Synopsis: This Article examines the constitutional implications of state legislation aimed at restricting institutional investors from participating in the single-family rental (SFR) market. Using Minnesota’s proposed HF 685 as a case study, it analyzes potential challenges under the Due Process, Equal Protection, Takings, and Commerce Clauses. The Article also explores the housing market impacts of such legislation, balancing concerns about housing supply with the need for stability and fairness in the rental market.
Many state and federal legislators view the growing presence of institutional investors in the single-family rental (SFR) market as a concerning development, raising questions about its potential adverse impacts on housing dynamics and community well-being. Institutional investors are companies or organizations that invest money on behalf of others. Examples of institutional investors are pension funds, insurance companies, banks, real estate investment trusts (REITs), and other capital management entities. Definitions of exactly what constitutes an institu-tional investor in the SFR market vary, but a publication by the Urban Institute defined institutional investors as an entity that owns at least 100 single-family homes.
In October 2022, three U.S. House members introduced a bill, the Stop Wall Street Landlords Act, to deter future institutional investors from entering the SFR market. Similarly, in December 2023, Senator Jeff Merkley introduced a bill titled End Hedge Fund Control of American Homes Act. The bill would impose an excise tax on certain hedge funds that own excess single-family residences. In July of 2023, seven U.S. Senators introduced the Stop Predatory Investing Act, which would prevent tax incentives for private equity and large investors associated with SFRs.
State lawmakers have also introduced legislation to address concerns over institutional investors in the SFR market. In January 2023, Minnesota State House Representative Esther Agbaje introduced HF 685, a bill aimed at prohibiting corporate entities, developers, and contractors from purchas-ing, owning, building, acquiring, or otherwise obtaining any interest in single-family homes for the purpose of using them as SFRs. While the bill addresses a broader range of actors, this Article focuses on the role of institutional investors in the single-family rental market and the impli-cations of such legislation on their activities. The bill’s objectives are (1) to encourage and protect home ownership and the single-family home as a basic housing option; (2) to allow families increased access to housing through homeownership; (3) for families to build equity and wealth through their housing; and (4) to enhance and promote the stability and well-being of families and society.
State laws that seek to impose restrictions on investor participation in the SFR market will likely face legal challenges, especially if formulated with retroactive application. Such laws could give rise to lawsuits based on violations of the Due Process Clause, the Equal Protection Clause, and potential breaches of the Takings Clause. Additionally, there may be risks of running afoul of dormant Commerce Clause principles if the legislation demonstrates discriminatory intent or effects against out-of-state investors. To investigate these issues, the Article begins with a historical overview of investor participation in the SFR market. It then analyzes the various constitutional challenges that a law, such as HF 685, will likely encounter, offering an assessment of the probable outcomes of each challenge. Finally, the Article concludes by providing a brief overview of the potential economic impact of implementing such laws.
This Article will analyze the constitutionality of HF 685 based on precedent set by the United States Supreme Court as opposed to the state of Minnesota so that its analysis could apply to similar state legislation. HF 685 targets more entities than investors, but the analysis will focus on the property rights of what the proposed legislation calls “corporate entities,” which it defines as “any partnership, corporation, limited liability company, pension or investment fund, or trust.” In place of the term “corporate entity,” this Article will use the word “investor.”
Institutional investors entered the SFR market in the wake of the 2008 financial crisis, when they purchased some of the approximately 3.8 million homes that went into foreclosure. Investors saw the foreclosures as an opportunity to buy homes at low prices and generate returns through leases. In 2012, the Federal Housing Finance Agency, established by the Housing and Economic Recovery Act of 2008, announced it would allow qualified investors to purchase pools of foreclosed properties with the requirement that the investors lease the purchased property for a specified number of years. The agency argued that the rental requirement could provide relief for local housing markets that continued to be depressed by the volume of foreclosed properties and could also provide additional rental options to certain markets. As of June 2022 there were 15.1 million one-unit rental properties nationwide, of which institutional investors owned 574,000, which suggests that the total institutional investor owner-ship share is 3.8 percent. Most owners “in the SFR market are small and medium-sized investors who own less than 100 properties.”
Since the financial crisis, institutional investors have continued to grow their share of ownership in the SFR market. An emerging SFR trend is the build-to-rent market in which developers purchase large tracts of land, subdivide lots, and build single-family homes. Instead of selling the lots and homes, an investor typically owns the entire development and leases the units. High-end, build-to-rent communities include amenities like pools and fitness centers.
Critics of investor owned SFRs argue that corporate landlords are more likely to evict their tenants, raise rents, and fail to maintain their units. Critics also argue that institutional investors might contribute to escalating home prices, highlighting that individual homebuyers often face constraints to credit access and typically need to secure financing for their homes. In contrast, institutional investors make cash purchases, poten-tially influencing upward price trends in the housing market.
The legal analysis of HF 685 involves an evaluation of its potential constitutional challenges. These challenges include claims under the Due Process Clause, Equal Protection Clause, Takings Clause, and Commerce Clause. Each of these legal theories represents a distinct avenue through which opponents might challenge the proposed legislation. This section examines these challenges in detail to assess the likelihood of their success.
