Why rental inspections matter

Durham's proposed rental property inspection ordinance was the subject of some discussion here at BCR last month when it was first announced. As proposed, Durham's Neighborhood Improvement Services department would begin annual inspections of all rental properties older than ten years of age (those newer properties would begin inspections five years from now) as a way of proactively finding housing code violations that otherwise never get reported.  Landlords would also be required to register with the city and to pay a nominal annual registration fee.

The topic has received additional coverage in the local press this week, including a very good treatment on the issue over at the N&O's Durham News section yesterday.  I wanted to take some time to focus a bit more on the subject -- which is, without exaggeration, one of the most important proposals on the table for improving the quality of life in Durham.

Durham's a great city with many wonderful neighborhoods, but sadly the Bull City has some pockets that continue to struggle with crime, drug and gang issues.  Rental property predominates in many of these sections, and to call some of these houses substandard is to be charitable at best.  The chicken-and-egg question, of course, depends on what the relationship is between substandard housing and crime.  Will improving the housing stock in an area lead to a reduction in crime, or does the city need to crack down on safety and crime issues in neighborhoods first before the housing situation improves?

Wade Penny, a local property-owner and landlord, makes the argument in The Durham News that the latter predominates and that it's up to the city to improve targeted neighborhoods' level of safety first.  With respect to Penny, who has a history of philanthropy in the Bull City, I think there is a key benefit to Durham cracking down on substandard housing: it changes the fundamental economics of rental property in a way that could significantly impact crime issues in these areas.

Let's step into the shoes of a rental property owner for a moment.  From an economic perspective, owning rental property is similar to holding a bond; you invest a certain amount of capital up front in exchange for a stream of income coming back to you over time.  (In real estate this income stream is called net operating income (NOI), basically rent income minus property taxes, management fees, insurance, and -- importantly -- repairs and maintenance.)  Of course, with real estate, there are other benefits outside the NOI income stream, like tax benefits from depreciation, intrinsic appreciation of the property over time, and so forth, but let's leave those aside for a moment.

Every time a tenant moves out, the owner has essentially three choices: rent the property again, sell the property to another investor, or sell the property to a prospective homeowner. The economic question ultimately comes down to, am I better off taking the ongoing NOI (and other benefits) than I would be selling this property to someone else? 

Unfortunately, for the slumlords who own and mismanage the worst of Durham's housing stock, in today's world without inspections the answer tends to be, let's keep renting.

Most slumlords spend the bare minimum -- or nothing at all -- on repairs and maintenance, which means they keep more of the take on rent.  Helpfully, their slum property depresses their own property tax value, which keeps taxes low, too.  And although the rent roll they collect on isn't the highest, they can get away with scrimping on repairs because they manage to attract individuals who, because of immigration status, criminal activity, or simply personal fear of authorities, aren't going to call the city to turn them in for poor heat, rodents and vermin, or other living situations that most people would consider unacceptable.

With the addition of an inspections program, the economics of being a slumlord suddenly change.  Repair and maintenance costs will necessarily rise, suddenly making the once-profitable business much less profitable.  If the slumlord tries to raise the rent to cover these new expenses, the properties become less attractive to dealers in drugs or prostitution, who in any event won't be keen on work crews and city inspectors visiting the property more often, anyway -- so the target market of renters starts to dry up, too.

So what happens if a slumlord decides to get out of the rental business and sell a house?  Let's come back to the point that investment property is sold more like a bond than a single family home, with the market value of such property directly linked back to the NOI.  The annual inspection portion of the ordinance will hinder landlords from using the age-old tactic of deferring maintenance and repair to make their bottom line look good.  Instead, they'll have big annual catch-up expenses to fix long-standing problems, making their NOI depressed and reducing the sales price they'll get when prospective investment buyers look at their books.

As a result, over time slumlords are likely to have three destinations to turn to in order to dump the properties they've driven into the ground:

• Quality property owners with the financial resources and cash flow to make up-front capital investments needed in some of these properties to bring them up to standard (and then earn a fair market rate.)
• Prospective homeowners looking for a fixer-upper opportunity in a neighborhood that has new promise.
• Public sector and non-profit buyers with the resources to restore or replace the property with quality affordable or market-rate housing.

In the end, then, I'd argue that while the city can and should do more to lower crime in some of Durham's blighted neighborhoods, an inspection program can work to change the slumlord game and help clear parts of Durham of these enablers to problems of gangs and crime.  If we change the economics of rental properties, we can change the fundamental nature of these properties at the same time.  In many of Durham's troubled pockets, problem rental properties are intermingled with long-time residents who've watched their neighborhoods decline into unsightly, unsafe places; I would imagine these Durhamites would welcome a change that would help turn the incentives against substandard rental properties. 

