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1 The Effects of Rent Stabilization and Vacancy Decontrol on Rents, Rental Property Values and Rent Burdens in Berkeley, California April 19, 2010 Jay Kelekian, Executive Director Stephen Barton, Ph.D., Project Manager Berkeley Rent Stabilization Board 2025 Milvia Street Berkeley, CA 94704 Tel: 510-981-RENT (7368) E-mail: [email protected]

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Page 1: The Effects of Rent Stabilization and Vacancy …...2010/04/19  · Rent stabilization protects tenants from rapid increases in rents while they remain in the same apartment, but vacancy

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The Effects of Rent Stabilization and Vacancy Decontrol

on Rents, Rental Property Values and Rent Burdens

in Berkeley, California

April 19, 2010

Jay Kelekian, Executive Director

Stephen Barton, Ph.D., Project Manager

Berkeley Rent Stabilization Board

2025 Milvia Street

Berkeley, CA 94704

Tel: 510-981-RENT (7368)

E-mail: [email protected]

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The Effects of Rent Stabilization and Vacancy Decontrol on Rents,

Rental Property Values and Rent Burdens in Berkeley, California

Contents Contents .......................................................................................................................................... 3 Summary ......................................................................................................................................... 4 Section 1: Overview of Rent Stabilization and the Rental Housing Stock ..................................... 6

The Rent Stabilization and Eviction for Good Cause Ordinance ........................................... 6 Rental Units Subject to Rent Stabilization.............................................................................. 7

Section 2. Berkeley Rents, 1978 to 2009 ...................................................................................... 11 Rent Levels in Berkeley, the Bay Area and the U.S. ............................................................ 11 Rent Increases Under Rent Stabilization in Berkeley, 1978 to 2009 .................................... 13

The Effects of Rent Stabilization on Tenancies Begun Prior to Vacancy Decontrol ........... 17

Effects of Rent Stabilization on Tenancies Begun After Vacancy Decontrol ...................... 18 The Overall Increase in Rents Resulting from Vacancy Decontrol ...................................... 21 Building Conditions and Maintenance .................................................................................. 21

Section 3: Berkeley Rental Property Values, 1978 to 2009.......................................................... 24 Sales Prices of Berkeley Rental Properties with Five or More Units ................................... 24 Comparison of Rental Property Sales Prices in Berkeley and Alameda County .................. 27

Trends in the Value of Multi-family Properties by Size ....................................................... 28 The Effect of Vacancy Decontrol on Property Values ......................................................... 29

The Effect of Vacancy Decontrol on City Tax Revenue ...................................................... 30 Price, Leverage and Risk ...................................................................................................... 31

Section 4: Fair Return and Low-Turnover Properties ................................................................... 34

Fair Return in Berkeley ......................................................................................................... 34

Effects of Tenant Turnover Rates on Rents .......................................................................... 37 Section 5: Changes in Rent Burden, 1980 – 2009 ....................................................................... 39

Bay Area Rent Burden, 1980 - 2008 ..................................................................................... 39

Berkeley Rent Burden, 1988 - 2009 ..................................................................................... 41 Section 6: The Economics of Rent Stabilization ......................................................................... 42

Section 7: Recommendations ........................................................................................................ 47 Appendix 1: Annual General Adjustments, 1981 - 2010 ............................................................. 49

Appendix 2: Numerical Tables for Figures .................................................................................. 50 Appendix 3: Vacancy Rate Data: Findings and Analysis ............................................................ 60 Appendix 4: Estimating Land Rent in the Bay Area Rental Housing Market .............................. 64

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Summary

A majority of the housing units in Berkeley are rented and tenants make up half of Berkeley's

household population. Berkeley’s rent stabilization program has jurisdiction over three-quarters

of Berkeley rental units, those built prior to 1980 in properties with two or more units. The

program normally registers about 19,000 units each year, and potentially covers another 2,000

rental units that are temporarily exempt, most often because those units are occupied by tenants

who receive rent subsidy. Nearly 2,800 rental property owners own registered units, but more

than half are owned by the 281 owners with 15 units or more. Nearly 4,000 units are occupied by

tenant households who have been in place since 1998, before the beginning of state-mandated

vacancy decontrol. The remaining 15,000 units have tenants who moved in after 1998 and began

their tenancy at market rent.

Rents in the Bay Area have consistently increased faster than rents in the rest of the U.S. and are

higher than any other major metropolitan area. Current rents in Berkeley are consistent with this

trend. According to the American Community Survey the 2008 median monthly rent was $676

for all U.S. metropolitan areas, while Berkeley rent registration records showed a 2008 median

rent of $1,100. In contrast, for the one fifth of rent stabilized units that have never received a

vacancy increase since vacancy decontrol began in 1999 the 2008 median rent was $679.

Rent control delivers major economic benefits to the rent stabilized tenants who have not moved

since 1999 when vacancy decontrol went into effect and delivers modest benefits to later tenants,

whose initial rent is set at market but whose subsequent rent increases are limited to 65% of the

increase in the Consumer Price Index (CPI). As a result of vacancy decontrol, investors in rental

housing receive approximately $100,000,000 a year more in rent than they would have if

Berkeley had continued its strong rent control system and this amount increases as the remaining

long-term rent controlled tenants move out. Rent stabilization has reduced rents for long-term

tenants by $27,000,000 annually and for post-decontrol tenants by as much as $10,000,000.

The average sales price per unit for Berkeley rental properties with five units or more built prior

to 1980 has gone from $53,000 for properties sold in 1998, just prior to full vacancy decontrol, to

$162,500 in 2009 and the price per square foot increased from $78 in 1998 to $192 in 2009. The

value of the 19,000 pre-1980 rental units in Berkeley has increased by over $1 billion as a result

of vacancy decontrol. Just over 70% of Berkeley’s rental properties are still under the same

ownership as in 1998, so most owners have enjoyed major increases in property values.

Maintenance in Berkeley properties has improved somewhat since vacancy decontrol, but there a

still a substantial number of properties where tenants report poor conditions and multiple

physical problems with their buildings.

There are around 600 units in properties, mostly with one to four units, that had little or no tenant

turnover since 1998. The annual rent increase formula of 65% of the increase in the Consumer

Price Index (CPI), which replaced annual cost studies in 2005, may not provide a sufficient rent

increase in these properties. Past Rent Board studies found that in Berkeley average rent

increases for most properties needed to roughly match the increase in the CPI, although their can

be substantial variation in the rents of particular units. Where there is regular tenant turnover, the

vacancy increases make up the necessary difference. For the exceptional cases where there is

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little or no turnover, the Rent Board should provide an expedited, low-cost procedure to allow

owners to request an increase in building rents to match the increase in the CPI.

In the Bay Area as a whole, rents have increased faster than both incomes and the cost of living,

and as a result the Bay Area’s low and moderate income tenants had less real income left after

paying rent in 2008 than tenants had in 1980. In post-vacancy decontrol Berkeley, rent takes an

increasing percentage of the income of Berkeley tenants. In 1998 41% of non-student tenants

spent more than Federal affordability standard of 30% of income for rent. This increased to 53%

in 2009 for non-student tenants who moved in after vacancy decontrol even though new tenants

have higher incomes. The rent burden did not change between 1998 and 2009 for the long-term

tenants whose rents were set prior to vacancy decontrol. Although its economic effects are

reduced, rent stabilization continues to protect tenants from displacement due to drastic increases

in rents such as occurred during the dot-com bubble.

The Bay Area housing market does not work the way markets are supposed to. Increases in rents

fail to generate sufficient additional housing production to hold rents down to levels that are

normal elsewhere in the U.S. As a result, Bay Area and Berkeley rents are based on scarcity and

the limits of what tenants can afford, rather than on the actual cost of operating and maintaining

the buildings. Rent stabilization protects tenants from rapid increases in rents while they remain

in the same apartment, but vacancy decontrol ensures that overall rents are at levels that are far

above the level necessary to actually operate and maintain rental housing. It remains an open

question what can be done to reduce the rent burden of low-income tenants.

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Section 1: Overview of Rent Stabilization and the Rental Housing Stock

The Rent Stabilization and Eviction for Good Cause Ordinance

Berkeley Municipal Code Section 13.76: “Rent Stabilization and Eviction for Good Cause

Ordinance” has two main components, as described in its title.1 Rent stabilization limits rent

increases for most tenants who live in properties with two or more units constructed prior to

1980, which is the year the ordinance went into effect. Good cause for eviction requirements

apply to all rental units, even those units exempt from rent stabilization, with the exception of

duplexes that were owner-occupied in 1979 and are owner-occupied currently.2

Rent stabilization in Berkeley began in 1978, when the voters passed a local initiative that

temporarily reduced rents, requiring landlords to pass through to tenants the majority of the

operating cost savings the landlords received from the property tax reductions resulting from

passage of Proposition 13. During the campaign for Proposition 13, proponents had claimed that

reduced costs to owners would result in lower rents. Since rents continued to increase after its

passage, tenant advocates in a number of cities including Berkeley successfully proposed

measures to require rent reductions. Then, in 1980, Berkeley voters passed the Rent Stabilization

and Eviction for Good Cause Ordinance, making rent controls permanent, requiring rent

registration and establishing a Rent Stabilization Board to implement the requirements of the

ordinance. In 1982, the voters passed a Charter Amendment establishing an elected Rent

Stabilization Board (Berkeley Charter, Article XVII, section 121). From 1980 through 1998

rents in units built prior to 1980 were controlled permanently, so that the rent did not change

when a tenant moved out and new tenants moved in.3

In 1995 the State of California passed new legislation denying local governments the power to

place units under permanent rent controls. From 1996 to 1998 there was a phase-in period in

which owners could rent vacant units for 15% more than the previous rent ceiling. Then as of

January 1, 1999, local governments could no longer limit the initial rent for new tenancies,

although they can limit subsequent rent increases on the tenants as long as they remain in the

unit.4 This system is usually called “vacancy decontrol” although it is really “vacancy decontrol

– recontrol.” The new law also permanently removed all single-unit properties from rent control,

including both single-family houses and condominiums, except for tenancies that began prior to

1999.

1 Berkeley Municipal Code, Chapter 13.76, et seq.

2 Eviction for good cause does not apply when a tenant does not rent a unit but rather shares one with the owner.

3 For a detailed history of Berkeley’s rent stabilization program and changes in the ordinance up to 1994, see

Planning & Development Department, City of Berkeley, Rent Control in the City of Berkeley: 1978 to 1994: A

Background Report, May 27, 1998. 4 California Civil Code sections 1954.50 through 1954.535

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In 2004 voters approved an amendment to the Rent Stabilization Ordinance to cease doing

annual cost studies and simply index the Annual General Adjustment to the rent at 65% of the

increase in the CPI-All Items.5

The major purpose of the Rent Stabilization and Eviction for Good Cause Ordinance is to

provide a stable housing environment for tenants while assuring that landlords are able to receive

a fair return on their investment. It assures tenants in rent-stabilized units that once they move in

their rents will not drastically increase, giving tenants a level of security similar to that of

homeowners who are protected from rapid cost increases by the state property tax limitation and

fixed-rate mortgages. In addition to annual rent increases (through the Annual General

Adjustment, or AGA), landlords can apply for individual rent adjustments if the increases they

receive through tenant turnover and the AGA are not sufficient to provide them with the legally

required fair rate of return. The ordinance also protects tenants from arbitrary evictions through a

system of eviction controls and twelve defined just causes for eviction. Good cause for eviction

requirements apply to virtually all rental units, including those built after 1980, condominiums

and single-family houses.

Rental Units Subject to Rent Stabilization

Berkeley currently has approximately 27,700 rental units.6 Virtually all of these rental units are

subject to Berkeley’s “good cause for eviction” ordinance. About 21,000 of them - about 75% of

Berkeley’s rental housing stock - are currently or potentially subject to rent stabilization.

The major categories of units not subject to rent stabilization are:

Units built after 1980. There are approximately 2,700 such rental units.

Single-family or condominium units. Currently there are only 144 tenants in one-unit

properties who moved in prior to 1999 and are still covered by rent stabilization.7 There

are approximately 4,000 exempt single unit rentals.

Rental units in two-unit properties which were owner-occupied on December 31, 1979 as

long as an owner occupies the other unit. These units are covered by the ordinance when

an owner does not occupy the other unit. Currently there are 270 such exempt units.8

5 The Rent Board and the Berkeley Property Owners Association jointly proposed this amendment in settlement of

litigation brought by the BPOA challenging the Rent Board’s practice of reducing increases for maintenance of net

operating income by the amount of past increases that were more than legally necessary. 6 The U.S. Census found that as of April 1, 2000 Berkeley had 46,875 housing units, of which 26,498 were either

rented or vacant and for rent. By the end of 2009 approximately 1,200 additional multifamily rental units were

completed, for a total of about 48,100 units and 27,700 rentals. The Census counts rented rooms as separate units if

they have direct access to public spaces, such as a hallway, leading to an exit. Otherwise they are considered group

quarters. According to the Housing Department, the Rental Housing Safety Program (RHSP) inventory includes

25,708 rental units and 3,011 rooms for rent. This inventory likely includes many rooms that the Census counts as

group quarters but likely also misses a number of rented single-family homes, which are often rented only

temporarily. 7 As of August 3, 2009.

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Units whose tenants receive rental assistance from the government through programs

such as the Section 8 Housing Choice Voucher Program or Shelter Plus Care are not

covered by rent stabilization as long as the landlord does not charge a rent above the

“payment standard” set by the Berkeley Housing Authority. Currently there are 1,426

such units. When occupied by a tenant who is not receiving rental assistance, these units

are subject to rent stabilization unless another reason for exemption applies.

Units in non-profit housing provided at below-market rents to low-income tenants are

exempt unless the occupant is an original tenant who moved in prior to the non-profit

organization taking ownership. Currently there are 114 such units.

A total of about 21,000 rental units are normally subject to rent stabilization.9 For the 2008-2009

fiscal year landlords paid registration fees for 19,050 units, indicating that they were subject to

rent stabilization. Another 1,810 units were reported exempt, either because they were occupied

by tenants receiving rental assistance or because they were in a 1979 owner-occupied duplex.

There are also as many as 1,000 units in multifamily properties that would be subject to rent

stabilization if they were rented out, but are currently owner-occupied or otherwise used by the

owner, occupied rent free, or vacant and not available for rent.10

This suggests that the maximum

potential coverage of Berkeley’s rent stabilization ordinance is around 22,000 units.

Physical Characteristics of the Rental Housing Stock

Berkeley’s rental housing stock is quite diverse, with about one-quarter in one- and two-unit

buildings, one-sixth in each of the following size categories: 3-4 unit buildings, 5-9 unit

buildings and 10-19 unit buildings, and one quarter in buildings with 20 or more units. Almost

all of the rental housing constructed since 2000 has been in buildings with 20 units or more.

Table 1 compares the 2000 Census data for rental units by the number of units in the building

with 2009 Rent Board data for rent-stabilized units and units temporarily exempt while occupied

by tenants receiving monthly rental assistance, mostly through the Section 8 Housing Choice

Voucher program. There are differences of definition to deal with, for example two duplexes on

8 As of August 3, 2009.

9 The registered and exempt units almost exactly match the 2000 Census data. According to the 2000 Census,

24,028 of Berkeley’s 25,748 occupied rental units were built prior to 1980. The Census also reports 750 units that

were vacant and for rent, but does not give a construction date for them. Assuming these are similar to the occupied

units, we can add another 700 rental units to the total built prior to 1980. Of this total of 24,728 rental units built

prior to 1980, the Census reports that 4,033 of these were in single-family houses, and all but 144 of these are now

permanently exempt due to tenant turnover since 1999. This leaves about 20,850 units subject to rent stabilization.

There are two offsetting sources of error in this estimate. The Census counts units in the structure, rather than units

on the property. Berkeley has a number of multi-unit properties with separate cottages, so single-family rental units

of this type are generally subject to rent control. In addition, some rental units in pre-1980 multi-family buildings are

not subject to rent control because they are condominiums. 10

According to the 2000 Census there are a total of 25,021 units in multifamily structures in Berkeley, of which

about 23,400 units were built prior to 1980. Of these, about 2,300 units were owner-occupied at the time of the 2000

Census. At least 1,000 of these owner-occupied units are condominiums and thus permanently exempt from rent

stabilization. Another 270 are in 1979 owner-occupied duplexes that are exempt as long as they are owner-occupied.

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one lot would count as two duplex rentals for the Census and one four-unit rental for the Rent

Board, but the broad trends are clear. Exempt rentals are concentrated in single-family units,

smaller multi-family properties where condominium conversion has been concentrated, and in

newly constructed larger properties.

Table 1: Renter-occupied units by units in structure

All 2000 Rentals by 2009 Registered Rentals by

Units in Structure Units in Property

1 unit 4,428 152

2 units 2,504 1,201

3 or 4 units 4,282 3,299

5 to 9 units 4,425 4,491

10 to 19 units 4,258 4,082

20 to 49 units 4,163 4,340

50 or more units 1,666 1,163

Total units 25,748 18,728

Sources for Table 1: U.S. Census Bureau, 2000 Census (does not include rentals built after April 1, 2000, all of

which are exempt from rent stabilization); Berkeley Rent Stabilization Program, August 25, 2009 (point in time data

gives several hundred fewer units than the total for registrations during a full year.) The 2000 Census is used

instead of the 2006-8 American Community Survey because there are major discrepancies between the Census and

ACS unit totals and the Census count methodology is more accurate than the ACS survey.

