Final answer:
The introduction of new rent control regulations in the Bronx that limit annual rent increases for property owners will likely lead to an increase in cap rates due to the reduced income growth and attractiveness of real estate investments in the area.
Step-by-step explanation:
If a multi-family property in the Bronx is valued at $2,000,000 on December 31, 2018, with the introduction of new rent control regulations limiting annual rent increases to 3%, it is likely that cap rates in the Bronx market will increase. With the implementation of rent control, property owners' potential to raise rents is limited, which typically makes real estate investments less attractive. Consequently, investors may demand a higher yield (i.e., a higher cap rate) to compensate for the lower income growth potential.
Rent control laws, like the one described, often lead to a mismatch between the quantity supplied and the quantity demanded, as seen in similar cases around the world. For example, in the Philippines, rent control led to a housing shortage due to the equilibrium price being restricted by a price ceiling. The same phenomenon occurred when a city government set a legally fixed maximum rent price, which was intended to help renters but resulted in fewer apartments being rented out than would be the case at market rent.
In the Bronx scenario, the reduction in income potential due to regulated rent increases can lead to capital flight, as the ability to recover investment costs through rent becomes more constrained, diminishing the attractiveness of the property as an investment. Investors then look for other, more lucrative opportunities, leading to increased cap rates as they demand higher returns for taking on the perceived additional risk associated with rent-controlled properties.