It's worth noting that there are some challenges the city will need to address in order to fairly undertake a program like this:

• As Chris McKeel from Apple Realty points out, not all problems are caused by landlords, and there needs to be more accountability sometimes against tenants as well.  (Apple Realty, it's worth pointing out, are some of the genuine "good guys" on the Durham rental scene, with support from local neighborhood associations for their efforts to maintain quality rentals.)  I'd be curious what sort of aid or assistance landlords would find useful in terms of being able to turn out truly problem tenants.
• One major risk in undertaking a program like this is that the rising tide of rents will force out lower-income individuals or lead to waves of gentrification that can change neighborhoods in a different but, for some, equally problematic way.  Durham government and non-profits will need to redouble their efforts over the first decade at least of such an inspection program in order to provide safe, affordable housing to the community.
• Additionally, the changing economics may discourage slumlords from doing anything productive with their properties, as the rising cost of owning runs head-on into the falling value of the houses and apartments they own.  As such, the city will need to be more aggressive in attacking the problems of abandoned properties, which can on the plus side provide more outlets for new affordable housing developed by organizations like Self-Help and Habitat for Humanity.

Assuming that reasonable answers can be found for these problems, a strong rental inspection program is a big start to meeting Bill Bell's goal of turning around blight in Durham's core.

Comments

[GK]

Kevin

Good breakdown of the issue. I do disagree, primarily because I think that many of the folks who own the worst rental property in the most disinvested neighborhoods are, for a host of reasons, less likely to act to prevent their property from being demolished. Studies have shown that demolition lowers community property values, lowering average neighborhood NOI, causing deferred maintenance and thereby worsening property conditions elsewhere in the neighborhood. Also, the demolition of historic properties carries a social as well as an economic cost to the neighborhood. Thus, I think NIS has been very aggressive in attacking abandoned properties (by demolishing them) and not aggressive enough in attacking owners of abandoned properties (the actual problem) by seeking legal remedies to re-internalize the costs to them without exacting costs from the neighborhood.

I don't think that code inspection is in-and-of-itself-bad - in fact, I think it is an essential tool. The remedies utilized in Durham for violation are the problem. Other cities puruse city repair or receivership strategies that can create change beneficial to all parties. We are not so enlightened.

GK

[Kevin Davis]

Hi Gary,

Thanks for the feedback. I actually completely agree with you that the landlords in some of the more blighted areas of Durham have preservation at the very bottom of their priority list (heck, if they can't be competent landlords, they probably aren't enlighted ones!)... and that, as you've well documented over at Endangered Durham, the city's response has been to just tear down.

Looking back at my post, I sort of 'compressed' in the end some of my thoughts on needed mitigation, and only mentioned the opportunity for affordable housing. Of course, the City simply turning more properties over to groups like Habitat and Self-Help is likely to lead to just more demolition and in-fill. Ideally I'd like to see the City do more to try to find, well, good homes for these unloved and underinvested-in homes; that is, to find owners willing to invest in and fix them up. (I'm assuming this is the sort of strategy you mean by receivership programs.)

I guess the broader point I was trying to make is that this program is critical to me in helping to force bad landlords out... but that the City also be, as you say, more enlightened in what it does with abandoned properties. Thanks for covering some of the pain points on the latter piece.

[Kevin Davis]

...and have actually just seen your interesting and thought-provoking thoughts on the subject over at Endangered Durham (95% of the folks who read this blog read E.D., but in case you've missed the post, see http://endangereddurham.blogspot.com/2007/03/rental-inspections-good-idea-wrong.html).

I agree with the strategies Gary's laid out over there, including city-funded repairs at the expense of liens on the owners' property. I mean, lots of homeowners' associations -- including the one that the City of Durham has put in place at its own Eastway Village development -- have this stipulation. If HOAs (which put the quasi, or is that queasy, in quasi-governmental) can get away with this, why not our own government?

I'd like to see this linked to the code violation inspection program. If it weren't... would I no longer support the program as stated? Tougher call. I think I'd still be in favor, due to the positive (and undiscussed by me) benefits to folks who take these properties as rentals of last resort and have to endure poor conditions. To the extent there's a personal safety issue -- God forbid we have a case of the space heater causing a fire in an otherwise-unheated apartment -- it still tips the scales for me. Still, to Gary's point, we need to gird this proposal with protections to preserve the Bull City's architectural history.

[GK]

Thanks for the linkage, Kevin. Point well-taken on the safety issue. I would never want to imply that people should live in unsafe conditions to more broadly preserve old housing. I agree with you completely that a proactive approach is the right approach. I think there is a certain path dependence to Durham's approach that just accepts demolition as the tool to abate unsafe housing, and I want people to realize that we can actually have our cake and eat it too - by creating safe, affordable housing and preserving our neighborhoods.

Receivership is a tool used in ~20 states to varying degrees. We don't have it. If a property is declared blighted/nuisance/etc. (i.e. end stage of a code enforcement process) the court system can appoint a receiver (typically a third party) who can repair the property and place priority liens on the property. Sometimes these are affordable housing CDC's or land trusts who, if the lien is not paid off, gets the property and resell as affordable housing.
The city can do this here - but there is no avenue to appoint a third party.

Thanks for the discussion on the issue - this is obviously a longstanding (and ongoing) cause for me - to try to get more refined policy and procedures in place in Durham - borrowing innovative and successful tools from other cities, etc.

GK