Table 2 shows the size of Berkeley’s rental housing by number of bedrooms. Exempt units are

fairly evenly distributed among zero, one and two-bedroom units, but make up more than half of

rental units with three or more bedrooms because many of the larger rental units are in single-

family houses that are exempt.

Table 2: Renter-occupied units by number of bedrooms

All Rentals Registered Rentals

Bedrooms in Unit

No bedroom 5,184 3,792

1 bedroom 10,532 7,890

2 bedrooms 7,371 5,677

3 bedrooms 1,945 873

4 or more bedrooms 716 293

Total units 25,748 18,525

Sources for Table 2: U.S. Census Bureau, 2000 Census (does not include rentals built after April 1, 2000); Berkeley

Rent Stabilization Program, August 25, 2009 . Point in time data gives several hundred fewer units than the total for

registrations during a full year. Several hundred units with missing data are excluded. Units with no bedrooms

include both studio apartments and rooms in a rooming house or residential hotel as long as the rooms have

independent access to hallways and entry areas.

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The distribution of ownership of registered rental units in Berkeley is very diverse, ranging from

a family that owns only one unit to a family that owns over a thousand units. Table 3 shows the

distribution of ownership by number of units owned as reported to the Rent Stabilization Board.

This table somewhat overstates ownership dispersal, because the Rent Board data do not take

into account situations in which one owner or a group of owners use different corporations or

partnerships. Two-thirds of the owners have from one to four registered units, but all together

they own only 22% of all the registered units. The ten percent of owners with 15 units or more

own over 50% of the registered units. The average number of registered units per owner is 6.7.

Table 3: Ownership by Number of Registered Rental Units11

Separate Owners Currently Registered Units

Total 2,792 18,732

Owners with 1-4 units 1,876 4,104

Owners with 5-14 units 635 5,170

Owners with 15-29 units 193 3,996

Owners with 30+ units 88 5,462

Owners with 1-14 units 2,511 9,274

Owners with 15+ units 281 9,458

11

The number of units owned does not include rental units exempt from registration, such as units rented to

tenants with Section 8 vouchers.

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Section 2. Berkeley Rents, 1978 to 2009

Rent Levels in Berkeley, the Bay Area and the U.S.

Rents in Berkeley, as in the Bay Area as a whole, are among the highest in the United States. The

major exception is units that have not received a vacancy decontrol increase.

Table 4: 2008 Contract Rent in 25 Largest Metropolitan Areas and Berkeley Area

Lower

quartile Median

Upper

quartile

San Jose-San Francisco-Oakland, CA CSA $882 $1,188 $1,623

Washington DC-Arlington, VA-MD-WV $850 $1,127 $1,484

San Diego-Carlsbad-San Marcos, CA $861 $1,126 $1,524

Alameda County, CA $828 $1,091 $1,438

Berkeley, CA $762 $1,069 $1,488

Los Angeles-Long Beach-Santa Ana, CA $790 $1,046 $1,420

Boston-Cambridge-Quincy, MA-NH $653 $983 $1,323

New York-N. New Jersey-Long Is., NY-NJ-PA $678 $956 $1,295

Riverside-San Bernardino-Ontario, CA $709 $950 $1,247

Miami-Fort Lauderdale-Pompano Beach, FL $702 $923 $1,219

Oakland, CA $694 $912 $1,204

Sacramento--Arden-Arcade--Roseville, CA $707 $892 $1,184

Seattle-Tacoma-Bellevue, WA $656 $839 $1,125

Baltimore-Towson, MD $601 $812 $1,094

Phoenix-Mesa-Scottsdale, AZ $607 $777 $1,015

Chicago-Naperville-Joliet, IL-IN-WI $602 $766 $978

Minneapolis-St. Paul-Bloomington, MN-WI $606 $761 $969

Philadelphia-Camden-Wilm., PA-NJ-DE-MD $561 $748 $960

Denver-Aurora, CO $578 $743 $979

Tampa-St. Petersburg-Clearwater, FL $588 $741 $948

Atlanta-Sandy Springs-Marietta, GA $588 $738 $905

Portland-Vancouver-Beaverton, OR-WA $596 $720 $913

Berkeley, CA -- pre-1999 tenancies $599 $679 $813

United States $466 $676 $965

Dallas-Fort Worth-Arlington, TX $531 $665 $848

Houston-Sugar Land-Baytown, TX $507 $638 $827

Detroit-Warren-Livonia, MI $497 $637 $810

Cincinnati-Middletown, OH-KY-IN $423 $549 $708

Pittsburgh, PA $362 $495 $643 Table 4 sources: U.S. Census Bureau American Community Survey 2006-2008 (ACS). Berkeley 2009 Tenant

Survey median for pre-1999 tenancies was $697, less the 2.7% AGA increase is $676. The U.S. median is at the

low end because it includes all U.S. metropolitan areas, not just the 25 largest shown in this table.

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The median Berkeley rent is slightly lower than that of Alameda County, but Berkeley rental

units are significantly smaller, with a median of 3.4 rooms each compared with 3.8 for Alameda

County and the Bay Area as a whole.

Figure 1 shows the long-term trend of San Francisco Bay Area and U.S. real rents.12

The term

“real” in this context means adjusted for inflation.13

When the other items people buy increase in

price faster than rents, then “real” rents go down and when rents increase faster than the other

items people buy, “real” rents go up.

Prior to 1959, changes in Bay Area rents closely tracked changes in rents nationally. Since then

Bay Area rents have increased while nationwide rents have remained largely stable. The Bay

Area real rent has also been more volatile, including the rapid rise and decline caused by the dot-

com bubble. Figure 1 shows that by 2008, Bay Area real rents had increased by nearly 170%

12

“Bay Area” statistics from the U.S. government are based on the San Jose-San Francisco-Oakland Consolidated

Statistical Area covering the eleven counties of Alameda, Contra Costa, Marin, Napa, San Francisco, San Benito,

San Mateo, Santa Clara, Santa Cruz, Solano and Sonoma. The nine-county area covered by the Association of Bay

Area Governments does not include Santa Cruz and San Benito Counties. 13

The CPI-Rent is adjusted by the CPI-All Items Less Shelter because increases in rents are included in the overall

CPI, with housing costs making up one-third of the total index. Using the CPI-All Items would place rents in both

the numerator and denominator of the adjustment and this circularity would minimize the actual increase. The

change in U.S. real rents is adjusted by the U.S. CPI-All Items Less Shelter and the Bay Area CPI-Rent is adjusted

by first the U.S. CPI-LS from 1935-76 and then the Bay Area CPI-LS for 1976-2008 because the Bureau of Labor

Statistics only provides the CPI-LS for the Bay Area since 1976 although it provides it nationally since 1935.

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over U.S. real rents, which is the main reason why the median Bay Area rent is 175% of the

median U.S. rent as shown in Table 4.

Rent Increases Under Rent Stabilization in Berkeley, 1978 to 2009

Figure 2 shows median Berkeley rents from 1978 to 2009. The line that starts in 1978 shows the

median rents under Berkeley’s rent stabilization system.14

The AGA figures in this and all

subsequent figures and tables underestimate the actual increases between 1980 and vacancy

decontrol in 1999 and illustrates the most restrictive possible situation. Diverging off from the

AGA line in 1996 is a line showing the rate of increase in the average rent of all controlled units,

including those that received a vacancy increase. Hovering above both lines is a line showing the

median vacancy rent for a one-bedroom apartment.15

14

This figure assumes that all increases after 1979 were only those allowed under the AGA, so all individual rent

adjustments (IRAs) are omitted, and it assumes that there was partial compliance between 1978 and 1980 prior to

rent registration so that rents on average were flat rather than reduced between 1978 and 1979 and increased by 5%

in 1980. The starting point is the median Berkeley rent of $223 reported in the 1980 Census. In some years the AGA

was a fixed dollar amount, so that units with rents below the median had a higher percentage increase and units with

rents above the median had a lower percentage increase. 15

Medians for all vacancy registrations are not available, but the one-bedroom rent is usually only slightly below

the median rent for all units since over half of Berkeley’s registered rental units are one-bedroom or less.

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The AGA line does not include the additional “utility allowance” increases for those units, about

a quarter of the total, in which the landlord pays for gas or electricity within the individual unit.

It also leaves out individual rent adjustments made for over 6,000 units to compensate owners for

“historically low rents”, capital improvements and various other purposes.16

The year 1991 is

shown twice in order to show the special increase for maintenance of net operating income that

was added to the normal AGA in that year pursuant to a court order.

Within the history of rent stabilization in Berkeley there are distinct periods with quite different

policies. From 1978 to 1980 there were a series of temporary ordinances. In 1978 voters passed

an initiative under which rents were supposed to be rolled back by 80% of the amount of the

decrease in property taxes, estimated to be approximately 7% of the rent for an average unit, with

increases allowed only for operating costs over and above the landlords’ 20% of the decrease in

property taxes. This was followed by another temporary rent ordinance which allowed a limited

rent increase of up to 5% in 1980 to cover increased operating expenses.17

At that time there was

no agency with the administrative capacity to systematically enforce the requirements of the

ordinances. Surveys conducted in 1979 and 1981 found widespread non-compliance and an

informal practice of vacancy decontrol during this period.18

Figure 3 follows this finding and

assumes partial compliance during this period averaging out to a rent freeze from 1978 to 1979,

rather than a roll-back of rents as required under the ordinance.

In 1980 a voter initiative established the Rent Board and a process for setting general and

individual rent increases and required landlords to register all rents. From 1980 to 1991 the

Annual General Adjustments (AGAs) increased by 61%, compared with the increase in the Bay

Area CPI of 72%. AGAs were based on an annual operating cost study and no increase was

provided for Net Operating Income (NOI). NOI increases were allowed at 40% of the rate of

inflation through an individual adjustment process. In 1990 the California courts ruled that this

did not provide owners with a fair rate of return because it was overly burdensome to expect

each owner to separately file for an individual rent adjustment to gain an increase for NOI and

the 40% of CPI formula was not adequately supported.

In 1990 the courts mandated that the Board provide an increase in AGA for maintenance of NOI

retroactive to 1979 in order to meet constitutional fair return standards. The year 1991 is entered

twice in Figure 3 in order to show the major increase that resulted. The Rent Board decided to

provide a retroactive NOI increase indexed at 100% of the CPI-Less Shelter going back to 1979.

The City Council sued on the grounds that the increase was excessive, presenting evidence that

NOI increases could reasonably be indexed at 50% of the increase in the CPI. This could provide

rental property owners with a fair return because most investors in rental property leverage their

investment by borrowing a substantial part of the purchase price of the property. For example, if

the owner’s mortgage payments take up half of the NOI, leaving the other half for cash flow,

16

Planning & Development Department, City of Berkeley, Rent Control in the City of Berkeley: 1978 to 1994: A

Background Report, May 27, 1998, p.148 indicates 6,326 IRAs made by 1993. 17

For a detailed discussion of the effect of Berkeley’s temporary rent ordinances see “The Temporary Ordinances:

June 1978 – May 1980”, pp. 139-142 in Planning & Development Department, City of Berkeley, Rent Control in the

City of Berkeley: 1978 to 1994: A Background Report, May 27, 1998, Appendix A. 18

Ibid.

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then an increase in NOI at 50% of the rate of increase in the CPI would increase the landlord’s

cash flow sufficiently to maintain its real, inflation-adjusted value.19

The courts ruled that the Board had substantial flexibility in choosing an appropriate percentage

increase and held that while the increase granted might or might not be good public policy, it was

within the discretion of the Board. After changes in its composition, the Board it changed its

regulations. A 1995 study determined that indexing NOI at 65% of the CPI-Less Shelter would

provide a fair return and meet constitutional requirements and the Board adopted this standard.20

From 1996 to 2005 the Board held annual AGA increases to the amount necessary to cover

increases in operating expenses and provided little or no increase for maintenance of NOI on the

grounds that previous increases had surpassed what was necessary under the new standard. By

2005 this process of absorbing the “excess” NOI increase was completed.21

In 2004, voters approved an amendment to the Rent Stabilization Ordinance to cease the annual

cost studies and simply index the Annual General Adjustment to the rent at 65% of the increase

in the CPI-All Items, beginning with the 2005 AGA. The Rent Board and the Berkeley Property

Owners Association jointly proposed this amendment in settlement of litigation brought by the

BPOA in opposition to the Board’s AGA policy.

Vacancy decontrol began in 1999 just as the dot-com bubble took off in the Bay Area. Market

rents in Berkeley and throughout the Bay Area increased dramatically, reaching a peak in 2001.

Rents declined somewhat between 2001 and 2004, then began to rise again. As shown in Figure

3, median Berkeley rents continued to increase as long-term tenants gradually moved out and

new tenants moved in at market rate. Despite the recession of 2008-2009, Berkeley vacancy rents

in the first half of 2009 were virtually unchanged from the first half of 2008 and then declined by

3% in the third quarter of 2009 compared with the third quarter of 2008. 22

Bay Area rents

stabilized in 2009 at a level 3% higher than the average for 2008.23

Figure 3 compares the rate of increase in Berkeley rents with the increase in the Bay Area

Consumer Price Index since 1978. Each indicator starts at 100 in 1978 so that all increases refer

back to that starting point.

19

The clearest and most comprehensive analysis of fair return standards is Kenneth K. Baar, “Guidelines for

Drafting Rent Control Laws: Lessons of a Decade”, Rutgers Law Review, V.35,No.4, Summer 1983, pp.723-885. 20

Kenneth K. Baar, “Issues and Options for Rent Increase Standards Under Berkeley’s Rent Stabilization

Ordinance”, October 26, 1995. 21

Memorandum dated October 18, 2004 from Jay Kelekian, Executive Director, to Members of the Rent

Stabilization Board, “2005 Annual General Adjustment”, pp.4-5. 22

Berkeley Rent Board, “Market Medians: January 1999 through June 2009”, September 18, 2009. 23

Bureau of Labor Statistics, Consumer Price Index – All Urban Consumers, Rent of Primary Residence. San

Francisco-Oakland-San Jose.

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Figure 3 shows that during the strong rent control period, and for long-term tenancies where an

owner has never received a vacancy increase, Berkeley’s rent control system has usually held

rent increases to somewhat below the increase in the consumer price index. (Berkeley’s AGAs

increased rents at roughly the same rate as the CPI-Less Shelter.) After vacancy decontrol,

however, overall rents in units subject to rent stabilization increased far above the cumulative

increases in the CPI. The current median Berkeley rent is 155% of what it would have been if

rents had been indexed to the CPI. In other words, more than one third of the current median rent

is due to vacancy decontrol.

Figure 4 shows that Berkeley rents have increased even more than Bay Area rents over all.

During the period from 1978 to 2009, median registered rents in Berkeley have increased by

438% while Bay Area rents increased by 377% as measured by the residential rent component of

the Consumer Price Index.

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The Effects of Rent Stabilization on Tenancies Begun Prior to Vacancy Decontrol

The economic effects of rent stabilization vary depending on when the current tenancy began.

They are most substantial for units with long-term tenants that have been in place since 1998

because that means the unit’s rent has been under continuous control since 1980.24

The total

number of registered units with tenancies that began prior to January 1, 1999 is around 4,000,

which is 21% of all registered units and 15% of all rental units in the City.25

In order to estimate the total rent discount provided to long-term tenants we can compare the

mean rent of $745 reported in the 2009 tenant survey for pre-vacancy decontrol tenancies with

the mean rent of $1,301 that the survey reported for post-vacancy decontrol non-student

24

The figures for long-term tenancies include an unknown but very small number of units with more recent

tenancies where the landlord was not allowed to charge a market rent because of the circumstances under which the

former tenant left the unit. 25

Currently there are about 4,000 units that have not registered a vacancy increase with the Rent Board since

1999 when vacancy decontrol began. In the Rent Board’s 2009 tenant survey 15% of the units where the Rent Board

had no record of a vacancy rent increase the tenant reported that they had moved in after January 1999. In some

cases the landlord may have been denied a vacancy increase due to the circumstances under which the previous

tenant left the unit. There may also be some misclassified units, so the total may be anywhere from 3,600 to 4,200.

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tenancies. This removes the student tenancies, which tend to be located in different areas and

have higher rents. Applying this difference of $556 monthly, $6,672 annually, to 4,000 units

results in an estimated total discount of $26,700,000.

Effects of Rent Stabilization on Tenancies Begun After Vacancy Decontrol

The economic effects of rent stabilization on any particular housing unit in Berkeley largely

depend on when the current tenancy began. Table 5 shows the rate at which units turned over

after full vacancy decontrol began on January 1, 1999.

Table 5: First-Time Vacancy Registrations, 1999 to 2008

Year

1st Time

VRs

Units Turning Over

with Pre-1999 Tenants

As % of All Units

Total Units

with VRs

% of All

Units With

No VR

Registered

Units

1999 3,668 19.1% 3,668 80.9% 19,169

2000 3,226 16.7% 6,894 64.3% 19,290

2001 1,549 8.1% 8,443 56.1% 19,236

2002 1,613 8.5% 10,056 47.2% 19,029

2003 1,246 6.6% 11,302 39.7% 18,758

2004 861 4.6% 12,163 34.8% 18,652

2005 630 3.4% 12,793 30.5% 18,418

2006 617 3.3% 13,410 27.6% 18,534

2007 494 2.7% 13,904 25.0% 18,545

2008 610 3.2% 14,514 22.8% 18,798 Source: Berkeley Rent Stabilization Board. Note that the total registered units each year is a point in time figure

which varies depending on how many owners miss registration payments each year.

