INFORM

WHAT PROPERTY OWNERS SHOULD KNOW FOR 2023

By Daniel Winkler

Two important issues will drive property trends in 2023 when it comes to property ownership and management in the East Bay Area. These areas include: awareness of higher cap rates and lower prices for property owners interested in selling due to higher interest rates; and the legal liability property owners are exposed to because of the ever-increasing regulation and impact from the City of Oakland when it comes to operating and managing rental properties. The rules change so frequently and are always increasing. It is hard for a property owner to do anything with a property without consulting a lawyer. These two things bring tough challenges that will influence the property marketplace.

CAP AND INTEREST RATES

Property investors will see an increase in cap rates in the 5.5 percent range, up from historic 4 percent cap rates or so for the last five years. For property investors new to the market, the cap rate is a real estate valuation measure used to compare different real estate investments. It is calculated as the ratio between the annual net operating income produced by a real estate asset to its current market value. Cap rates between 5 and 10 percent are considered high, but higher cap rates lead to lower values. It is an inverse relationship. Investment properties could see a 10 percent or greater reduction in value over the coming years.

A high cap rate incentivizes an investor to invest. If interest rates are high, the available cash flow is reduced, the return is reduced. This leads to cap-rate expansion. Add to that the burdensome regulations, it will reduce the field of buyers, because only wellheeled, wealthy investors, with good real estate attorney relationships, can handle the regulation will to invest. It will drive out the smaller “mom and pop” investors because they simply can’t keep up with the ever-changing laws. If you can find properties that make sense from a cap-rate perspective, value and location, then it may be a good time to buy. Generous cap rates will attract more sophisticated investors to the East Bay Area.

Interest rates have risen through much of 2022. Rates seen throughout 2022 of 3 to 4 percent will not return to these lower levels – those opportunities are gone. Interest rates are expected to level off over the next few months and drop toward the end of 2023. We are seeing predictions that expect interest rates to range between 5 to 5.5 percent starting in the second half of 2023.

GREATER INVESTMENT IN LEGAL SERVICES

In the meantime, the City of Oakland continues to propose and pass numerous property laws, increased property taxes, rules and regulations. Investors and owners are advised to monitor these activities and changes. This regulatory environment makes it difficult to operate your property business and affords too much risk and exposure to lawsuits from renters. For example, the City Council recently capped annual rental increases at 60 percent of CPI up to 3 percent, which means you can’t raise your rent by more than 3 percent a year. As an investor analyzes a deal, they have to factor in the rising costs of operation due to taxes, fees and other regulations. The City does not let an owner raise the rent to cover the increased taxes or any other costs caused by inflation. It is just 60 percent of CPI up to 3 percent.

As a result, owners must add to their expenses the cost of an attorney and have someone available to call in case of litigation. I advise all clients interested in buying investment property to pay for one to two hours of consultation

from a real estate attorney who knows Oakland/Berkeley/San Francisco rent and eviction control laws so you fully understand the environment you are investing in. Between state legislation, county legislation and local legislation, it has gotten too complex in the property industry not to have a lawyer.

This additional but necessary requirement can be expensive since many attorneys in the East Bay Area charge an average of $400 to $500 an hour (rents often don’t cover that extra fee). In contrast, renters can receive free legal services through the City, which a few years ago funded $600,000 for the Oakland Tenant Defense. This inequitable situation makes it easy for renters to receive free legal services and the regulations set it up for the renters to be far more likely to sue property owners. A contested eviction can easily cost a property owner $20,000 to $25,000. This wipes out nearly any return on rental investments. And the regulations invite this sort of renter action, because the renter attorneys need to keep their funding from the cities, so they go looking for issues to sue.

With too many challenging rules and regulations and expensive legal fees just to survive in the marketplace, expect to see more top, large investors dominate the East Bay marketplace. Smaller and inexperienced investors won’t want to get into it for fear of lawsuits and pricey legal fees. As a result, this segment of investors will likely decrease.

Daniel Winkler is a broker at Winkler Real Estate Group based in Albany.