The Due Process Clause of the Fourteenth Amendment to the United States Constitution provides that no state government may deprive indi-viduals of “life, liberty, or property, without due process of the law.” The Due Process Clause and the Takings Clause are often intertwined in cases challenging state government regulation of private property. However, a Due Process Clause challenge exists independently of a Takings Clause analysis and necessitates scrutiny through its own distinct set of tests.
The Due Process Clause encompasses two separate government limi-tations: procedural due process and substantive due process. As its name suggests, procedural due process applies to the procedures or methods the government must employ when it deprives someone of life, liberty, or property. At a minimum, procedural due process requires notice, an opportunity to be heard, and an impartial decision-maker. On the other hand, substantive due process is concerned with the substance of the law itself. Questions that arise in a substantive due process context revolve around whether the government has a sufficient purpose for its action.
The outcome of a substantive due process challenge will depend in great part on the level of scrutiny the court applies to the challenged gov-ernment action. At a minimum, any law challenged under either the Due Process Clause or the Equal Protection Clause must be rationally related to a legitimate government purpose. The so-called rational basis test was introduced in the 1934 case Nebbia v. New York: “If the laws passed are seen to have a reasonable relation to a proper legislative purpose, and are neither arbitrary nor discriminatory, the requirements of due process are satisfied, and judicial determination to that effect renders a court functus officio.” The rational basis test is extremely deferential to government action. As such, a reviewing court very rarely strikes down a law under this test.
The middle level of review is the intermediate scrutiny test, under which the court is required to uphold a government action as constitutional so long as the government action is substantially related to an important government purpose. The last and most severe level of scrutiny is strict scrutiny, which requires a court to strike down a government action if the government is unable to show that the law is necessary to achieve a compelling government purpose. Strict scrutiny applies when a govern-ment action discriminates on the basis of race, national origin, or citizenship. It also applies when a government regulation interferes with fundamental rights such as the right to vote or travel.
To summarize, if a reviewing court applies the rational basis test to a challenged law, the odds that the reviewing court will strike down the law are extremely low. On the other hand, if the court employs the strict scrutiny test, it is very likely the court will strike down the law as unconsti-tutional. Although winning a lawsuit based on a substantive due process violation where the rational basis test is applied is unlikely, the Supreme Court has, on rare occasions, invalidated laws using this test.
A component within the broader concept of substantive due process is economic substantive due process. Economic substantive due process refers to substantive due process challenges to laws that regulate economic interests as opposed to personal freedoms. From 1905–1937, the Court struck down several government actions as unconstitutional under substantive due process as an infringement upon economic liberties. This era is commonly referred to as the Lochner era in reference to Lochner v. New York, where the Court struck down a New York law that set a maxi-mum number of working hours for bakers. A detailed overview of the history of economic substantive due process is beyond the scope of this Article, but it is important to note that the Supreme Court has not declared a single law unconstitutional under an economic substantive due process challenge since 1937.
State governments derive their power to regulate within their borders from the Tenth Amendment to the United States Constitution. “The powers not delegated to the United States by the Constitution, nor prohib-ited by it to the States, are reserved to the States respectively, or to the people.” The Tenth Amendment, as interpreted by the Supreme Court, grants states their police power. The police power gives the states extremely broad regulatory power limited only by a state’s own consti-tution, the Takings Clause, and the incorporation of fundamental rights through the Fourteenth Amendment. The police power is often described as a state’s ability to pass laws that regulate public health, safety, and welfare.
Because the ability to purchase property for use as an SFR is not a fundamental right that requires strict scrutiny analysis, a court that reviews a due process challenge to HF 685 will apply the rational basis test, which will require a two-step approach. First, a court will have to determine if the purpose of HF 685 is legitimate for the government to pursue. Second, the court will have to determine if banning investors from owning SFRs is rationally related to the government purpose.
To begin the analysis, the first step of a substantive due process challenge is to determine whether the government’s purpose is legitimate. HF 685’s stated objectives, including encouraging homeownership, increasing access to housing, and promoting family and societal stability, align with well-established principles of permissible legislative goals under the Tenth Amendment. HF 685 regulates economic interests. The Supreme Court has repeatedly held that economic land-use regulation is a valid exercise of the states’ Tenth Amendment police power. This regulatory authority often manifests through zoning ordinances, which emerged in the early twentieth century to prevent property uses detrimen-tal to citizens. “The use of the police power is generally understood to prevent harm. Because property can be put to uses that are detrimental to citizens, the government can through its police power regulate such activity.”
The Supreme Court initially considered the constitutionality of a zoning ordinance in the 1926 landmark case, Village of Euclid v. Ambler Realty Co., in which the Court considered the constitutionality of a zoning ordinance passed by the Village that established various zoning districts, thereby placing restrictions on how private landowners could use and develop their property.