The simultaneous arrival in 1999 of vacancy decontrol and the dot.com boom created a

particularly dramatic difference between the rents of tenants who moved in before and after

January 1, 1999. When the dot-com boom collapsed, Bay Area rents stabilized for several years,

and Berkeley rents have only recently risen above the 2001 level. As a result, when people

discuss rent stabilization in Berkeley, they often refer to the units occupied by pre-1999 tenants

as “rent-controlled units,” and describe more recent tenancies as “market rate units,” lumping

units that have received a vacancy increase since 1999 with exempt units. This shorthand way of

describing the Berkeley rental market obscures the more complex reality and the benefits that

rent stabilization provides to more recent tenants.

Figure 5 illustrates the economic effects of rent stabilization depending on when a tenancy

began. One solid line shows the rent ceiling of a long-term tenant who has been in a one-

bedroom apartment since 1998, prior to vacancy decontrol, starting with the median one-

bedroom rent in 1998. Another solid line shows the median vacancy rent reported to the Rent

Board for newly rented one-bedroom units starting in 1999 when vacancy decontrol began.

Dotted lines show the rent ceilings for these one-bedroom units in subsequent years under rent

stabilization and how they vary depending on the year the tenant moved in. (Under Berkeley’s

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current rent stabilization system, after a tenant moves in no rent increase is allowed for the first

full calendar year after move-in, so that if a tenancy began in June 2006, the first AGA was

allowed on January 1, 2008 rather than 2007.)

Figure 5 illustrates the modest but real economic benefits that rent stabilization provides to the

majority of tenants who moved in at market rents after vacancy decontrol but who still receive

protection from rising rents. The 2009 Tenant Survey found that about 43% of all tenancies

began between 1999 and 2007, and most of these have directly benefited financially from rent

stabilization to some degree. Tenancies that began in 1999 were shielded from rising rents and

displacement caused by the dot-com bubble, and tenancies that began after the bubble collapsed

have been shielded from subsequent increases. Only those who moved in at the top of the market

in 2001 have as yet received no economic benefit from rent stabilization.26

The most recent

tenants, the approximately 38% who moved in during 2008 and 2009, have not been in place

long enough for rent stabilization to have a direct financial effect, but they benefit from good

cause for eviction and the knowledge that their future rents will remain stable.

26

When market rents decline, a tenant may ask for and receive a rent reduction from the landlord but this does not

change the rent ceiling, which is based on the actual rent charged during the first year. In subsequent years the rent

can be raised to the ceiling at any time with 30 or 60 days advance notice to the tenant.

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The pattern shown in Figure 5 for tenancies since 1999 is characteristic of a rent stabilization

system. Tenants are protected against displacement by rapid rent increases and, as with

homeowners, are rewarded economically for remaining in one place. The stability and security

provided by the combination of rent stabilization and good cause for eviction is also very

important to many tenants, but this is not something that is readily given a dollar value. For the

community, residential stability is generally correlated with civic involvement, such as

participation in neighborhood watch and disaster preparedness groups and voting. Encouraging

such stability may be all the more important in a city with a large student population that results

in unusually rapid turnover in many neighborhoods, but again such benefits are impossible to

quantify with dollar values.

Table 6 shows the difference between the median 2009 vacancy rent for a one-bedroom

apartment and the 2009 rent ceiling for a tenant who moved in under each year’s median vacancy

rents from 1999 to 2008.27

The difference in monthly rent represents the potential savings that

rent stabilization provides tenants. The difference ranges from 0% to 14% and averages 5% of

the 2009 vacancy rent, an average of $800 annually. The difference for tenants in two-bedroom

units ranges from 0% to 16% and averages 7% of the 2008 vacancy rent, an average of $1,400

annually. Applying the move-in dates reported from the 2009 tenant survey, we can project that

the total economic benefit to them from rent stabilization is approximately $10.5 million a year

even under vacancy decontrol. We cannot say that the entire tenure discount is created by rent

stabilization, however. Even without rent regulation many landlords hold down increases for

tenants who remain in place, since changing tenancies creates costs and uncertainties.28

Table 6: 2009 Rent Stabilization Savings to Tenants

(Median One-Bedroom Unit)

Move-in Year Move-in (Market) Rent

2009 Rent Ceiling (Move-in Rent plus AGAs)

Savings over 2009 Market Rent

1999 $950 $1,097 14%

2000 $1,100 $1,252 2%

2001 $1,200 $1,329 0%

2002 $1,150 $1,274 0%

2003 $1,100 $1,204 6%

2004 $1,050 $1,139 11%

2005 $1,095 $1,179 8%

2006 $1,100 $1,155 9%

2007 $1,200 $1,232 3%

2008 $1,275 $1,275 0%

2009 $1,275 $1,275 0%

27

The 2009 rent is for the January through September period. Rent Stabilization Board, “Market Medians:

January 1999 through September 2009”, December 11, 2009. 28

W.A.V.Clark and Allan D. Heskin, “The Impact of Rent Control on Tenure Discounts and Residential

Mobility”, Land Economics, 58:1 (February 1982) 109-117. Clark and Heskin found rent discounts for tenants in

Los Angeles prior to passage of rent stabilization in 1979, with the discount becoming substantially higher under

rent stabilization, particularly for long-term tenants.

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The Overall Increase in Rents Resulting from Vacancy Decontrol

The cost of vacancy decontrol to tenants and its benefit to landlords is currently about $100

million annually and this amount increases each year, as more units receive vacancy increases

and as rents increase faster than vacancy rent regulation would have allowed.

This estimate is based on a comparison of current rents with those that would have been allowed

under a strong rent control system in which rents increased at the same rate as the increase in the

consumer price index since 1978. In 1980 the Census reported the mean Berkeley contract rent

was $245. Based on Figure 2 and the associated table in the appendix, we estimate that the 1978

rent was 5% lower. Indexing this rent to the CPI starting in 1978 the current mean rent would be

$808. Comparing that to the current mean contract rent of $1,252 yields a differential of $444

monthly and $5,328 annually that applies to 19,000 registered rental units. This results in an

estimate of $101 million in increased rent annually, with the current annual rent amounting to

$285 million annually and the hypothetical annual rent under continued strong rent control

amounting to $184 million.

Table 7 compares current median market rents with median rents as they would have been

without vacancy decontrol.29

This is likely somewhat of an overestimate, since as previously

mentioned vacancy rents are skewed towards higher rent areas.

Table 7: Median 2009 Rents for Tenancies Starting Prior to 1999 and in 2009

Median 2009 Rent With Jan.-Sept. 2009

Unit size No Vacancy Decontrol Median Vacancy Rent Difference

Studio $657 $975 $318

1 BR $774 $1,275 $501

2 BR $959 $1,765 $806

3 BR $1,317 $2,450 $1,133

All Units $797 NA NA

Building Conditions and Maintenance

Some of the increased revenue from vacancy decontrol is clearly being spent on improved

maintenance. However there are still a substantial number of properties where tenants report

unresponsive owners or managers and units in poor condition, despite major rent increases.

29

1998 median rents are updated with subsequent AGAs to 2004 followed by a 100% of CPI adjustment instead of

the 65% of CPI adjustment formula because without vacancy decontrol AGAs would have continued to approximate

the increase in CPI. This increases the hypothetical controlled rent by 3.8% over the rent that results from the

current formula.

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In the 2009 tenant survey, 75% of respondents reported that there is a physical problem in their

building. The most frequently listed were “doors or windows” at 38%, “plumbing” at 30% and

“mold” at 26% and “heat” at 18%. In addition, 25% reported problems with “noise or other

tenants”. This is a very substantial set of building problems. Nonetheless, it is slightly better

than in 1998, when 83% reported having one or more problems in their building. In addition, the

number of problems in each building has declined from an average of 3.5 per building with

problems to 2.4 per building with problems.

Table 8: Problems Reported in Building, 2009 and 1998

2009 1998 Decrease

Doors/Windows 38% 45% -7%

Plumbing 30% 37% -7%

Mold/Mildew 26% 46% -20%

Paint 19% 38% -19%

Heat 18% 27% -9%

Security/Lighting 16% 36% -20%

Secure Mailboxes 16% NA NA

Appliances 15% 24% -9%

Roof 9% 20% -11%

Stairs/Porch 9% 16% -5%

Elevator 6% NA NA

Since three-quarters of the respondents reported physical problems in their building, it is not

surprising that 76% of tenants have complained to the landlord or building manager at some time

during the previous year. Among those with complaints, 70% reported that the owner or manager

responded quickly, 26% said that they responded after repeated complaints, and 12% reported

that there was a complaint that the owner or manager did not respond to. Two-thirds (65%)

reported getting a problem fixed in less than 30 days and another 12% got the problem fixed in

more than 30 days. One third reported a problem either only partially fixed or not fixed,

including 19% reporting a problem was not fixed. (These figures add up to more than 100%

because respondents could pick more than one type of response and more than one type of

outcome.) The proportion describing their unit as being in poor condition (8%) is not much

changed from 9% in 1998 and 11% in 1988.

The substantial number of buildings with unresolved problems cannot be explained by the

remaining pre-vacancy decontrol tenancies. The 2009 tenant survey did not find clear differences

in reported unit conditions and building problems between pre- and post-vacancy decontrol

tenants. Pre-vacancy decontrol tenants are somewhat more likely to describe their unit as being

in “fair” rather than “good” condition, but they are somewhat less likely to report physical

problems with their building. The only substantial difference between the two groups is that 30%

of pre-vacancy decontrol tenants report problems with paint compared with 17% of post-vacancy

decontrol tenants.

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Section 3: Berkeley Rental Property Values, 1978 to 2009

Sales Prices of Berkeley Rental Properties with Five or More Units

Rental property values are closely tied to rent levels. Since smaller multifamily properties with

2-4 units can also be in the homeownership market, we will focus on properties with five units or

more. Figure 6 shows the trend in Berkeley’s rental property values for the 32 years from 1977 to

2009.30

The solid line shows the average sales price per unit, and the dotted line shows how the

1978 price would have increased if it went up with the consumer price index, meaning that the

“real” inflation-adjusted price remained the same. There are two distinct periods, first the strong

rent control period from 1980 to 1998 in which property values increased at roughly the same

rate as the consumer price index, going from $16,150 to $52,950 per unit, and second, the post-

vacancy decontrol period from 1999 to 2009 in which values have increased more rapidly, from

$52,950 to $162,500 per unit.

30

Alameda County property records, accessed through RealQuest. Data from this source is extremely limited or

non-existent prior to 1977. Transactions were removed when they involved properties built since 1980, sales of

fractional interests, or where the property records hold internally contradictory data. The number and mix of

transactions varies from year to year. During the recession of 1981-82 there were very few property sales as well as

reduced prices.

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Figure 7 shows that property values have generally changed with changes in rents. It compares

the rate of increase in the average sales price per square foot of Berkeley properties with five

units or more built prior to 1980, the rate of increase in median rents for rent-stabilized units and

the rate of increase in median one-bedroom vacancy rents since vacancy decontrol began in

1999.31

From 1978 to 1998, just prior to vacancy decontrol, changes in Berkeley’s multifamily

property values per square foot closely tracked both changes in Berkeley’s rent levels and the

increase in the consumer price index. From 1978 to 1998 the average price per square foot went

from $31.49 to $78.44, matching the 157% increase in the CPI during the same period. In other

words, the “real” inflation-adjusted price of Berkeley rental property remained about the same

from 1978 to 1998.32

31

The initial index number for vacancy rents is based on the ratio between the median for all rents and the median

one-bedroom vacancy rent in 1999. No median is available for all vacancy registrations, but with two-thirds of all

vacancy registrations occuring in units with one bedroom or less, the one-bedroom median only slightly

underestimates the overall vacancy median. In addition, vacancies occur at a higher rate in the areas near the U.C.

Berkeley Campus that serve a predominantly student population and have somewhat higher than average rents, so a

modest underestimate is likely to better represent the rental market as a whole. 32

A study by Michael St. John covering 1970 to 1988 found much the same thing for the early period of strong

rent control. He indicates that the “real” inflation adjusted sales price per square foot of Berkeley rental property

with 5+ units had been stable during most of the 1970s, began to rise in 1978-79 and then returned to the prior “real”

values in the 1980s. Michael St. John, “The Impact of Rent Controls on Property Value”, Working Paper No. 90-

178, Center for Real Estate and Urban Economics, U. of California at Berkeley, May 1990, p.18.

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From 1998 to 2008 the CPI increased by 36% but property values tripled, reaching $230 a square

foot and $166,500 per unit. Just under 30% of Berkeley’s pre-1980 rental properties with five

units or more have sold since 1999, meaning that 70% of these properties remain under the same

ownership and these owners have enjoyed extraordinary increases in property values.33

The rapid increases in sales prices from 1999 to 2002 reflected investor expectations that there

would be major future rent increases, since vacancy decontrol allowed rents to increase to market

rate as tenants moved, and the dot-com bubble created unusually rapid increases in market rents.

From 2003 to 2008, however, the property sales prices increases were greater than could be

explained by either actual or reasonably anticipated future rent increases. Instead, they reflected

declining interest rates and the unrealistic expectations of the housing bubble. The Federal

Reserve lowered interest rates to keep the economy from falling into a recession when the stock

market collapsed at the end of the dot-com bubble and these low interest rates helped create a

housing price bubble. Lower mortgage interest rates lowered the cost of borrowing to purchase

real estate and lower interest rates lowered the rate of return from bonds, which raised the value

of alternative investments in rental property that promised a steady or increasing net operating

income (NOI). Increases in property values resulting from the increased value to investors of

each dollar of NOI are reflected in changes in the capitalization rate, which means the NOI

divided by the sales price. Capitalization rates or “cap rates” measure the initial rate of return

that the NOI provides an investor paying a given sales price to purchase the property.

Figure 8 shows average capitalization rates for rental property sold in Berkeley from 1990 to

2009.34

33

Alameda County property data accessed through RealQuest listed 1,311 multi-family properties with five+ units

built prior to 1980, of which 384 had been sold during the period between January 1999 and December 2009. 34

CoStar Group, “City of Berkeley Apartment Sales, 5 units & greater, 1/1/1990 – 10/13/2009.

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The financial crisis and recession that began in 2008 slowed property sales, made financing more

difficult and reduced prices. Capitalization rates rose in 2009 to 6.6%. The average price for

properties built prior to 1980 with five units or more fell to $192 per square foot and $162,500

per unit, levels that are more in line with median market rents. There were some sales in 2009

that were for less than the previous buyer had paid only a few years earlier.

Comparison of Rental Property Sales Prices in Berkeley and Alameda County

Berkeley rental property sales prices have been higher than those for Alameda County as a

whole. CoStar Group, a major commercial real estate information company, maintains a database

on property sales that goes back to 1990 and includes Berkeley and Alameda County.

Figure 9 compares the median price per square foot for sales of residential rental properties with

five units or more in Alameda County and in Berkeley, with the Berkeley prices limited to

properties built prior to 1980 in order to show any potential effects of rent stabilization. Price

data for 2009 is for the first half of the year.

During the strong rent control period, prior to the retroactive increase for maintenance of NOI in

1991, Berkeley prices were lower than those for Alameda County as a whole. After the

maintenance of NOI increase Berkeley prices were virtually identical to those for the county as a

whole until vacancy decontrol began. From 1998 on, Berkeley prices have been higher than

those for all of Alameda County.

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Trends in the Value of Multi-family Properties by Size

Figure 10 shows the changes in average multifamily property values from 1978 to 2009 for

properties with 5 units or more, 4 units and 2 units.35

Two-unit properties are partly in the homeownership market and partly in the rental market, with

the result that the average price per square foot is substantially higher than in properties with 5 or

more units, which are almost exclusively rental properties. Two-unit properties are also much

more responsive to increases in prices in the homeownership market, as is shown in the increase

in the price of two-unit properties in the late 1980s and during the housing bubble that began in

the Bay Area with the “dot-com” boom in 1998 and declined after 2006.

The prices for four-unit properties were generally similar to those for properties with five or

more units from 1978 to 1986 and from 1991 to 1997. In 1986 - 1991 and 1997 – 2003 they were

somewhat higher priced than properties with five units or more. The late 1980s was a period of

rising home prices in which there was extensive conversion of small rental properties to

35

Alameda County property records, through RealQuest.

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homeownership through tenancy in common (TICs).36

During the five year period from 2004 –

2008, the height of the housing bubble, prices rose rapidly to levels that can only be explained by

people investing in four-unit properties to use them for owner-occupancy or sell them to owner-

occupants. (Conversion to owner-occupancy can be done through conversion to condominiums,

sale of tenancies in common or converting a property that was originally a single-family home

back from four units to the original one.) The financial crisis took full effect in 2009. As home

prices declined and unconventional financing became more difficult to find, four-unit property

values returned to the level of other rental properties.

The prices of properties with five units or more increased slowly until 1998 when both vacancy

decontrol and the “dot-com” bubble began. After 1999 prices rose rapidly and then, in 2009, fell

back to the level of prices in 2003. Differences between 5-9 unit properties and those with 10

units or more were minor so we simply show all those with five units or more together.

The Effect of Vacancy Decontrol on Property Values

Given the general tendency for trends in multifamily property values to follow trends in rents, we

can estimate the effect of vacancy decontrol on property values. We compare current values with

the expected values if Berkeley had a system of strong rent controls that indexed rents to the rate

of inflation. If prices since 1998 had continued to follow the increase in the CPI, as they did from

1978 to 1998, then as shown in Figure 6, by 2009 they would have reached only $83,000 per unit

rather than $162,500 and $111 a square foot rather than 2009’s $192.

