Saturday, April 13, 2024

Can Rights Of First Refusal Help Lower The Cost Of Rental Housing?

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Efforts to promote affordable housing through legislation could be backfiring.


Rental apartment buildings are bought and sold regularly. To try to promote affordable housing, some jurisdictions have enacted legislation to give government authorities, nonprofit entities, or tenants to have a “right of first refusal” whenever a rental apartment building is about to trade. Rather than allow an evil capitalistic landlord to buy the building, a white knight could buy it instead for the same price and then keep the rents affordable.

This all sounds great. As a practical matter, however, nothing stops this or any other white knight from participating in the ordinary real estate investment sales process just like any other purchaser. If the white knight has the financial wherewithal to buy a building at its market price, then they can call a real estate investment sales broker just like any other purchaser. That broker will be delighted to tell the white knight about suitable properties that are on the market and just waiting for offers. A white knight can participate in any bidding process just like anyone else. If the white knight offers the highest price—even just a hundred dollars higher than the next bidder—it can buy whatever it wants.

Any such white knight may live to regret paying market value, because market value typically assumes market rents. If the white knight charges less than market rents, it may find it cannot successfully operate the building and cover its debt service, assuming use of ordinary debt financing. In response, the white knight owner will probably cut back on maintenance and capital projects except in emergencies, thus assuring the building will deteriorate over time. This is what happens in New York City Housing Authority buildings and in rent-regulated buildings. It reflects an apparent belief among progressive policymakers that if you own real estate, you just get money automatically and don’t have to think too much about anything else.

Of course, the white knight might make up for charging below-market rents by obtaining subsidies or contributions from governments (i.e., taxpayers, so it becomes just another form of income redistribution) or philanthropists. But those subsidies or contributions might better supplement rent payments by impoverished tenants who live in lower-quality buildings that don’t trade. It’s much simpler. It’s much less of a long-term financial burden.

Colorado’s legislature recently enacted some right of first refusal legislation that would burden sales of multifamily rental property. The legislation had notice requirements, waiting periods, and procedures so white knights could step in and match the negotiated market purchase price of rental apartment buildings. To his credit, Colorado governor Jared Polis vetoed it.

In his veto message, Polis said he supports the ability of local governments “to buy these properties on the open market”—exactly the point made above—but recognized that a mandatory right of first refusal would just add “costs and time to transactions.” He also worried about imposing further burdens, uncertainties, and delays on real estate transactions as a whole. He noted that the Colorado legislation was murky and ambiguous, leaving many questions unanswered. That’s typical in any right of first refusal, an arrangement that often leads to nasty and difficult litigation. Colorado was well advised to steer clear of the whole mess.

If rights of first refusal are not the panacea for unaffordable rental housing, what might work better? To put it bluntly: build more rental housing. States and cities from New York to California, including Colorado, ought to figure out how to make it easier, quicker, and cheaper for developers to build rental housing at all levels of the market. While those states and cities are thinking about rental housing, they also ought to get rid of rent regulation, which leads to overconsumption of—and underinvestment in—housing. Those two measures would before too long restore a functioning rental housing market.

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