Most people are familiar with Tarek El Moussa from his role on "Flip or Flop," the reality TV show he starred in with his now ex-wife Christina Hall. The couple bought, remodeled and flipped homes for a profit on the show. Although they have parted ways, Hall and El Moussa are still involved in real estate. Ironically, El Moussa's latest exploit into real estate development is a virtual snapshot of all the factors that are creating housing unaffordability in America's biggest cities.
A Simple Plan In North Hollywood That Became Complicated
On the surface, buying land and developing it into a luxury mixed-use complex isn't controversial — unless you are trying to do it while removing affordable housing stock from a city with rent-control legislation and a housing crisis brought on by skyrocketing rents. This is the situation El Moussa is in.
He has moved on from home flipping to larger developments. His project, NoHo 138 is a medium-scale development slated for the heart of North Hollywood. The 138-unit luxury development will have high-end amenities such as a first-class fitness center and a rooftop deck. At an estimated cost of $50 million, it's one of the most ambitious projects El Moussa has ever taken on.
The problem for El Moussa's development is acquiring enough land to build it. El Moussa's company purchased a network of bungalows and single-family homes on several adjoining lots. The existing buildings must be torn down to complete the project.
That's where it gets complicated. Many of the units have tenants living in apartments covered by Los Angeles's rent stabilization ordinance.
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What Is Rent Control?
The rent control ordinance caps how much landlords can raise rent in their occupied units. Traditionally, rent-control laws only covered older buildings. For example, Los Angeles's original rent-control law only covered properties built before Oct. 31, 1978. It was enacted to make sure people on fixed incomes and low-wage earners were not priced out of the housing market in the late 1970s.
The amount of a landlord's rent increase is determined by the city and usually runs between 2% and 4% per year. Landlords can't get around rent control by terminating leases because the law limits the circumstances under which they're permitted to do so. The law helps tenants remain in apartments they otherwise could not afford.
For example, an elderly tenant in one of the buildings El Moussa wants to tear down pays $824 per month in rent. If the same tenant moved into that apartment today, the current market rent would be at least double, if not triple what they currently pay — and it isn't a luxury apartment. By the time Noho 138 is finished, rents will be in the $3,000- to $5,000-per-month range.
The Only Way Around Rent Control
Los Angeles's rent-control statutes are difficult but not impossible to get around. Legislation known as The Ellis Act allows landlords to declare they are getting out of the rental business and pay tenants a buyout fee — currently $50,000 — to leave.
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El Moussa could declare the properties fall under the Ellis Act and pay tenants to move. Then he would be free to complete his development.
But, there is still a problem. Most of L.A.'s mom-and-pop landlords who operate between four and 10 rental units don't have the capital to buy out their rent-control tenants under the Ellis Act. At the same time, rent control limits their earnings, and there isn't a cap on expenses like management, repairs and maintenance.
When smaller, independent landlords can no longer afford to operate their rental properties because of an overabundance of rent-control tenants, they sell the properties. The buyers are usually developers like El Moussa or real estate investment trusts (REITs) with deep pockets that can buy tenants out under the Ellis Act, knock the old buildings down and put up an all-new structure that's not under rent control.
This Is The Crux Of Los Angeles's Housing Affordability Crisis
It's no secret there is a severe shortage of affordable housing in Los Angeles — a problem shared by most of America's largest cities. The problem is that while tenants need affordable housing, land and construction costs make building affordable housing a losing proposition. If the total cost of NoHo 138 is $50 million and it consists of 138 units, the average unit cost is $362,000.
For a development like this to make money, it needs to pull in a minimum of 7% of the total building cost on an annual basis. If NoHo 138 can't hit that threshold, it's unlikely there will be money left over to pay owner dividends after financing, management, maintenance and other expenses are subtracted from the balance.
In this case, 7% of $50 million is $3.5 million per year, which translates to an average rent of $2,113 per unit. That's a conservative estimate — El Moussa likely will shoot for between an annual return of 7% to 10%.
It's More Than Greed — It's Math
El Moussa's situation at NoHo 138 is why no one builds affordable housing. By the time an investor purchases a property in a big city, does the necessary repairs (or buyouts and tear-downs) to get the new development up and running, they are in the hole tens of millions of dollars, which was the case before the Federal Reserve began hiking interest rates this year.
The mathematics of building affordable housing in Los Angeles doesn't add up to profits for the owners. One of the best protections tenants have against runaway rents is to continue living in their rent-controlled units for as long as possible. But that also encourages landlords and property owners to take advantage of laws like the Ellis Act, which at the end of the day means there is even less affordable housing.
Affordable Housing Stock Continues To Dwindle
By some estimates, over 20,000 rental units have been taken off the California rental market since the Ellis Act was passed in 2001. In the case of NoHo 138, the previous owner served all the tenants with the Ellis Act declarations shortly before selling the properties to El Moussa. So, even though El Moussa didn't issue the notices, he is facing the brunt of the backlash.
The tenants know that even with a $50,000 buyout, they won't be able to stay in their old neighborhood for long. Take the elderly tenant paying $824 per month as an example. If they move out and find a comparable apartment for $1,824 the next block over, they will spend the $50,000 from the buyout in four years. That's assuming rent stays at $1,824 per month for the entire time, which is unlikely.
Even as tenants take the move-out money that was theoretically supposed to help them stay in their neighborhoods, they will find themselves in a rental market with fewer affordable options than ever. Add this to a median home price approaching $1 million in the Los Angeles metro area, and it's easy to see why there is a housing crisis.
Tenants Are Organizing And Fighting Back
Even though the Ellis Act gives property owners some flexibility where rent control is concerned, it is not a panacea. Tenants have learned how to organize and use the legal system to delay being moved out for as long as possible. This is an admirable effort that any group of reasonable people in their position would make.
Although these efforts are not always successful at staving off tenant removal entirely, they are sometimes able to extract concessions from the developer in exchange for going along with the program. For example, El Moussa agreed to designate 14 of his 138 units as "affordable" but by Los Angeles standards, that could still be expensive rent.
No matter how you slice it, NoHo 138 will take affordable housing stock away from a city in desperate need of it. The same thing holds true for any similar planned development in the L.A., New York, San Francisco or other urban area.
What Is The Solution?
The free market is not going to self-regulate and incentivize landlords to create affordable housing. Placing artificial caps on rents has not relieved the housing affordability problem.
Many cities with the strictest rent-control laws have the highest rents in the country. Tenants looking to generate extra income could invest in crowdfunded real estate or syndication deals to prepare for retirement.
Become A Real Estate Investor
Nonaccredited investors have more opportunities to own real estate than ever. Many offerings on Benzinga's Real Estate Offering Screener have buy ins under $500. It may not be the ideal solution to affordable housing, but by investing, you can get out in front of rising rents instead of constantly losing ground to them.
One thing is for certain: There are going to be a lot more NoHo 138 developments than $824 bungalows coming down the pike. Until local, federal and state governments can partner with real estate investors to bring affordable housing online, the best way for tenants to win this battle might be to start investing in real estate themselves.
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