We can produce a very conservative estimate of the total value of all 19,000 rent stabilized units

by simply applying these average prices and ignoring the greater value of many 2 – 4 unit

properties. On a per unit basis the total value of all of these units is approximately $3.1 billion,

with $1.5 billion added by vacancy decontrol.

Making an estimate based on average per square foot prices is more complex. The RealQuest

compilation of Alameda County data indicates that there are nearly 11 million square feet of

multifamily residential property in Berkeley in 15,425 units in properties with 5 or more units for

an average size of just over 700 square feet. This would yield an average per unit value of

$135,000 under vacancy decontrol and $78,000 under strong rent control. Applied to all 19,000

units this results in an estimate of current total value of $2.6 billion, increased by $1.1 billion by

vacancy decontrol. The discrepancy between per unit and per square foot values may indicate

that the properties sold in the base year 1978 tended to be smaller than average or that those sold

in 2009 tended to be somewhat larger or it may simply reflect the limits of the data that is kept

by the Alameda County for tax purposes.

We have estimated a total annual rent roll of $285 million in registered units. Applying an

average NOI of 60% and a capitalization rate of 6.6% results in an estimated total current value

of $2.6 billion. The estimated rent roll for a hypothetical strong rent control system was $184

million. Applying an average NOI of 50% and a capitalization rate of 6.6% results in an

36

Michael St. John, “The Impact of Rent Controls on Property Value”, Working Paper No. 90-178, Center for

Real Estate and Urban Economics, University of California at Berkeley, May 1990, pp.25-29.

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estimated total value of $1.4 billion. This suggests that vacancy decontrol has increased property

values by $1.2 billion, within the range of $1.1 to $1.5 billion in the previous estimates.

The Effect of Vacancy Decontrol on City Tax Revenue

The increased rents and sales prices of property generate increased tax revenue for the City of

Berkeley through the property tax, real property transfer tax and the business license tax and

decreased revenue through the sales tax.

Real Property Transfer Tax

Over the past eleven years since vacancy decontrol nearly 30% of Berkeley’s rental properties

were sold, a rate just under 3% annually. Based on the 1.5% transfer tax rate and the estimate

that rental property values have increased by from $1.2 billion, the increased annual tax revenue

would currently average around $450,000.

Business License Tax on Gross Rent

The tax rate is 1.08% so based on the estimated annual rent increase of $100 million, annual tax

revenue should have increased by $1,080,000. (Assumes full compliance. The Auditor has been

finding significant underpayment.)

Property Tax

The basic property tax rate is 1%. If all properties were reassessed at new, higher values, that

would increase overall County property tax by $12 million a year. However, so far about 30% of

multi-family rental properties with five units or more have been sold since vacancy decontrol,

and many of those were sold at prices below current market values. We estimate that so far

County tax revenues have increased by $2,250,000, of which 32.5% or $730,000 goes to the

City. The remainder goes to the Berkeley Unified School District, the Peralta Community

College District, Alameda County and other special purpose districts.

Sales Tax

Berkeley receives 1% of the sales tax collected here. All tenants live in Berkeley and many do

not have cars and spend most of their money in Berkeley, so the maximum possible decrease in

sales tax revenue would be $1 million. Not all money going to increased rent would be spent on

taxable items in Berkeley however. In addition, while the majority of investors in rental property

live outside of Berkeley a substantial minority live in Berkeley. A more plausible guestimate

would be a $300,000 reduction in sales tax revenue. In addition, there is an unknown loss of

business license tax from retail businesses due to the reduced sales.

Total

Overall, vacancy decontrol has likely increased tax payments to local governments in Alameda

County by about $3.5 million annually, including an increase in City of Berkeley revenues of

nearly $2 million annually. This does not take into account costs that the City or County may

incur due to increased financial hardship to tenants.

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Price, Leverage and Risk

The value of rental property, whether in Berkeley or anywhere else in the U.S., is based on its net

operating income (NOI), which is the flow of income that an investment in that property

provides the investor after paying the operating expenses. The average NOI reported for

properties sold during the past 10 years in Berkeley is 62% and for Alameda County is 61%.37

Typically there are two investors in a rental property, an owner and a mortgage lender. The

mortgage holder receives payments from the NOI first and the loan is secured by the right to

foreclose on the mortgage and take over ownership if these payments are not made. In return for

this greater security, the mortgage lender accepts a limited return with either a fixed or variable

interest rate. Owners can profit from an investment in rental property in four ways: The owners

gain equity as the value of the property increases, they gain equity as any mortgage used to help

purchase the property is amortized; the owners gain positive cash flow from the NOI (less

investment costs such as mortgage repayment) and the depreciation allowance provides the

owners with tax savings that increase their after-tax cash flow. All of these depend on NOI.

Investors may use shortcuts such as a gross rent multiplier, but prudent investors will use such

shortcuts only to screen properties for further investigation.

Investors have to choose how much of the purchase price they want to pay with their own money

and how much they want to borrow. If the investor purchases the property using only his or her

own money, then the investor receives the entirety of the NOI as positive cash flow as well as

getting an equity gain to the extent that the property increases in value at the time of sale. The

more the investor borrows, the greater the “leverage,” which means that the potential rate of

return on investment is higher because the investor uses less of his or her own money and still

gets all the equity gain from increased property values. In addition, capital gains from increased

property values are generally taxed at a lower rate than corporate or personal income from

positive cash flow.

Highly leveraged investments have higher risk for the investor. First, they put most of the NOI

into repaying a mortgage. This reduces the investor’s cash flow and creates a risk of foreclosure

if the investor is unable to keep up the payments due to an increase in expenses or a decline in

rents. Second, more of the investor’s return on investment depends on increased property values,

which depend not only on increased NOI but also on capitalization rates, which usually track

interest rates and can change unpredictably from year to year. The present value of any

particular property will vary depending on the current and expected future NOI and interest rates.

The value of the property increases with the perceived likelihood that NOI will increase in the

future. The value of the property also increases if the current and expected rates of return for

alternative safe investments such as government bonds are expected to decrease or remain low.

37

CoStar, “City of Berkeley Apartment Sales, 5 Units & Greater, 1/1/1990 – 10/13/2009, built 1979 & older”.

CoStar, “Alameda County, Apartment Sales, 5 Units & Greater, 1/1/1990 – 10/13/2009”.

IREM Institute of Real Estate Management, "Income/Expense Analysis: Conventional Apartments", 2008

reports a median NOI of 62% in 2007for garden apartment buildings in the Oakland metropolitan area.

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As the property turns over, each buyer pays the seller the capitalized value of the NOI and

possibly also of some of the future increases that the buyer expects will take place. Normal

mortgage financing will use up to 80% of the NOI for mortgage payments and reduce the new

owner’s cash flow to a modest level. Similarly, as longer-term investors refinance to take out

accumulated equity they also take on mortgage obligations that reduce cash flow to a modest

level. Many things may not go as the investor anticipated: increases in rents may not be as fast

as expected; operating and maintenance costs may be higher than expected; interest rates may

increase on a variable rate mortgage, among other possibilities. These further reduced cash flow

and create an incentive for the owner to reduce maintenance in an effort to recapture their

investment.

The market for investments is generally biased in favor of increased risk. When an investor in

rental housing decides to sell, the property is sold to the highest bidder. That is another way of

saying that the property is sold to the bidder who makes the most optimistic assumptions about

future rents, operating, maintenance and renovation costs, net operating income and interest

rates. It is not uncommon for buildings to be purchased for prices that are based on mistaken

expectations about future rent increases rather than on current rents. The Federal and State tax

systems reinforce this bias towards risk by taxing capital gains at lower rates than income. To the

extent that investment in rental property is highly leveraged and based on expectations of

substantial future increases in net operating income the investment becomes more speculative

and carries serious risks for the community as well as for the investor.

There is excellent evidence for this phenomenon in a survey of landlords in Los Angeles,

conducted in November 2007 through February 2008. During the 2000s, rents in Los Angeles

rose at an exceptional pace by national standards. The median contract rent went from $612 in

2000 to $933 in 2008.38

Yet only 28% of apartment owners reported making a profit in the

previous year. Fully one-third of respondents reported a loss in the previous year, another quarter

reported that they only broke even and another 14% did not know how they did.39

The majority

of Los Angeles landlords who purchased their properties prior to 2000, before the housing

bubble, reported that their property was profitable, while the vast majority of those who

purchased after 1999 reported that their property was not profitable.40

In the L.A. study 23% of

landlords reported that they were postponing maintenance on major problems rather than

handling them as quickly as possible, and an equal proportion reported that they were postponing

maintenance on minor problems.41

So despite rent increases of over 50% in only a few years,

many landlords in Los Angeles are running negative cash flows due to the size of the mortgages

they have taken on in order to purchase the properties or in order to take out equity from their

increased property values and now they are failing to properly maintain their properties.

How much the current owner profits from Berkeley’s increasing rents and property values

depends on when they bought the property, how much they paid for it, how they financed the

purchase, how long they hold it and whether rents and property values increase at the expected

38

U.S. Census Bureau. 2000 Census and 2006-8 American Community Survey. 39

Economic Roundtable, Economic Study of the Rent Stabilization Ordinance (RSO) and the Los Angeles Housing

Market, Los Angeles, 2009, pp. 195-196. 40

Ibid, p.199. 41

Ibid, p.192.

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rate. Approximately 30% of Berkeley rental properties with five units or more were purchased

since 1999, during the series of housing-related economic bubbles, and an unknown number

have refinanced.

The revenue side of most investment in Berkeley’s rental property is not very risky as long as

owners do not overestimate the rate of future increases. The presence of the University of

California at Berkeley guarantees high demand for housing within walking and bicycling

distance from Campus, an area encompassing the majority of Berkeley’s rental units, and the

University’s investment in seismic reinforcement of its buildings ensures that even in the event

of a major earthquake the University will be back in operation in a fairly short period of time.

Competition to meet this demand is limited. The city’s relatively high densities mean that

increases in supply in supply within the city can only be made in an already built-up area where

the cost of constructing additional housing will be high. Overly high expectations for future

increases, however, may have negative effects on building maintenance, especially if rents level

off or even decline for a few years as a result of the current recession.

There are also risks in projecting future costs, especially with buildings that require seismic

reinforcement or where major building systems are coming to the end of their useful life and

need major renovations or where other requirements, such as energy efficiency, are strengthened.

Recommendations:

The City should investigate measures to reduce the adverse impacts of the speculative element of

investment in rental property in Berkeley. Such measures might include requirements that take

effect when a rental property is transferred or refinanced:

Mandatory code inspection prior to or no more than 30 days after the time of sale or

refinance and all code violations cleared.

Energy efficiency inspection prior to or within 30 days of the time of sale or refinance and

must meet required standards (possibly as set by RECO, CECO).

Soft story buildings fully retrofit to meet a life-safety standard within one year of transfer.

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Section 4: Fair Return and Low-Turnover Properties

Fair Return in Berkeley

Rent control systems must provide for increases in the legal rent ceiling that allow sufficient

increases in Net Operating Income (NOI) so that the owner receives a “fair return” on investment

and the return is not gradually reduced by inflation. (The analysis of a fair return applies to a

property as a whole, not to individual units within a property, and there can be considerable

variation in allowable rents among different units as long as the property as a whole provides a

fair return.) NOI increases may be set at less than a full inflation adjustment, because a normal

amount of leveraging will still allow an owner to maintain their current level of profitability. The

following example illustrates this point.

Table 9: Example of the Effects of Leverage on Cash Flow Under Rent Control

Base Year Current Year Increase over Base Year

Consumer Price Index 100 125 25%

Gross Rental Income $10,000 $12,000 20%

Operating Expenses -$4,000 -$5,000 25%

Net Operating Income $6,000 $7,000 17%

Debt Service Payments -2,000 -2,000 0%

Cash Flow $4,000 $5,000 25%

Table 9 simulates the effect of a rent control annual increase formula that set the allowable

increase at 80% of the increase in the Consumer Price Index in a property with no turnover

among its tenants. With a CPI increase of 25%, rents increase by 20%. With operating expenses

assumed to increase by the rate of inflation, 25%, the NOI increases by only 17%. Although this

is an increase in total dollars, it is a decline in real inflation-adjusted dollars to the equivalent of

$5,600 in base year dollars. As a proportion of rental income NOI declines from 60% to 58%.

Yet the owners’ cash flow increases by 25%, the same as the increase in the CPI, because the

debt service payments were fixed. This example uses a very conservative level of debt service,

since lenders will typically allow debt service to reach 70% of the NOI. If, for example, the debt

service payments were $4,000 and the initial cash flow $2,000, then the increase in cash flow

would be 50%, double the rate of the CPI. This does not take into account the additional profit

resulting from amortization of the mortgage and the tax savings from the depreciation allowance.

Table 10 shows the same example, but using an AGA set at 65% of the CPI. In this hypothetical

case, the increase in cash flow does not keep up with inflation, although it could with a higher

degree of leveraging or if some tenants moved during the year so that vacancy increases raised

total rental income.

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Table 10: Example of the Effects of Leverage on Cash Flow with 65% of CPI AGA

Base Year Current Year Increase over Base Year

Consumer Price Index 100 125 25%

Gross Rental Income $10,000 $11,625 16%

Operating Expenses $4,000 $5,000 25%

Net Operating Income $6,000 $6,625 10%

Debt Service Payments -2,000 -2,000 0 %

Cash Flow $4,000 $4,625 16%

We have previously seen that the average NOI in Berkeley is likely around 60%, which means

that operating expenses constitute the other 40% of the rent. The Rent Board has established an

NOI adjustment of 65% of CPI as sufficient to ensure that most owners are able to maintain a

fair rate of return on their investment.42

If we apply this standard to the 60% of the rent that goes

to NOI, then a rent increase of 39% of the increase in the CPI is necessary to provide the NOI

adjustment (.65X.6=.39). Operating expenses are the other 40% of the rent, and there is a

“historical tendency for apartment operating costs to track the general rate of inflation.”43

If

operating expenses increase at the same rate as the CPI, then a rent increase of 40% of the

increase in the CPI is necessary to meet that increase. In total, then, the annual rent increase

called for in this example will be 79% of the CPI.

The best available historical evidence on actual changes in operating costs is from a combination

of the annual cost studies carried out for the Berkeley Rent Board, which provide limited

information but are specifically about Berkeley, and the annual apartment operating cost surveys

published by the Institute of Real Estate Management, which provides more comprehensive data

on operating costs for the broader Oakland metropolitan area.

In Berkeley annual operating cost studies were done from 1980 to 2004 for purposes of setting

the AGAs from 1981 to 2005. The 1980 and 1981 studies were very preliminary, but we have a

series of comparable studies covering changes in operating costs for the 23-year period from

1981 to 2004. These studies provided the basis for AGAs from 1982 to 2005. These studies

assume a property in which the annual rent increases for all units have been limited to the AGA,

ignoring any vacancy increases that have occurred since 1999. The studies are based on the

actual changes in the cost of taxes, fees and utilities, but not on actual changes in the costs of

management, maintenance or insurance. Instead they assume that these later three expense

categories increase with inflation.

The 1982 study was re-examined and modified slightly in 1991, and we will use the modified

version as the baseline for comparison with the 2004 study to look at changes in operating

42

Based on Kenneth K. Baar, “Issues and Options for Rent Increase Standards Under Berkeley’s Rent

Stabilization Ordinance”, October 26, 1995. 43

Hamilton, Rabinovitz & Alschuler, The 1994 Los Angeles Rental Housing Study: Technical Report on Issues

and Policy Options, December 1994, p.245. Prepared for the Los Angeles Rent Stabilization Board.

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expenses over time.44

(This analysis looks only at individually metered units in which the tenant

pays for gas and electricity used within the unit and the owner pays gas and electricity only for

common areas, the predominant format in Berkeley.) During this period the Bay Area CPI

increased by 119%, and according to the studies operating expenses increased by 197% (a “real”

inflation-adjusted increase of 36%) By far the largest source of these increases was local

government efforts to deal with the loss of property tax revenue due to Proposition 13 by

establishing local parcel taxes.

Table 11: Changes in Berkeley Operating Expenses, 1981 to 2004

1981 2004

Median Rent $234 $602

Operating Expenses $103 $306

OE as percent of Rent 44.1% 50.8%

The Rent Board’s annual cost studies simply assumed that the costs of management,

maintenance and insurance would increase at the same rate as the CPI and there is no source of

data on these costs specifically for Berkeley. However the Institute of Real Estate Management

of the National Association of Realtors (IREM) publishes an annual report for the United States

and major metropolitan areas based on an annual membership survey, and this provides data on

the Oakland area as well as on the U.S. as a whole. The IREM data comes primarily from large

apartment complexes with an average of over 100 units, so its specific cost findings are not

directly applicable to most of the Berkeley market, but it does provide information on trends in

operating costs in the East Bay. IREM has used a consistent methodology from 1985 to the

present.45

Table 12: Changes in Oakland Area Cost of Administration, Maintenance & Insurance as

Reported by IREM Members

1985 2006 Increase

Admin., Maint. & Ins. $1.79 $2.81 57%

Bay Area CPI Index 108.4 209.2 93% Source: U.S. Bureau of Labor Statistics; Institute of Real Estate Management of the National Association of

Realtors, Income/Expense Analysis: Conventional Apartments, IREM, Chicago, 1986 and 2007 editions.

