California rent caps and how lenders underwrite 5-10 unit buildings

The statewide cap in plain terms

The Tenant Protection Act of 2019 created a statewide limit on rent increases for most covered rental housing. Over any 12-month period, an owner may raise rent by no more than a figure tied to the regional change in the cost of living, subject to a fixed ceiling. The California Attorney General’s office publishes the current maximum increases by region, and owners should check them before any increase.

The Act exempts housing with a certificate of occupancy issued within the previous 15 years, on a rolling basis, and certain other categories. Most 5-10 unit buildings in California are older than that, so the cap usually applies. The Act also includes just-cause eviction rules in Civil Code § 1946.2.

Local rent programs

Many California cities run their own rent stabilization programs. These can set lower allowable increases than state law, require registration of units and rents, and add their own eviction and relocation rules. Coverage is usually defined by when the building was first occupied. Los Angeles, San Francisco, Oakland, Berkeley and San Jose are well-known examples, and other cities have adopted narrower rules in recent years.

When a building is covered by a local program, that program’s rules govern rent increases. Where no local program applies, the state cap generally does.

Costa-Hawkins and vacancy reset

The Costa-Hawkins Rental Housing Act (Civil Code § 1954.50 and following) limits local rent control in two important ways. First, it generally prevents local programs from limiting rents on housing with a certificate of occupancy issued after February 1, 1995. Second, it generally allows an owner to set a new starting rent when a tenant moves out voluntarily or is lawfully evicted, after which the applicable cap applies again.

For small apartment buildings, the 1995 date matters because so much of the stock is older. The vacancy reset matters because it explains why a single building can show very different rents for similar units: long-term tenancies at regulated rents next to units re-leased at market after turnover.

What lenders do with all of this

Lenders and appraisers deal with rent regulation every day in California, and it does not make a building unfinanceable. It changes how the loan is sized.

• In-place rent governs. The lender counts what each tenant pays now, checked against market rent in the appraisal.
• Planned increases are not income. A business plan that assumes long-term tenants reach market rent quickly is the owner’s upside.
• Registration is checked. In cities with registration, lenders may ask for proof that the building is registered and that the rent roll matches the program’s records.
• Disputes matter. Open petitions, rent board cases or tenant disputes can delay a file until they are explained.

The result is that a building with several long-term tenants supports a smaller loan than its price might suggest. The down payment and reserves have to be planned around today’s income.

How to read a rent roll with regulated units

When you review a rent roll on a building you plan to buy or refinance, separate the units into three groups: long-term tenancies at regulated rents, units re-leased at market in the last year or two, and vacant units. Note the move-in date and the last increase for each tenant.

Then build two numbers. The first is the rent roll as it stands, which is what the lender will count. The second is your own estimate of how the rent roll could change over several years as units turn over naturally. Make the loan work on the first number. Treat the second as the reason you are buying.

Common mistakes

The most common mistake is underwriting a purchase on a listing’s pro forma. The second is assuming a building is exempt because it looks newer, without checking the certificate of occupancy date. The third is counting rent from units that are not legally permitted. Each of these can change the loan size late in escrow.

This guide is a summary for general education. Rent rules are detailed, have exceptions and change. Confirm a building’s status with the city and with counsel before relying on it.

Frequently asked questions