Rental revenue will be closely monitored and the budget projection will be re-assessed at mid-year.

10 CONTRACT AWARD CONSIDERATIONS Not applicable. This action does not involve the award of contracts. ENVIRONMENTAL CONSIDERATIONS Not applicable. The proposed action is an administrative matter and is not a project subject to the guidelines of the California Environmental Quality Act (CEQA). Attachments: 1. Proposed Fiscal Year Not-to-Exceed CADA Market-Rate Rent Schedule 2. FY Exceptions to the Market Rent Increase Averages 3. Rental Market References - May CADA units constructed and occupied since 1978 Footnotes: 1 There are a total of 21 apartments where the increase to the market rent falls outside of the ranges noted. The details on those units are noted on Attachment 2: FY Exceptions to the Market Rent Increase Averages Class B properties are generally well-maintained and have a middle class tenant base of both whitecollar and blue-collar workers. Some are renters by choice, and others by necessity. Class C properties generally have blue-collar and low- to moderate-income tenants, and the rents are below market. This is where you'll find many tenants that are renters "for life." On the other hand, some of their tenants are just starting out. And as they get better jobs, they work their way up the rental scale. (Source: Wikipedia 2017) 5 With updated kitchens, bathrooms and flooring many of CADA s Class B properties could become Class A, which will occur as CADA continues to renovate properties on a unit-by-unit basis as they turn over. And while the same could hold true for Class C properties becoming Class B properties, CADA presently chooses to maintain rather than increase the value of its Class C properties in order to keep them affordable for lower income households such as workforce wage earners (essential workers in a community, such as restaurant, office and safety personnel) who are often overlooked as candidates for regulated affordable housing units

11 The rent increase cap does not apply in the following circumstances: For 6-month and month-to-month lease term rents: These rents are set as a function of the 12-month lease rate (upon which the cap IS based). 1) Residents who receive a rent discount (concession) at move-in: Upon expiration of the move-in lease (or whatever term was agreed upon for the concession to be in effect), it is CADA s practice to increase the resident s rent to the rate it would be had the concession not been provided; 2) Residents who have too many violations: It is CADA s practice to only offer month-to-month terms to residents who repeatedly violate critical terms of the lease. When this is the situation, the resident s rent is increased to the month-to-month rate without benefit of the cap first being applied to the 12-month lease rate. 12 Now that all of CADA s residents are on some form of a lease (of varying length), the former practice of staff increasing rent only once a year cannot be avoided in the case of residents on 6- month and month-to-month terms if the market rent has changed since the effective date of the current lease. Month-to-month residents are subject to a rent increase whenever their rent is below the month-to-month rate currently in effect. 13 Concessions will be reversed for two residents who received large concessions at move-in. 14 CPI Index: All Urban Wage Earners & Clerical Workers (San Francisco, Oakland, San Jose) the same index staff uses for CADA s commercial tenant rent adjustments Affordability calculations are based on information provided by HUD on April 14, In calculating affordable rents, it is assumed that single person households occupy studio and one bedroom units, and three person households occupy two bedroom and three-bedroom units. The range of monthly income for a household making 50%, 60% and 80% of AMI and the corresponding affordable rents is as follows: Household Size 1 person 2 persons 3 persons 4 persons Income Limit: 50% AMI (Very Low) $26,600 $29,700 $33,400 $37,100 Affordable Rent $650 $743 $835 $928 Income Limit: 60% AMI (Other Low; $49,200 $35,600 $40,840 $29,200 Workforce) Affordable Rent $780 $890 $1,021 $1,230 Income Limit: 80% AMI (Low) $59,350 $47,500 $53,450 $59,350