44

Hamilton, Rabinovitz & Alschuler, “Inflation Indexing in Berkeley Rent Regulation in the Aftermath of the

Searle Decision”, August 19, 1991, pp.22-26. Prepared for the Berkeley Rent Stabilization Board.

Kenneth K. Baar, “Apartment Operating Cost Increases in Berkeley: Analysis for the 2005 Annual General

Adjustment” presented to the Berkeley Rent Stabilization Board, October 18, 2004. 45

Institute of Real Estate Management of the National Association of Realtors, Income/Expense Analysis:

Conventional Apartments, IREM, Chicago, 1986 and 2007.

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As shown in Table 12, the IREM surveys indicate that from 1985 to 2006 the cost of

administration, maintenance and insurance in the Oakland area increased at only 81% of the rate

of increase in the CPI. Nationally they increased by 91% of the CPI. This suggests that the

presumption that these costs increase at the same rate as the CPI is somewhat conservative and

may result in overestimating the actual increase in operating expenses.

The 2004 Berkeley cost study estimates that in the average property that has never received a

vacancy increase the operating expenses and NOI each make up half of the rent. If the NOI

maintenance standard is that it must increase by 65% of the rate of increase in the CPI, then an

increase in the rent of 32.5% of the CPI increase is necessary for maintenance of NOI, since NOI

is half of the rent. If operating expenses increase by 135% of the rate of the CPI, then a rent

increase of 67.5% of the increase in the CPI is necessary to cover increased operating costs. The

two add up to rent increase of 100% of the CPI.

Berkeley’s annual cost studies from 1981 to 2004 found that rent increases roughly equal to the

increase in the CPI-All Items have been necessary to compensate for increases in operating costs

and provide an adequate increase in NOI in order to provide a fair return in buildings without

tenant turnover or under strong rent control where units do not decontrol on vacancy.46

Past

history does not mean the future will follow the same pattern, but over all we can say that the

AGAs from 1980 to 2005 clearly met constitutional fair return standards and that they provided

rent increases roughly equal to the increase in the CPI-All Items during that period.

Effects of Tenant Turnover Rates on Rents

Berkeley’s rent stabilization system is required to ensure that owners receive a fair return on

their investment. Properties subject to rent stabilization will be affected differently based on a

combination of the rate of turnover among their tenants and the number of exempt units.

Properties where all units either have turned over since 1998 or are rented to tenants in the

Section 8 program will have rents that are at or close to current market levels and have received

rent increases well above the U.S. average. Properties where all tenants have been in place

continuously since prior to January 1, 1999 have received the Annual General Adjustments,

which until 2005 were based on annual cost studies to ensure a fair return. Many properties have

a mixture of both long-term and post-vacancy decontrol tenancies.

As of September 2009, 78% of registered rental units had reported a new tenancy since January

1, 1999, nearly 11 years ago, while 22% had not. Vacancy increases are not evenly spread out

among all Berkeley rental properties. They are more frequent in the areas close to the UC

Berkeley campus, where the student population is most concentrated. Larger properties generally

have substantial turnover, partly because more of them are located near campus and partly

because with more units each property is more likely to have an experience that reflects average

turnover rates.

46

By 2005 the Rent Board’s consultant reported that “excess” NOI increase that resulted from adjusting NOI by

100% of CPI in 1991 rather than 65% of CPI had been almost entirely eliminated by reductions in subsequent

annual increases. Memorandum dated October 18, 2004 from Jay Kelekian, Executive Director, to Members of the

Rent Stabilization Board, “2005 Annual General Adjustment”, pp.4-5.

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According to the currently available information, there are 271 units in 186 properties where no

unit has received a vacancy increase. These are mostly in small properties, including 98 single-

family or condominium units, another 98 units in 49 two-unit properties and 75 units in

properties with three units or more.

There are another 472 units that have not received a vacancy increase in 59 properties where at

least one other unit has turned over, but where at least two-thirds of the units have not received a

vacancy increase.

In total, then, there are 643 units in 245 properties, less than 4% of all registered rental units,

where two-thirds or more of the units are not reported to have received any vacancy increase.

The current AGA formula, in effect since 2005, sets annual rent increases for sitting tenants at

65% of the increase in the Bay Area Consumer Price Index for All Urban Consumers during the

June to June period of the previous year. During the period from June 2005 to June 2009 the Bay

Area CPI-All Items increased by 12.3%, so that under the formula, AGAs as of January 2010

have increased rent ceilings by 8.0%. This means that in those properties where all or nearly all

tenancies began prior to 1999 the increases have been 4.3% less than the increase in the CPI.

This will not be a problem in buildings where there has been turnover. The average rent in

Berkeley's rent stabilized units overall increased by 18% between 2005 and 2008, well above the

rate of inflation.

In buildings where there is little or no turnover the disparity will increase over time and may be

problematic for some owners. This could lead to petitions for individual rent adjustments based

on net operating income that would require an administratively burdensome level of analysis for

the Rent Board as well as additional costs for the owner. The administrative costs to both the

Rent Board and the owner could be reduced by creating an expedited Individual Rent

Adjustment process that simply assumes the historical rate of cost increases and allows increases

in the rent ceilings sufficient to increase the property’s total rent by the increase in the CPI since

2005.

Recommendation

Provide an expedited Individual Rent Adjustment process that allows increases in the rent

ceiling for properties where the aggregate AGAs for all units in the property have not provided a

rent adjustment that matches the increase in the Bay Area CPI-All Items.

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Section 5: Changes in Rent Burden, 1980 – 2009

Bay Area Rent Burden, 1980 - 2008

The Bay Area’s extraordinary rent increases have had major consequences for the quality of life

available to most low-income. Fully 25% of Bay Area tenants, and virtually all very low-income

tenants who do not receive rent subsidies or live in non-profit housing, pay half or more of their

income for rent.47

Figure 11 shows the incomes of tenants at the 25th

percentile, the lowest-

income quarter of all tenants, and shows how much of that income would be required to rent a

unit at the 25th

percentile, the lowest quarter of all rents.48

The figure first compares incomes and

rents for low-income tenants in 2008 with 1980, just after Berkeley, San Francisco, San Jose and

Oakland instituted rent stabilization. It then shows what the Bay Area tenant income after rent

would be if rent increases had been held to the increase in the Consumer Price Index so that the

“real” rent did not increase.

47

2006-2008 American Community Survey 3-Year Estimates, Gross Rent as a Percentage of Household Income. 48

Sources: 1980 Census, 2006-2008 American Community Survey, Bureau of Labor Statistics, author’s

calculations. (1980 census data provides rent for 1980 and income for 1979. Both are adjusted to 2008 using the

CPI-Less Shelter, since the purpose of the exercise is to measure buying power left after paying rent.)

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Not only have real incomes gone down for these tenants, real rents have increased so much that

in 2008 this group of tenants has one-third less money left after paying rent than they had in

1980. The percentage of income that a tenant at the 25th

percentile in income would have to pay

for a unit whose rent was at the 25th

percentile went up from 28% in 1980 to 48% in 2008.

Figure 12 shows that incomes have gone up since 1980 for median-income tenants, but increased

rents have eaten up the entirety of the increase.49

The amount of income required for the median

tenant to rent the median unit has increased from 20% in 1980 to 30% in 2008.

49

Source: 1980 Census, 2006-2008 American Community Survey, Bureau of Labor Statistics, author’s

calculations. (1980 census data provides rent for 1980 and income for 1979. Both are adjusted to 2008 using the

CPI-Less Shelter, since the purpose of the exercise is to measure buying power left after paying rent.)

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Berkeley Rent Burden, 1988 - 2009

Determining the effect of rising rent on tenants in Berkeley requires taking into account the

city’s large student population. The Rent Board commissioned surveys of tenants in rent

stabilized units in 1988, 1998 and 2009 in which non-student households’ incomes and rent

burdens are analyzed separately, so we can use this to track the rent burdens of the non-student

households over time. In 1988 the median rent burden for non-student households was 22%.

This increased to 25% in 1998 and it remains at that level for pre-vacancy decontrol tenants, but

for more recent non-student tenants the median rent burden is now 32%.

Table 13: Rent Burden of Non-Student Households: 1988, 1998, 2009

Survey Year 1988 1998 2009

All Pre-1999 Post-1998

Up to 30% income 71% 59% 50% 58% 47%

More than 30% 29% 41% 50% 42% 53%

More than 50% 14% 20% 26% 21% 28%

In 2009 26% of all non-student tenant households reported that they are severely rent burdened,

paying over 50% of their income for rent and utilities. In comparison, in 1998 20% paid over

50% of income for rent and only 14% in 1988. This means approximately 3,400 non-student

households were severely rent burdened.

Looking separately at pre- and post-vacancy decontrol tenants we find that among post-vacancy

decontrol non-student households the median rent burden is 32%, with 53% of households

paying over the Federal affordability standard of 30% of income for rent and utilities. Twenty-

eight percent paid over 50% of their income in gross rent. This projects out to a total of 5,000

rent burdened households in this group, including about 2,650 households that are severely rent

burdened.

Overall, the situation in Berkeley is not very different from that in the Bay Area as a whole, but

it is significantly better for long-term tenants. For pre-vacancy decontrol tenancies the median

rent burden is 25%, with 58% paying no more than 30% of income for rent and utilities and 42%

paying over 30%. One fifth (21%) pay over 50% of income in gross rent. There are

approximately 3,500 pre-vacancy decontrol tenancies in Berkeley, so this indicates that

approximately 1,500 households are overpaying for rent despite the benefits of continued strong

rent controls, and about 750 are severely overpaying. The rent burden of these long-term non-

student tenants remains basically the same as it was for all tenants in 1998.

If rent controls were eliminated the rents of long-term tenants would be increased by at least

50%. Such a rent increase would raise the median rent burden for this group to 36% of income.

The proportion of households paying over 30% of income for rent would increase to 59%, with

more than half of those (36%) paying over 50% of income for rent.

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Section 6: The Economics of Rent Stabilization

Berkeley’s Rent Stabilization and Eviction for Good Cause Ordinance states that “The purposes

of this chapter are to regulate residential rent increases in the city of Berkeley and to protect

tenants from unwarranted rent increases and arbitrary, discriminatory, or retaliatory evictions, in

order to help maintain the diversity of the Berkeley community and to ensure compliance with

legal obligations relating to the rental of housing. This legislation is designed to address the City

of Berkeley's housing crisis, preserve the public peace, health and safety, and advance the

housing policies of the city with regard to low and fixed income persons, minorities, students,

handicapped, and the aged. “

In order to properly implement the ordinance, the Rent Board has defined when rent increases

are “unwarranted” through its implementing regulations. These regulations that start with 1980

base rents and then allow rent increases to cover increases in operating costs and, where

renovations require a significant capital investment, increases to cover both the costs of the

renovations and a reasonable interest rate on the investment, as well as increases for net

operating income set at 65% of the increase in the consumer price index. As we have seen, this

formula would generally have allowed rents to increase at roughly the same rate as the consumer

price index over the past thirty years since rent stabilization began in Berkeley.

Opponents of rent control argue that rent controls are inherently destructive because any

reduction in market rent will result in a corresponding decrease in the quality and quantity of

rental housing. Yet we saw in Table 4 that rents are substantially lower in most U.S.

metropolitan areas than they are in the Bay Area and these areas continue to produce and

maintain decent quality rental housing. Portland is a thriving city and metropolitan area where

the median rent is 61% of the median rent in the San Francisco Bay Area. How is it that

landlords in Portland are able to profitably operate and maintain rental housing whose quality

seems quite comparable to rental housing in the Bay Area while charging rents that are

comparable to what Berkeley rents would have been under strong rent control?

The critics of rent control assume an ideal market. In a completely open and competitive market,

competition among the producers of goods and services holds housing costs to the minimum

feasible level and provides its own stringent price controls. Under ideal conditions, if demand

increases, then the price will increase, but only for a short period of time. Higher prices result in

higher profits that bring in additional investment in production of housing and this increases the

supply. The increased supply increases competition among sellers and brings the price back

down. In this ideal housing market all prices are either at the minimum necessary to provide a

desired good or service or will be reduced to that minimum soon. If prices in this fully

competitive market are reduced by regulation, then the reduction in profitability will lead to a

reduced supply as producers shift their investments to other more profitable opportunities and the

reduction in cost will result in inefficient allocation of units as consumers lucky enough to obtain

housing at below market rate stay in apartments that they would otherwise leave and make

available to other tenants. This is the standard economic critique of rent control.

In the real world, however, many markets have substantial and durable barriers to competition

that allow businesses to raise prices and extract unearned “windfall” profits from consumers over

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a long period of time. This is why there is public regulation of the prices charged by private

companies that distribute electricity, gas and water, for example, and it is one of the major

reasons for rent regulation. Rental housing is not a “natural” monopoly, the way distribution of

gas or electricity is, but even though there are many separate owners of residential rental

property there are significant barriers to adequate competition in many rental housing markets.

Production of new rental housing is a separate business from operation and maintenance of

existing rental housing and rental housing production requires land that is suitably located and

zoned for construction of multi-family housing.

In a fully competitive housing market production of housing can easily be increased because

sites to build on are readily available and the cost of the land is minimal. In many successful

urban areas, however, there are physical constraints resulting from the density of the built

environment that make it more difficult to find suitable sites and more costly to build on those

sites. Land use regulations also add to the difficulty of finding sites on which to build more

housing, especially multi-family housing in the already developed areas. And much of the land

near the central Bay Area is occupied by water or steep slopes that make it very difficult to build

housing.

In addition, housing is a product that requires a major up-front investment, another similarity to

utilities. Once the costs of construction are paid, usually over a significant period of time (the

standard amortization period for tax purposes is 27.5 years) the cost of operating and maintaining

the housing is greatly reduced. If an urban area has long-term stability in population and

household formation this will likely result in an adequate supply of older housing that will be

affordable to many renters with below-average incomes. However, where population and

household formation increase faster than increases in multi-family housing production, then the

scarcity of older housing drives up rents to levels closer to the cost of new rental housing. As a

result of these two factors, scarcity of sites for development and mismatch between past rates of

housing production and current need, housing in many economically successful urban areas has

prices far greater than would be charged in a fully competitive market.50

This revenue over and above the economically necessary costs of producing, operating and

maintaining the housing plus a reasonable return on the investment is what economists call

“economic rent”, meaning revenue that is over and above what is necessary to support

production of a good or service. Economic rent is not earned through production but rather is

unearned revenue from ownership of a needed commodity, such as places to live, in a setting

where demand is higher than supply. This is typical of successful urban areas in coastal settings

where the limited supply of additional developable land limits competition. Economic rent in the

housing market is typically called land rent, because payments over and above those necessary to

operate and maintain the building are attributed to the land or location.

The San Francisco Bay Area has high demand driven by a successful knowledge-based

economy, major investments in education, transportation and other public services and the high

50

For an overview of various types of market failures in the rental housing market ,including the historical

mismatch issue, see Andrejz Skaburskis and Michael B. Teitz, “The Economics of Rent Regulation”, pp.41-60 in W.

Dennis Keating, Michael B. Teitz and Andrejs Skaburskis (editors), Rent Control: Regulation and the Rental

Housing Market, Center for Urban Policy Research, Rutgers, New Brunswick, N.J., 1998.

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quality of its regional environment and culture. It has extreme constraints on increased housing

supply in its central core and due to the combination of geographical constraints from the ocean,

the Bay and the hills, density constraints in its central core due to the high costs of in-fill

development at higher densities, and regulatory constraints on development of multi-family

housing, particularly in the outlying suburbs. For the past fifty years the amount of new rental

housing built has fallen far short of the quantity necessary to hold down rents. As a result, Bay

Area rents are far above the level necessary in order to operate and maintain rental property,

which is what rents would be in a genuinely competitive market. The Bay Area median rent is

75% higher than that for all U.S. metropolitan areas and 65% higher than the Portland, Oregon

area. About one-third of the aggregate rent paid in the Bay Area is over and above the necessary

cost of operating and maintaining the buildings. (For a detailed analysis see Appendix 4:

Estimating Land Rent in the Bay Area Rental Housing Market). Rents here are limited less by

competition and more by the limits of what tenants can manage to pay.

The presence of land rent or economic rent has major implications for the economics of different

housing policies. Prof. Lee Friedman, at the University of California’s Goldman School of Public

Policy, has demonstrated that in the presence of substantial land rent, the economic models of the

effects of rent controls become indeterminate and “perfect rent control could, in theory, affect

only economic rents and cause no supply inefficiency even in the long run”. 51

The Berkeley

Rent Board’s definition of an “unwarranted” rent increase is basically an increase in “economic

rent” or “land rent”, while allowing increases in rent that are necessary for the maintenance and

operation of the building itself plus a reasonable profit on operating the building. Mayer and

Olsen have argued that well-designed rent controls could improve maintenance and the Berkeley

Rent Board’s regulations allowing increases for maintenance costs and decreases for reductions

in service due to inadequate maintenance follow the pattern that they recommend.52

If we measure a “fair rent” and a “fair return on investment” by the rents and rate of return that a

housing market would provide under conditions of perfect competition, the evidence shows that

prior to the imposition of vacancy decontrol by the State of California Berkeley’s rent control

system had evolved, after lengthy court battles and often bitter political conflicts, into a system

that for the most part provided fair rents to tenants and a fair return on investment to owners.

Investors in rental property would have received a fair return on their investment in Berkeley

even if strong rent control had continued to the present day because the controlled rent level

would provide investors with the same rental income they would receive in a genuinely

competitive rental housing market.

Today, Berkeley’s rent stabilization program provides most tenants with valuable stability and

somewhat lower rents if they stay in place for more than a year or two. Together with “eviction

for good cause” it reduces the displacement caused by rent increases that are not justified by

51

Lee S. Friedman, The Microeconomics of Public Policy Analysis, Princeton University Press, 2002, p.537.

Friedman provides an excellent overview of the economics of rent controls in areas with substantial land rents in

Chapter 13, “The Control of Prices to Achieve Equity in Specific Markets”. 52

Mayer, Neil S. (1984) “Conserving Rental Housing: A Policy Analysis”, Journal of the American Planning

Association, 50:311-325.

Olsen, Edgar O. (1988). “What Do Economists Know About the Effect of Rent Control on Housing Maintenance”,

Journal of Real Estate Finance and Economics, 1:295-307.

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actual increases in costs or quality of services. The ordinance successfully meets its goal of

reducing arbitrary evictions and it prevents unwarranted rent increases for tenants after they have

moved into a unit. The state requirement of decontrol on vacancy means that the Rent Board

cannot prevent unwarranted rent increases on units at the time tenants move in. As a result, only

a diminishing number of very long-term tenants are shielded from overall rents that are well

above the levels that would otherwise be considered “warranted” by the ordinance and

implementing regulations.

Residential land in Berkeley is valuable in part due to major public investments such as the

University of California, the East Bay Regional Park District, the freeways and BART and in

part due to the efforts of all those who live and work in Berkeley and give the city its character as

a center for learning and creativity. Berkeley is the home or workplace of many people who

contribute greatly to the community even though they do not make much money and do not own

their own homes. They work as attendants to people with disabilities, they work for small non-

profit service and advocacy organizations, they work in restaurants and stores, they do research

and write books that don’t make the best seller list and they do many other things that make

Berkeley a great place to be. Together the public at large and the Berkeley community make the

city a desirable place to live and work, and the result of making it desirable is that land values in

Berkeley increase and rents and home prices go up. For those who already own real estate this

often works out well, but for those who don’t it creates a cruel irony. Their own contributions to

this community make it harder for them to afford to live here.

Berkeley’s Rent Board is on record supporting a change in state law to give back to local

governments the power to regulate rents on a continuous basis could allow Berkeley restart

strong rent control again at current rent levels and prevent drastic future increases in rents. There

are many intermediate possibilities between the full vacancy control system Berkeley had in

1995 and the current modest vacancy decontrol-recontrol system that State law allows today.

Limited vacancy increases such as those allowed during the three years prior to full vacancy

decontrol provide one example.

However, restoration of vacancy control could not roll back current rent levels. Rent controls

must take into account the legitimate investment expectations of investors in rental property, who

in many cases have only recently purchased the property and paid much of the profit from

increased land values to the previous owners. That is why rent controls must start with the

current or a recent year as the base year, rather than rolling back rents to a previous level. It

would take at least a generation for stronger rent controls to roll back land rents in any Bay Area

city to a significant degree. Furthermore, tenants have no constitutionally protected rights to the

benefits of rent control and strong rent controls are vulnerable to the political process. No strong

rent control system other than New York City’s has survived over an extended period.

It remains an open question what can and should be done to reduce the excessive rent burdens of

most low-income tenants in Berkeley and the Bay Area.

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Recommendation

The Rent Board should sponsor or cosponsor an affordable housing workshop or conference to

examine a range of approaches to improving maintenance, energy efficiency and seismic safety,

and making housing more affordable to low-income tenants. This should include consideration

of ways to generate additional funding for housing that is under alternative forms of ownership

such as land trusts, limited-equity cooperatives and non-profit housing corporations.

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Section 7: Recommendations

I. The City should investigate measures to reduce the adverse impacts of the speculative

element in investment in rental property in Berkeley.

Such measures could include requirements that take effect when a rental property is

transferred or refinanced, such as:

Mandatory code inspection prior to or no more than 30 days after the time of sale or

refinance and all code violations cleared.

Energy efficiency inspection prior to or within 30 days of the time of sale or refinance

and must meet required standards (possibly as set by RECO, CECO).

Soft story buildings fully retrofit to meet a life-safety standard within one year of

transfer.

II. The Rent Board should provide an expedited Individual Rent Adjustment process that

allows increases in the rent ceiling for properties where the aggregate AGAs for all units

in the property have not provided a rent adjustment that matches the increase in the Bay

Area CPI-All Items.

III. The Rent Board should sponsor or cosponsor an affordable housing workshop or

conference to examine a range of approaches to improving maintenance, energy

efficiency and seismic safety, and making housing more affordable to low-income

tenants. This should include consideration of ways to generate additional funding for

housing that is under alternative forms of ownership such as land trusts, limited-equity

cooperatives and non-profit housing corporations.

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Appendices

1. AGAs: 1981 - 2009

2. Numerical tables for all Figures

3. Vacancy Rate Data: Findings and Analysis

4. Estimating Land Rent in the Bay Area Rental Housing Market

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Appendix 1: Annual General Adjustments, 1981 - 2010

1981: 5% OR 6.2% if owner paid for space heating

1982: 9% plus, if the owner paid for gas and electricity, including space heating, the

following additional increases were authorized: $4 for studio; $7 for 1-bedroom; $9 for 2-

bedroom; $10 for 3-bedroom; $12 for 4-bedroom; $16 for house with 3+ bedrooms.

Rental property owners who deferred the 1982 rent increase are entitled to a banking

bonus of an additional 1% for each year of deferral.

1983: 4.75% OR 5% if owner paid for electricity or gas

1984: 0%

1985: 2%

1986: 3% plus $2.50 per month

1987: 3.5%

1988: $25.00 per month OR $15.00 per month for residential hotels

1989: 3% OR 3.5% if owner paid for gas, electricity, or heating within the unit

1990: $16.00 per month

1991: 4% or $17.00 per month, whichever is higher

1991: 1991 Inflation Adjustment Order--45% of the 5/31/80 rent

1992: $26.00 per month

1993: $20.00 per month

1994: $18.00 per month

1995: 1.5%

1996: 1%

1997: 1.15%

1998: 0.8%

1999: 1% not to exceed $8.00

2000: $6

2001 : $10, plus an additional $8 if the owner pays for all gas service to the rental unit

2002 : 3.5% or $30, whichever is less, plus an additional $9 if the owner pays for interior space

heating to the rental unit

2003 : 0%

2004 : 1%, plus an additional $3, for units with new tenancies between 1/1/99 and 12/31/02;

1.5%, plus an additional $3, for units with no new tenancies since 1/1/99.

2005 : 0.9% (9/10ths

of a percent)

2006 : 0.7% (7/10ths

of a percent)

2007 : 2.6%

2008 : 2.2%

2009: 2.7%

2010: 0.1% (1/10th

of a percent)

Beginning with the 2000 AGA, the AGA is not applicable to units with new tenancies

starting in the previous calendar year. Example: the year 2000 AGA does not apply for

units with qualifying new tenancies during 1999.

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Appendix 2: Numerical Tables for Figures

This appendix provides the numerical data that provided the basis for figures that did not include

the numbers on or below the figure itself. Figure 1: Bay Area & US Real Rent, 1935 - 2008

Real Rent (CPI-R/CPI-LS) 1935-2008 Year

US Real Rent

Bay Area Real Rent

Ratio of Change in Bay Area vs. U.S. Real Rent

1935 100.0 100.0 100.0

1936 100.90 99.2 98.4

1937 102.61 99.6 97.1

1938 109.19 105.0 96.2

1939 110.75 107.1 96.7

1940 109.96 106.4 96.7

1941 106.25 101.3 95.3

1942 96.18 91.5 95.1

1943 89.28 85.9 96.2

1944 88.18 85.5 96.9

1945 85.84 83.7 97.5

1946 78.63 76.0 96.7

1947 70.04 67.9 96.9

1948 69.19 66.4 96.0

1949 73.34 68.9 93.9

1950 75.60 69.3 91.7

1951 72.46 69.1 95.3

1952 73.91 70.8 95.8

1953 77.82 75.0 96.3

1954 80.57 77.5 96.2

1955 82.01 79.4 96.8

1956 82.46 80.2 97.2

1957 81.50 80.2 98.4

1958 80.39 80.8 100.5

1959 81.14 82.9 102.2

1960 80.89 84.5 104.5

1961 80.90 86.0 106.3

1962 81.16 88.1 108.5

1963 80.97 89.5 110.5

1964 80.78 90.6 112.2

1965 80.35 91.2 113.5

1966 79.15 90.6 114.5

1967 78.43 90.9 115.9

1968 77.19 91.9 119.1

1969 76.15 92.8 121.9

1970 75.49 94.7 125.5

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1971 75.86 95.7 126.1

1972 76.15 95.5 125.5

1973 74.34 92.3 124.1

1974 70.26 86.5 123.1

1975 67.76 82.8 122.2

1976 67.41 82.8 122.8

1977 67.18 82.9 123.3

1978 67.26 82.7 123.0

1979 65.51 80.4 122.8

1980 63.84 80.1 125.5

1981 63.19 81.4 128.9

1982 64.33 83.0 129.0

1983 65.62 89.0 135.6

1984 66.30 91.7 138.3

1985 68.36 96.4 141.0

1986 71.66 103.2 144.0

1987 72.16 105.0 145.6

1988 72.14 104.8 145.3

1989 71.45 103.8 145.3

1990 70.63 103.8 147.0

1991 70.22 103.2 146.9

1992 69.99 101.9 145.5

1993 69.54 101.7 146.2

1994 69.58 102.1 146.7

1995 69.47 101.5 146.1

1996 69.36 102.2 147.4

1997 69.95 106.2 151.8

1998 71.62 113.2 158.1

1999 72.49 118.0 162.8

2000 72.61 122.4 168.5

2001 74.06 132.1 178.3

2002 76.49 136.4 178.3

2003 77.00 133.5 173.4

2004 76.99 129.8 168.7

2005 76.39 126.7 165.8

2006 76.74 123.9 161.4

2007 78.08 124.5 159.5

2008 77.46 124.8 161.2

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Figure 2: Median Berkeley Rents, 1978 - 2009

Median Rent plus AGA

Median After Vacancy Decontrol

Median Vacancy Rent, 1 BR Year

$212

1978

$212

1979

$223

1980

$234

1981

$255

1982

$267

1983

$267

1984

$273

1985

$283

1986

$293

1987

$318

1988

$328

1989

$344

1990

$361

1991

$461

1991

$487

1992

$507

1993

$525

1994

$533

1995

$538 $570

1996

$545 $606

1997

$549 $643

1998

$554 $690 $950 1999

$560 $750 $1,100 2000

$570 $810 $1,200 2001

$590 $882 $1,150 2002

$590 $900 $1,100 2003

$602 $932 $1,050 2004

$608 $950 $1,095 2005

$612 $994 $1,100 2006

$628 $1,042 $1,200 2007

$642 $1,100 $1,275 2008

$659 $1,145 $1,295 2009

Note: Rent Board records on median rents are not available on an annual basis prior to 1998. Median rents for 1996-

97 in the “Median After Vacancy Decontrol” column are imputed on a straight line basis to represent the partial

vacancy decontrol increases allowed during the transition period. This is not entirely accurate, since part of the

difference between the “Median plus AGA” column and the “Median After Vacancy Decontrol” column is actually

IRAs from previous years.

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Figures 3 & 4: Change in Berkeley Rent and Bay Area CPI and CPI-Rent 1978 - 2009

Year Median Rent plus AGA

Median Rent After Vacancy Decontrol

Median Vacancy Rent, 1 BR CPI

CPI-LS CPI-R

1978 100

100 100 100

1979 100

109 110 107

1980 105

125 125 121

1981 110

141 135 133

1982 120

152 145 146

1983 126

153 149 160

1984 126

162 157 174

1985 128

169 161 188

1986 133

174 163 204

1987 138

179 168 213

1988 150

187 175 222

1989 154

197 184 231

1990 162

205 192 242

1991 170

214 201 250

1991 217

214 201 250

1992 229

222 208 256

1993 239

228 214 263

1994 247

231 217 268

1995 251 251

236 222 272

1996 254 268

241 226 279

1997 256 285

249 231 296

1998 258 302

257 233 319

1999 261 324 460 268 240 342

2000 264 352 532 280 247 366

2001 269 380 581 295 253 405

2002 278 414 557 300 255 420

2003 278 423 532 305 260 420

2004 284 438 508 309 267 420

2005 286 446 530 315 275 421

2006 288 467 532 325 285 427

2007 296 489 581 336 295 444

2008 302 517 617 346 306 462

2009 310 538 627 348 305 477

Note: 2009 CPI is for the month of June.

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Figure 5: Market & Stabilized Rents, 1998 - 2008, 1 BR Apartment

Year

1998

Tenant

Vacancy

Rent

1999

Tenant

2000

Tenant

2001

Tenant

2002

Tenant

2003

Tenant

2004

Tenant

2005

Tenant

2006

Tenant

1998 $624

1999 $630 $950 $950

2000 $636 $1,100 $950 $1,100

2001 $646 $1,200 $960 $1,100 $1,200

2002 $669 $1,150 $990 $1,130 $1,200 $1,150

2003 $669 $1,100 $990 $1,130 $1,200 $1,150 $1,100

2004 $682 $1,050 $1,003 $1,144 $1,215 $1,165 $1,100 $1,050

2005 $688 $1,095 $1,012 $1,155 $1,226 $1,175 $1,110 $1,050 $1,095

2006 $693 $1,100 $1,019 $1,163 $1,235 $1,183 $1,118 $1,057 $1,095 $1,100

2007 $711 $1,200 $1,046 $1,193 $1,267 $1,214 $1,147 $1,085 $1,123 $1,100

2008 $726 $1,275 $1,069 $1,219 $1,294 $1,241 $1,172 $1,109 $1,148 $1,124

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Figure 6: Average Sales Price Per Unit, Berkeley Rental Properties with 5+ Units

Built Prior to 1980.

Year Price Per Unit

1978 PPU + CPI

Properties Sold

Units Sold

1977 $16,154 $16,154 8 110

1978 $23,593 $23,593 14 167

1979 $12,759 $26,271 8 141

1980 $25,404 $29,817 6 52

1981 $18,600 $32,892 1 5

1982 $18,986 $34,919 3 69

1983 $26,657 $36,041 4 67

1984 $24,468 $37,597 15 204

1985 $44,549 $38,935 8 61

1986 $38,176 $39,659 20 176

1987 $28,277 $41,106 18 159

1988 $32,253 $42,807 20 182

1989 $31,476 $44,870 17 172

1990 $47,965 $47,294 10 71

1991 $51,813 $49,284 11 75

1992 $47,545 $50,768 13 171

1993 $31,611 $52,288 19 312

1994 $48,527 $53,627 25 354

1995 $54,222 $55,146 23 232

1996 $51,640 $56,775 40 352

1997 $46,973 $58,077 23 253

1998 $52,962 $58,982 36 354

1999 $81,377 $60,285 28 326

2000 $94,436 $62,311 23 243

2001 $109,086 $64,084 22 203

2002 $106,858 $65,097 18 166

2003 $126,415 $66,581 31 331

2004 $139,033 $68,354 45 455

2005 $149,728 $70,670 57 517

2006 $134,314 $72,950 20 253

2007 $160,927 $75,027 34 344

2008 $166,486 $77,908 23 276

2009 $162,486 $81,198 15 158

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Figure 7: Change in Berkeley Rents and 5+ Unit Property

Values, 1978 – 2009

RealQuest Alameda County data, CPI, Rent Board

Year AGA

Change in

Median Rent

Change in 1 BR

Vacancy Rent CPI

Change in value of 5+ unit

properties

1978 100 100

100 100.0

1979 100 100

109 60.2

1980 105 105

125 128.8

1981 110 110

141 63.4

1982 120 120

152 90.4

1983 126 126

153 106.9

1984 126 126

162 118.3

1985 128 128

169 221.0

1986 133 133

174 166.3

1987 138 138

179 144.9

1988 150 150

187 132.4

1989 154 154

197 163.4

1990 162 162

205 200.0

1991 170 170

214 239.6

1991 217 217

214 239.6

1992 229 229

222 228.3

1993 239 239

228 177.0

1994 247 247

231 219.3

1995 251 251

236 244.6

1996 254 268

241 257.6

1997 256 285

249 220.8

1998 258 302

257 249.1

1999 261 324 460 268 345.2

2000 264 352 532 280 410.9

2001 269 380 581 295 481.0

2002 278 414 557 300 522.4

2003 278 423 532 305 598.3

2004 284 438 508 309 630.4

2005 286 446 530 315 656.5

2006 288 467 532 325 577.5

2007 296 489 581 336 656.9

2008 302 517 617 346 729.7

2009 310 538 627 351 610.0

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Figure 9: Berkeley and Alameda County

price per square foot, 1990 – 2009

CoStar data

Year

CoStar Berkeley 5+ units, median

CoStar Alameda County, 5+ units, median

1990 $52.69 $68.64

1991 $51.76 $59.22

1992 $52.91 $57.93

1993 $53.38 $50.72

1994 $59.10 $56.73

1995 $60.10 $55.84

1996 $61.88 $57.58

1997 $76.71 $67.93

1998 $80.91 $64.66

1999 $95.92 $67.96

2000 $120.41 $79.28

2001 $125.63 $102.35

2002 $128.93 $113.64

2003 $166.41 $131.86

2004 $176.06 $142.06

2005 $179.11 $163.23

2006 $176.27 $154.02

2007 $192.94 $173.04

2008 $228.75 $165.97

2009 $159.00 $148.65

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Figure 10: Average Berkeley price per square foot, Alameda County property records via RealQuest

Year 5+ unit properties Four Unit Properties

Two unit properties

1978 $31.49 $26.89 $42.62

1979 $18.96 $37.04 $58.84

1980 $40.55 $26.69 $55.61

1981 $19.96 $36.83 $59.33

1982 $28.46 $35.76 $52.93

1983 $33.66 $33.46 $61.06

1984 $37.24 $46.85 $61.69

1985 $69.60 $47.73 $78.85

1986 $52.36 $61.27 $72.14

1987 $45.62 $59.18 $89.47

1988 $41.68 $63.77 $110.51

1989 $51.46 $58.12 $124.90

1990 $62.98 $87.11 $122.88

1991 $75.44 $80.85 $108.91

1992 $71.90 $63.50 $120.83

1993 $55.75 $54.33 $131.49

1994 $69.04 $84.64 $154.64

1995 $77.01 $87.61 $127.59

1996 $81.11 $71.96 $119.64

1997 $69.54 $82.00 $140.53

1998 $78.44 $103.12 $155.74

1999 $108.69 $132.02 $159.28

2000 $129.39 $150.45 $196.55

2001 $151.45 $174.09 $236.64

2002 $164.49 $194.91 $257.75

2003 $188.40 $201.07 $302.96

2004 $198.50 $247.07 $341.67

2005 $206.74 $281.55 $382.16

2006 $181.84 $294.90 $387.41

2007 $206.84 $284.26 $385.01

2008 $229.78 $262.77 $368.50

2009 $192.07 $203.98 $283.13

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Table for Figure 13: 2007 Median Rental Income and Expenses Per Square Foot

for Garden Apartment Buildings in Selected Metropolitan Areas

Income

Operating

Expenses

OE as %

Income NOI

NOI as %

Income

U.S. $10.44 $4.97 48% $5.51 53%

Houston, TX $9.74 $5.63 58% $4.14 43%

Portland, OR $9.76 $4.30 44% $5.81 60%

Minneapolis, MN $10.00 $5.14 51% $4.67 47%

Sacramento $12.28 $5.45 44% $6.50 53%

Oakland $18.14 $6.99 39% $11.23 62%

San Francisco $18.63 $6.07 33% $11.91 64%

Los Angeles $20.13 $6.69 33% $13.45 67%

San Jose $20.63 $6.89 33% $14.24 69% Source: IREM Institute of Real Estate Management, "Income/Expense Analysis: Conventional

Apartments", 2008, and author’s calculations. Due to use of medians, expenses and NOI will not

add up exactly to rental income.

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Appendix 3: Vacancy Rate Data: Findings and Analysis

Findings from the 2009 Tenant Survey

Postal returns from the 2009 tenant survey indicate that the vacancy rate in April 2009 was 4.0%

for units in the sampling universe – registered rental units and units with tenants in the Section 8

and Shelter Plus Care Programs. The month of April was chosen for the survey because it is the

month before students take their final examinations so that it has significantly less turnover than

the summer months.

The survey also found 38% of units occupied by tenants who moved in during the previous 16

months. Using an assumption that there is an average of one to two months between the time one

tenant leaves and another moves in, Berkeley’s rent stabilized units would have an annual

vacancy rate of from 2.4% - 4.8%.

In comparison, the most regular and readily available vacancy rate data is provided by the U.S.

Census Bureau’s American Community Survey (ACS) which estimated Berkeley’s overall rental

vacancy rate at 3.8% for the 2005-2007 period and 2.4% for the 2006-2008 period. This data is

for all rental units, including rented single-family houses and condominiums and rental housing

built after 1980. The Census Bureau does not make this data available for individual years for

Berkeley because sample size is too small to provide accurate results.

The Mail Survey and Postal Returns

In April 2009 the RSB sent a mail survey to “Tenant” at 1,809 addresses of registered rental

units and units temporarily exempt because the tenant was said to be in the Section 8 or Shelter

Plus Care rental assistance programs. Three separate mailings went to all survey units: an April

6th

introductory letter, an April 10th

letter containing the survey, and an April 17th

postcard

reminder. The Post Office returned at least one of these three mailings from 94 different

addresses. Of the 94 addresses with returns, 66 were returned with labels indicating that they

were vacant or likely vacant, including “vacant”, “unclaimed”, “unable to forward”, “box full”.

The other 28 were returned with labels such as “no such number”. These were not counted as

vacant but rather as undeliverable, either because of incorrect addresses in the Rent Board

database or postal error. There is no way to determine how many units were vacant where none

of the mailings were returned, nor is there any way to know how many of the apparent vacancy

returns were incorrectly labeled or returned. We received several completed questionnaires from

units from which the post office also returned one of the mailings and removed these from the

returned list.

As described previously, the survey went to two sampling groups, a one-in-fifteen sample and a

one-in-five sample. The one-in-fifteen sample represented 78% of all registered units and the

one- in-five sample represented 22%. Removing the undeliverable units from the base mailing

totals and assigning the vacancies proportionately for the two sample groups, we arrive at a

vacancy rate of 4.04% for the month of April.

In the 2009 tenant survey 38% of respondents had moved into their unit during the previous 16

months. This indicates a turnover rate of 28.5% annually. If each unit is vacant for an average of

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one month, then the annualized vacancy rate would be 2.4%. If the average vacancy is two

months, then the annualized vacancy rate would be 4.8%.

The Policy Implications of Vacancy Rates

The real estate industry frequently argues that a rental vacancy rate of four or five percent means

that there is a “balanced” housing market and that this means that rent and condominium

conversion controls are unnecessary. This involves a fundamental misunderstanding of the role

of vacancies in the rental housing market, particularly in high-rent areas such as the coastal

regions of California. Vacancy rates are important to the housing market as a necessary

precondition for adequate tenant mobility and as an indicator of the balance between supply and

effective demand. However, vacancy rates often do not serve as a good indicator of the balance

between supply and demand because they are affected by cyclical short-term economic changes

as well as by the underlying balance between the supply and the need for housing. The

fundamental indicator of “balance” in a housing market is rent levels and how the rents compare

with other markets.

Vacancy rates go up and down with the state of the overall economy and they also go up and

down with the rate of development of new housing in relation to population growth and

household formation, so at any given time the vacancy rate reflects both of these factors.

Vacancy rates typically increase during recessions, which reduce what consumers are able to pay

for housing and thus reduce what economists call “effective demand” for housing. Such an

increase in vacancies does not mean that the need for housing has decreased, nor does it mean

that the utility of housing to consumers has decreased. Rather, it simply means that due to the

recession consumers have less money with which to purchase housing and landlords have not

reduced rents in step with reduced consumer ability to pay. Even if vacancies increase, landlords

will be reluctant to lower rents for new tenants, since they may then be pressured to reduce rents

for current tenants who moved in at higher rents. Within limits the loss of revenue from vacant

units may be less than the loss of revenue from reducing rents for tenants already in place.53

Only if a recession is so severe that it leads to a decline in population does the actual need for

housing also decline during such a short-term economic cycle.

The coastal areas of urban California have a long-term, underlying housing shortage, caused by

the widely recognized shortfall of new housing development in relation to population growth.54

Despite this it is perfectly normal to also have short-term increases in the vacancy rate that result

from a recession or economic slow-down. Then when the cycle changes, vacancies go down and

rents start to increase again.

53

Eric Belsky, “Rental Vacancy Rates: A Policy Primer”, Housing Policy Debate, V.3#3,

1992, pp.793-813,

http://www.fanniemaefoundation.org/programs/hpd/pdf/hpd_0303_belsky.pdf. 54

John Landis, Michael Smith-Heimer, et al. Raising the Roof: California Housing Development Projections

and Constraints, 1997-2020, Department of Housing and Community Development, Sacramento, CA 2000.

Hans Johnson, Rosa Moller & Michael Dardia, In Short Supply? Cycles and Trends in California Housing,

Public Policy Institute of California, San Francisco, March 2004.

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In summary, Bay Area vacancy rates are subject to short-term cycles varying with the state of the

local economy; even though there is a long-term shortage of housing that is expected to last for

the foreseeable future. An increase in the vacancy rate in the Bay Area does not mean that

sufficient new housing has been constructed to balance the market, nor does it mean that there is

a sufficient housing supply to stabilize market prices over the long run without public

intervention. For this reason, it is important not to respond to short-term fluctuations in the

vacancy rate with changes in public policies that will result in a long-term loss of rental units.

Condominium conversion permanently removes the great majority of the converted units from

the rental market.

Finally, even looking at long-term vacancy rates, there is no consensus on what vacancy rate is

necessary to balance the market. Many ordinances use a five percent long-term vacancy rate as

the measure of a healthy rental market, largely because ordinances tend to follow one another.

The empirical evidence on appropriate vacancy rates is mixed. Gabriel and Nothaft support the

five percent estimate, while Gilderbloom and Appelbaum review a number of studies and

suggest that a vacancy rate of 9% or 10% is necessary.55

The U.S. Census Housing Vacancy

Survey has reported national metropolitan area rental vacancy rates averaging over 7% since

1990 and in the 8-10% range since 2001, even as rents continued to rise, further evidence that the

“normal” vacancy rate is generally higher than 5%. Eric Belsky argues that the equilibrium or

“natural” vacancy rate varies from one local market to the next, and will also vary by size of

building and property holdings, since small landlords tend to “minimize vacancies” while larger

landlords tend to “maximize rents”. 56

The table below shows median contract rents and vacancy rates as reported for the twenty-six

largest metropolitan areas by the Census Bureau’s 2006-2008 American Community Survey. It

shows that lower-rent areas tend to have higher vacancy rates. The majority of the areas with

rents in the bottom third have vacancy rates over 10%, most of the areas in the middle third have

vacancy rates over 8%, and all of the areas in the top third have vacancy rates under 8%. Even

so, there is a great deal of variation among regions with similar rents.

Vacancy rates are only one indicator of the state of the housing market. Prices are a much more

fundamental indicator. If housing costs in an area are well above average and remain so over a

long period of time, it means that there is an underlying housing shortage regardless of the

current vacancy rate.

55

Gabriel, Stuart A. & Frank E. Nothaft, “Rental Housing Markets, the Incidence and Duration of Vacancy

and the Natural Vacancy Rate”, Journal of Urban Economics, V.49, 2001, pp.121-149.

John I. Gilderbloom & Richard P. Appelbaum, Rethinking Rental Housing, Temple University Press,

Philadelphia, 1988, pp.52-56. 56

Eric Belsky, “Rental Vacancy Rates: A Policy Primer”, Housing Policy Debate, V.3#3, 1992, pp.793-813,

http://www.fanniemaefoundation.org/programs/hpd/pdf/hpd_0303_belsky.pdf

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Rents and Vacancy Rates for the 25 Largest US Metropolitan Areas

& Berkeley, Oakland, Alameda County, 2006-2008

Median contract rent Vacancy rate

Pittsburgh, PA Metro Area $495 9.10%

Cincinnati-Middletown, OH-KY-IN Metro Area $549 12.40%

St. Louis, MO-IL Metro Area $553 7.90%

Detroit-Warren-Livonia, MI Metro Area $637 10.90%

Houston-Sugar Land-Baytown, TX Metro Area $638 12.50%

Dallas-Fort Worth-Arlington, TX Metro Area $665 11.20%

United States $676 7.90%

Portland-Vancouver-Beaverton, OR-WA Metro Area $720 5.40%

Atlanta-Sandy Springs-Marietta, GA Metro Area $738 12.00%

Tampa-St. Petersburg-Clearwater, FL Metro Area $741 10.40%

Denver-Aurora, CO Metro Area $743 7.80%

Philadelphia-Camden-Wilmington, PA-NJ-DE-MD Metro Area $748 8.70%

Minneapolis-St. Paul-Bloomington, MN-WI Metro Area $761 6.80%

Chicago-Naperville-Joliet, IL-IN-WI Metro Area $766 8.20%

Phoenix-Mesa-Scottsdale, AZ Metro Area $777 10.60%

Baltimore-Towson, MD Metro Area $812 8.40%

Seattle-Tacoma-Bellevue, WA Metro Area $839 5.10%

Sacramento--Arden-Arcade--Roseville, CA Metro Area $892 6.60%

Oakland city, California $912 8.60%

Miami-Fort Lauderdale-Pompano Beach, FL Metro Area $923 9.20%

Riverside-San Bernardino-Ontario, CA Metro Area $950 6.60%

New York-Northern New Jersey-Long Island, NY-NJ-PA Metro Area $956 4.60%

Boston-Cambridge-Quincy, MA-NH Metro Area $983 5.50%

Los Angeles-Long Beach-Santa Ana, CA Metro Area $1,046 3.80%

Berkeley city, California $1,069 2.40%

Alameda County, California $1,091 6.70%

San Diego-Carlsbad-San Marcos, CA Metro Area $1,126 4.90%

Washington-Arlington-Alexandria, DC-VA-MD-WV Metro Area $1,127 7.20%

San Jose-San Francisco-Oakland, CA CSA $1,188 5.20%

Source: U.S. Census Bureau, American Community Survey 2006-2008

Notes: Vacancy rate is “vacant for rent” divided by occupied rentals plus vacant for rent. Geographical grouping is

Standard Metropolitan Statistical Areas except that the San Francisco Bay Area is the eleven county Consolidated

Statistical Area, which includes six MSAs: San Francisco-Oakland, San Jose, Santa Rosa, Vallejo, Napa and Santa

Cruz-Watsonville.

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Appendix 4: Estimating Land Rent in the Bay Area Rental Housing Market

Land Rent

The people who live and work together in urban areas collectively generate economic, cultural

and social benefits. This is partly done through government, the institution we use to provide

public safety, transportation, education and other systems that sustain urban life. It is partly

through the simple fact that urban areas generate dense networks of human interaction that

advance knowledge and creativity in every field and endeavor, whether it is the arts, the sciences,

business, government or ways of life. Locations within these areas with high concentrations of

desirable human interactions, activities and services become valuable because available space is

limited. More housing can be produced on the existing centrally located land only by building at

higher densities, which increases the cost of producing the housing. More land to build on is

available only on the outskirts of the area, away from the desirable activities.

Residential real estate is a form of property that combines buildings and the land the buildings sit

on. When people buy a home, part of what they pay is for the building and part is for the land it

sits on. When people rent an apartment part of the rent payment supports construction, operation

and maintenance of the building (building rent) and part of the payment is for access to that

location (land rent). The value of this location comes from a combination of public investment

and the network of activities generated by people who live and work in the surrounding area.

There is nothing new in these observations about the rental housing market. Adam Smith, often

considered the founding figure in economics, wrote about it in his book The Wealth of Nations,

published in 1776.

“The rent of a house may be distinguished into two parts, of which the one may very properly be

called the Building rent; the other is commonly called the Ground rent. … The building rent is

the interest or profit of the capital expended in building the house …and secondly, to keep the

house in constant repair. …Whatever part of the whole rent of a house is over and above what is

sufficient for affording this reasonable profit, naturally goes to the ground-rent… revenue which

the owner, in many cases, enjoys without any care or attention of his own”57

In the same pages, Smith also argued that land value or land rent is value created by the public,

saying “Ground-rents, so far as they exceed the ordinary rent of land (its agricultural value), are

altogether owing to … good government...” He further argued that it would be particularly

appropriate to tax land rent, since “A tax upon ground-rents would not raise the rents of houses.

It would fall altogether upon the owner of the ground rent…”

The investors who own the residential land in successful urban areas profit from its increased

value even when they have contributed little or nothing to that increase. This disconnect between

creation of land value and profit from land value results in a cruel irony for many residents who

57

Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776, Book V, Chapter 11, Part

2. (Modern Library Edition, 2000, pages 904-5, 909.)

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do not own real estate. They contribute to making the city they live in a better and more

interesting place and in so doing they increase land values, which increases the rent they have to

pay to continue to live there. A well-known example of this is the common pattern in which

artists who live in a low-rent neighborhood are then forced out by rising rents when it is

“discovered” by higher-income people.

When people cannot afford to pay enough rent to cover the costs of operating and maintaining a

decent apartment building they have an income problem. But when people have enough money

to cover those costs and still can't find decent quality housing they can afford, then housing

affordability is a problem of land rent.

Land Rent in the San Francisco Bay Area Rental Housing Market

The San Francisco Bay Area has the highest rents of any major metropolitan area in the U.S.

Figure 1 shows the 2008 median rents for the U.S. and the twenty-five largest metropolitan areas

as reported in the U.S. Census Bureau’s American Community Survey for 2006-2008. The

median rent in all U.S. metropolitan areas is 43% lower than the Bay Area rent. The median for

all U.S. cities is near the lower end of this table because the U.S. average includes all the smaller

metropolitan areas, which tend to have lower densities and housing prices. Even the 25th

percentile rent in the Bay Area is $882, higher than the median rent in most other major

metropolitan areas. (Table 1 in the appendix shows rents by quartile.)

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The sources of land rent in the Bay Area rental housing market are a combination of the factors

that make the Bay Area a desirable place to live and the factors that severely constrain the

availability of land that can be developed with multifamily housing. The Bay Area has a strong

economy led by Silicon Valley and biotechnology firms; high-quality infrastructure created by

public investment in world-class universities, highways, mass transit and parks; a beautiful

environment featuring the Bay and the California coast; and an open, diverse regional culture

that is highly attractive to creative people. At the same time, it features extraordinary barriers to

housing development, including difficult geography, with a coast, a bay and hilly areas with

steep slopes; highly developed local government land use regulations; and a central area that is

already relatively dense by U.S. standards, which makes increases in density more costly because

they often require redevelopment of sites already built on and more costly forms of high-rise

construction.

There are excellent overviews of the role of land values in the single-family housing market.

Davis and Palumbo used data on single-family home prices to separate out the value of buildings

and land in the homeownership market in the 46 largest metropolitan areas of the United States.58

They found that in 1984 in the largest 46 metropolitan areas the land value averaged 32% of the

value of a single-family home, a figure that ranged from 11% in the Midwest to 55% on the West

Coast, with the value in land reaching 61% in the Oakland area and 75% in the San Francisco

area. By 2004, near the high point of the 1998-2007 “housing bubble”, a nationwide average of

51% of the value of a single-family home in the 46 largest metropolitan areas could be attributed

to the land and the proportion ranged from 36% of total value in the Midwest to 74% in the West

Coast states. In the Oakland area 78% and in the San Francisco area 89% of the value of the

average single-family home was in the land by 2004, the highest ratio among the major

metropolitan areas. While the collapse of the housing bubble may return the U.S. to something

closer to the 1984 price structure, land values clearly constitute a major component of ownership

housing prices in many metropolitan areas, and are particularly high the San Francisco Bay Area.

Similar studies of rental housing are not available and far less data is available on rental housing,

but there are readily available data sources to produce rough estimates of the magnitude of land

rent in the Bay Area rental housing market.

There are, however, three possible alternative explanations for the Bay Area’s higher rents:

higher housing quality, higher operating costs, higher construction costs. I will examine each of

these possibilities in turn and provide estimates of the extent to which each of these may explain

the Bay Area’s higher rents. The part that cannot be explained by differences in quality and cost

is the land rent.

58

Davis, Morris A. and Michael G. Palumbo. (2006). “The Price of Residential Land in Large U.S. Cities”, Federal

Reserve Board Finance and Economics Discussion Series, No. 2006-25.

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Alternative Explanation: Housing Quality

There is an excellent source of data on residential rents that corrects for changes in quality – the

Bureau of Labor Statistics' Consumer Price Index residential rent component. The Consumer

Price Index (CPI) takes changes in quality into account, so that CPI increases for particular

components of consumer spending, such as rents, reflect actual price increases for goods of the

same quality. CPI data is available nationally, for all U.S. cities, and separately for the largest

metropolitan areas, including the San Francisco Bay Area. The CPI rent component is adjusted

for changes in the size and amenities of the units in the sample, which is periodically updated to

take into account changes in the composition of the housing stock. This CPI data allows

comparisons between changes in rents over time in the Bay Area and in other metropolitan areas

as well as in the average change for all U.S. Cities.59

Figure 2 shows the trend in Bay Area and US rents measured against the change in the CPI-All

Items Less Shelter since 1935, when the Less Shelter index first becomes available. U.S. and

Bay Area real rents follow each other closely until the late 1950s. After that point U.S. rents

remain largely stable, while Bay Area rents increase. Taking the ten year post-war period of

1946 to 1955 as a base-line, by 2008 Bay Area rents were 69% higher than they would have been

if they had changed in the same way as U.S. rents over all. Put the other way, if Bay Area rents

had followed the trend of rents in U.S. cities overall, they would have been 41% lower and they

would be comparable to rents in the Portland, Oregon area.60

59

Use of the CPI-All Items to measure increases in rent in the Bay Area would run into a problem of circularity.

When rents are going up faster than the cost of other consumer goods, as they have in the Bay Area, this increases

the CPI-All Items. Using a measure that includes rent increases to measure the rent increases will mask part of the

increase. The Bureau of Labor Statistics CPI index for all items except Shelter allows us to measure changes in rents

without this source of distortion.

The CPI-All Items Less Shelter index is available from 1935 to the present for all US cities, but only from

1976 to the present for the San Francisco Bay Area, so for changes in Bay Area rents in relation to CPI-LS I used a

omposite of the national index from 1935-1976 and the annual change in the Bay Area index from 1976-2008. The

CPI-All Items Less Shelter increased at virtually the same rate in the Bay Area and in all U.S. cities between 1976

and 2008, so use of the composite index makes little difference. This suggests that the Bay Area’s larger increase in

the CPI-All Items is mostly the result of the Bay Area’s more rapidly increasing housing costs. 60

There is reason to believe that the historical CPI data underestimates changes in rent, so that the quality-adjusted

gap between the Bay Area and the rest of the U.S. is even greater than it appears. Between 1953 and 1994 the

Bureau of Labor Statistics made a number of improvements in the way it gathers data on rents and these corrections

are retroactively estimated in Crone, Theodore, Leonard Nakamura, Richard Voith, “Rents Have Been Rising, Not

Falling, in the Post-War Period”, Working Paper 08-28, Federal Reserve Bank of Philadelphia, 2008.

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Figure 3 compares changes in real rents since 1935 for the Bay Area and Los Angeles area and

several major metropolitan areas with more balanced housing markets: Portland, Oregon;

Minneapolis-St. Paul; Houston, Texas. The trend for Los Angeles has been somewhat different

from the Bay Area’s, but they have diverged nearly as much from the trend for the U.S. as a

whole.

Portland is a successful, growing west coast metropolitan area well known for the high quality of

its urban life. Minneapolis-St. Paul is a Midwestern area also known for its high quality of life.

These metropolitan areas, along with San Francisco, San Jose and Oakland, are among the top

ten in Prof. Richard Florida’s urban “creativity index”, metropolitan areas that score highly on

“technology, talent, and tolerance”.61

Florida comments that “The greater Minneapolis region

combines a strong creative economy with low rates of poverty, affordable housing and a

balanced income distribution.”62

In the Houston area land values and land rents are at a

minimum. Houston is widely known as the only major city in America without zoning and

weaker land use regulations.63

61

Florida, Richard. (2005). The Flight of the Creative Class, HarperCollins, N.Y., pp.283-4. 62

Ibid, p.262. 63

Saiz, Albert. (2008). “On Local Housing Supply Elasticity”, SSRN: http://ssrn.com/abstract=1193422.

Siegan, Bernard. (1972). Land Use Without Zoning, Lexington.

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The comparison between the Bay Area and the U.S. as a whole is a conservative way to estimate

land rent. There is an element of land rent in virtually every local housing market, so any

comparison of the Bay Area with other cities will simply show how much more land rent is to be

found in the Bay Area rather than the total amount of land rent. For example, even in the

Portland, Oregon area, with a much more balanced housing market and much lower rents, a

study found that between1992 to 2002 “increased population, coupled with an essentially fixed

supply of land” caused real increases in apartment rents in the center and at major transportation

nodes, and “resulted in a wealth transfer from renters to owners”.64

The comparison with

Houston also suggests that U.S. rents already include significant land rent.

64

Wilson, Beth and James Frew. (2007). “Apartment Rents and Locations in Portland, Oregon: 1992-2002”, Journal

of Real Estate Research, V.29, p.214.

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Alternative Explanation: Operating Expenses

We can look at whether the Bay Area’s higher rents can be explained by higher operating and

maintenance expenses by using data from the Institute for Real Estate Management (IREM). The

Institute publishes an annual “Income/Expense Analysis” with data on operating expenses, rent

collections and net operating income from a survey of its membership broken down by

metropolitan areas so that we can make the necessary comparisons.

Figure 4 shows graphically the median rental income, operating expenses and net operating

income per square foot for the U.S. and Bay Area and other selected cities as reported to IREM

for garden apartment buildings for 2007.65

(Garden apartment buildings are low-rise rentals with

associated green space, the largest group in the IREM sample and the only type that can provide

a comparison with all areas.) The comparison cities are those shown previously in examining

changes in the CPI rent component.

Median rents for garden apartments in the central Bay Area, which includes the metropolitan

areas of Oakland (Alameda and Contra Costa Counties), San Jose (Santa Clara County) and San

Francisco (Marin, San Francisco and San Mateo Counties) are from 74% to 98% higher than the

median rents nationwide. The variation in net operating income is substantially greater than the

65

IREM Institute of Real Estate Management, "Income/Expense Analysis: Conventional Apartments", 2008. Debt

service is an investment expense, not an operating expense, and is paid out of NOI.

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variation in operating expenses. The median operating expenses in the Bay Area are from 22% to

40% above the U.S. median, while the NOI in the Bay Area is from 104% to 158% higher than

the U.S. median.

The higher expenses in the Bay Area average out to 9% of the average rent as do the higher

expenses in the Los Angeles area. (See Table 2)

Table 2: 2007 Median Rental Income and Expenses Per Square Foot for

Garden Apartment Buildings in Selected Metropolitan Areas

Income

Operating

Expenses

OE as %

Income NOI

NOI as %

Income

U.S. $10.44 $4.97 48% $5.51 53%

Houston, TX $9.74 $5.63 58% $4.14 43%

Portland, OR $9.76 $4.30 44% $5.81 60%

Minneapolis, MN $10.00 $5.14 51% $4.67 47%

Sacramento $12.28 $5.45 44% $6.50 53%

Oakland $18.14 $6.99 39% $11.23 62%

San Francisco $18.63 $6.07 33% $11.91 64%

Los Angeles $20.13 $6.69 33% $13.45 67%

San Jose $20.63 $6.89 33% $14.24 69%

Source: IREM Institute of Real Estate Management, "Income/Expense Analysis: Conventional Apartments", 2008.

The 2007 IREM data is based on 3,100 units in the Oakland area, 2,297 in the S.F. area, 3,782 in the San Jose area.

Due to use of medians, expenses and NOI will not add up exactly to rental income.

The higher NOI in the Bay Area means a typical rental property will have more than twice the

value of similar rental properties in many other parts of the U.S. With higher property values,

even with California’s property tax limitation, over half of the difference between average U.S.

operating expenses and the Bay Area and L.A. area is the result of higher property taxes. (See

Table 3) In effect, this is a small tax on land rent in the Bay Area and considering it as such

reduces the adjustment for higher operating expenses to 4% of the Bay Area rent. If we include

the public services paid for through real estate taxes as an essential aspect of housing, then the

higher operating cost differential is the appropriate comparison. Higher operating expenses thus

appear to explain from 4% to 9% of the 40% gap between Bay Area and U.S. rents.

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Table 3: U.S. and Bay Area Operating Expenses Per Square Foot

Income

Operating

Expenses OE-US OE

Difference

as % of

Income

Real Estate

Taxes

U.S. $10.44 $4.97 $0.00 0.00% $0.89

Houston, TX $9.74 $5.63 $0.66 6.78% $1.03

Portland, OR $9.76 $4.30 -$0.67 -6.86% $0.82

Minneapolis, MN $10.00 $5.14 $0.17 1.70% $0.89

Sacramento $12.28 $5.45 $0.48 3.91% $0.85

Los Angeles $20.13 $6.69 $1.72 8.54% $1.54

Oakland $18.14 $6.99 $2.02 11.14% $1.46

San Francisco $18.63 $6.07 $1.10 5.90% $2.31

San Jose $20.63 $6.89 $1.92 9.31% $1.76 Source: IREM Institute of Real Estate Management, "Income/Expense Analysis: Conventional Apartments", 2008.

Alternative Explanation: Construction Costs

The San Francisco Bay Area has among the highest construction costs in the United States, but

this has been true for quite a long time. In order to compare changes in Bay Area construction

costs with other cities, we can refer to ENR, the former Engineering News Record, which

maintains a general purpose building cost index based on the cost of a fixed quantity of skilled

and unskilled labor and materials from 22 different urban areas.66

Figure 5 shows the change in the ENR building cost index from 1948 to 2008 adjusted by the

change in the CPI-Less Shelter. It shows that both U.S. and Bay Area building costs increased

rapidly from 1948 to 1972 and then flattened out for a decade and have declined since 1979. Bay

Area building costs increased faster than U.S. costs from 1962 to 1976, but have actually

declined slightly more than U.S. costs since then. On average, since 1962 the Bay Area’s real

costs have increased by 9.5% more than U.S. real costs. The 2008 American Community Survey

indicates that 60% of Bay Area rental housing was built after 1960 and construction costs are

paid for out of the net operating income. A 9.5% increase in NOI would increase rents by the

proportion of NOI, which often reaches two-thirds of the rent in newly constructed buildings, for

an increase in rent of 6.4% applied to the 60% of buildings built since 1962, which suggests that

higher construction costs potentially added up to 3.8% to Bay Area rents.

66

McGraw-Hill, ENR.com http://enr.construction.com. The cost index is for all forms of construction, not

specifically for residential construction.

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However, while housing is a good that requires a major initial capital investment, the subsequent

cost of operation, maintenance and periodic renovations is much lower. Indeed, if newer

construction is higher quality it may be less costly to operate and maintain over the life of the

building, with lower utility costs due to better insulation for example. If there is sufficient

continuing production of new housing, which is usually directed towards higher income tenants,

then as it ages there will be a continuous stream of additional older housing that will compete for

tenants with existing older housing and this competition will reduce rents to closer to the actual

ongoing costs. Since construction costs are amortized over time, a reasonable argument can be

made that the effects of higher construction costs should only apply to buildings still in their

amortization period. The standard depreciation period of 27.5 years would take us back to 1980.

The American Community Survey (2006-8) indicates that 27% of Bay Area rental housing was

built since 1980, which would mean that higher construction costs are responsible for only 1.7%

of Bay Area rents.

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Estimate of Land Rent in the Bay Area

Drawing together this analysis of data on rents adjusted by quality, operating costs and

construction costs, we arrive at the following rough estimate of the proportion of land rent in the

Bay Area rental housing market.

Difference between Bay Area and U.S. median rent, 2008 43%

Quality adjusted gap between Bay Area and US rents: 41%

Based on change in CPI-R/CPI-LS, 1946/1955 to 2008

Correction for higher operating costs: -9%

Operating costs excepting real estate taxes: -4%

Based on IREM 2007 data

Correction for higher construction costs: -2%

Based on ENR index, 1948-2008

Estimated land rent: 30% - 35%

The estimate above is necessarily very approximate given the limitations of the data used. It

serves to give a general sense of how much tenants in the Bay Area pay in pure land rent, over

and above the rent actually necessary to support their rental housing.

According to the Bureau of the Census American Community Survey for 2006-8 there were

1,064,000 tenant households in the eleven-county San Jose-San Francisco-Oakland Consolidated

Metropolitan Statistical Area and together they paid an aggregate monthly contract rent of $1.3

billion, for a total of $15.6 billion annually. If the land rent is 30% to 35% of the current rent

then it amounts to $4.5 to $5.5 billion annually in the Bay Area. In sum, Bay Area tenants are

paying around $5 billion more annually than would actually be necessary in order to profitably

operate and maintain the housing they live in. Partially as a result, one-third of Bay Area tenants

(340,000 households) pay more than 40% of their income in gross rent and one-quarter (250,000

households) pay over half of their income. These tenants with high rent burdens are mostly very-

low-income tenants with incomes below 50% of the area median. It seems clear that Bay Area

rents are limited less by competition and more by the limits of what tenants can manage to pay.67

67

As Adam Smith explained in An Inquiry into the Nature and Causes of the Wealth of Nations, (1776) “The price

of monopoly is upon every occasion the highest which can be got. The natural price, or the price of free competition,

on the contrary, is the lowest which can be taken, not upon every occasion indeed, but for any considerable time

together. The one is upon every occasion the highest which can be squeezed out of the buyers, or which, it is

supposed, they will consent to give: The other is the lowest which the sellers can commonly afford to take, and at

the same time continue their business.” Smith used the term “monopoly” broadly to include any situation where

competition is limited, not just for situations where there is only one seller. Book V, Chapter 11, Part 2. (Modern

Library Edition, 2000, page 69.)

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Land Rent Is a Permanent Feature of the Bay Area Housing Market

The standard economists' response to high housing costs is to call for the elimination of

regulatory barriers to new construction. It is certainly true that reduction of regulatory barriers to

housing development at higher densities will increase supply and lower land values and land

rents to some degree. However this is unlikely to greatly reduce land rent in the Bay Area. High

rents and land values resulting from central urban locations were characteristic of successful

cities long before the development of modern land use regulations.

Not only is much of the central Bay Area is already quite dense, but there are major

environmental constraints on where housing can be built, most notably the bay itself. There was

a serious proposal in the 1950s to fill in most of the San Francisco Bay for development. This

would have added hundreds of square miles of new land in the heart of the Bay Area and further

reduced the value of the surrounding land by removing the Bay as an aesthetic and recreational

amenity. It was precisely this dystopian vision that lead in the 1960s to creation of the Save the

Bay movement and then establishment of the Bay Conservation and Development Commission

to protect the Bay and regulate shoreline development.

Moving farther out from the central area along the Bay, many suburban communities have

extensive restrictions on development of multi-family housing even though such development

would not have harmful effects on the regional environment. Indeed, a growth cap established by

the City of Pleasanton was recently overturned by the courts on the grounds that it was contrary

to state law requiring each city to provide for its “fair share” of projected growth. However,

additional construction of rental housing in outlying areas would have limited effects on the

urban core areas and even then only with a substantial delay. The effects of reductions in

regulatory barriers have been marginal at best. As shown in Figure 2, real rents began to increase

faster than those in the U.S. as a whole back in 1959, more than 50 years ago. Given the already

high density of the central Bay Area and its environmental constraints, it is clear that land rent

will be a major feature of the housing market for generations to come.