Ambler, a real estate development company, owned sixty-eight acres of undeveloped land within the Village’s jurisdiction. Ambler intended to sell and develop the land for industrial uses, as the Village was essen-tially a suburb of Cleveland and “immediately in the path [of] progressive industrial development.” With the implementation of the new zoning ordinance, Ambler could no longer develop its property for industrial use, which Ambler argued significantly decreased the property’s value. Ambler challenged the constitutionality of the ordinance based on violations of both the Due Process and Equal Protection Clauses of the Fourteenth Amendment of the United States Constitution.
The Court held that the zoning ordinance was a valid exercise of the Village’s ability to regulate public health, safety, and welfare. In justi-fying its position, the Court reasoned that exclusion of buildings devoted to business trade from residential districts would promote the health and safety of children, prevent disorder, and facilitate the extinguishment of fires and enforcement of street traffic regulations. Furthermore, the Court found that the ordinance preserved a favorable environment in which to rear children by providing quiet and open spaces for play. “[W]ith the great increase and concentration of population, problems have developed, and constantly are developing, which require, and will continue to require, additional restrictions in respect of the use and occupation of private lands in urban communities.”
Post Euclid, local governments expanded the scope of zoning regu-lations to address a wider range of land-use concerns. The Supreme Court considered zoning again in 1974 in Village of Belle Terre v. Boraas. The question before the Court in Belle Terre was whether a zoning ordinance that restricted the number of unrelated individuals who could live together in a single-family home was constitutional. The statute only allowed up to two unrelated people to live together in a single-family residence.
The plaintiff property owners leased a residence to a group of unre-lated college students. After the Village cited the property owners for a violation of the ordinance, the property owners initiated a lawsuit alleging that the ordinance violated the Equal Protection and Due Process Clauses of the Fourteenth Amendment. The property owners also argued that the ordinance impeded upon certain fundamental rights of the lessors. Once again, the Supreme Court upheld the constitutionality of zoning ordi-nances. The Court reasoned that the ordinance was a legitimate exercise of the state’s police power, and in justifying its conclusion the Court held:
A quiet place where yards are wide, people few, and motor vehicles restricted are legitimate guidelines in a land-use project addressed to family needs . . . . The police power is not confined to elimination of filth, stench, and unhealthy places. It is ample to lay out zones where family values, youth values, and the blessings of quiet seclusion and clean air make the area a sanctuary for people.
In 1977, the Supreme Court analyzed another zoning ordinance preventing unrelated people from living together. In Moore v. East Cleveland, the Supreme Court reigned in the states’ police power. The ordinance contained a stricter definition of family. Unlike in Belle Terre, which defined family as those who were related by blood, adoption or marriage, the ordinance in Moore allowed only certain categories of relatives to live together. In particular, the ordinance made it a crime for a grandmother to live with her grandson. In striking down the ordinance, the Court reasoned:
[B]efore a zoning ordinance can be declared unconstitutional it must be shown to be clearly arbitrary and unreasonable as having no substantial relation to the public health, safety, morals, or gen-eral welfare; the appellee city has failed totally to explain the need for a rule that would allow a homeowner to have grandchildren live with her if they are brothers but not if they are cousins; and that under that standard appellee city’s unprecedented ordinance constitutes a taking of property without due process and without just compensation.
Although courts typically defer to the states’ power to regulate public health, safety, and welfare, Moore established a limit to how much defer-ence the Court is willing to give before it will declare a zoning ordinance unconstitutional. The Court primarily focused on the unnecessary intrusion on the meaning of family.
On its face [the ordinance] selects certain categories of relatives who may live together and declares that others may not. In partic-ular, it makes a crime of a grandmother’s choice to live with her grandson in circumstances like those presented here. When a city undertakes such intrusive regulation of the family, neither Belle Terre nor Euclid governs; the usual judicial deference to the legislature is inappropriate.
The Court did not establish a bright line rule or test for when a land-use regulation exceeds the bounds of a legitimate government purpose but sug-gested that if a regulation intrudes on personal liberties, the regulation is more likely to be struck down than if the regulation intrudes on economic interests or liberties.
HF 685 regulates land use for public welfare concerns, citing as its purpose to encourage and protect home ownership. Land use regulations, such as zoning laws and restrictions on property usage, have long been recognized as legitimate exercises of a state’s Tenth Amendment police power when aimed at promoting public health, safety, and welfare. This section evaluates whether HF 685’s stated purpose falls within these established legal principles and whether it can withstand constitutional scrutiny.
A court analyzing HF 685 under a substantive due process challenge will very likely find that the legislature is acting within the scope of its Tenth Amendment police power. On the few occasions where the Court has stuck down a land use regulation under the rational basis test, the laws in place invaded on personal liberties or targeted only particular classes that are vulnerable to mistreatment.
After a court determines that the legislature has a legitimate purpose behind its law, it will next have to determine if HF 685 is rationally related to its stated purpose. In other words, a court will have to answer in the affirmative that excluding investors from the SFR market is rationally related to the law’s goals. This does not mean a court must conclude that preventing investors from participating in the SFR market is the best way or even a good way to achieve the purpose of HF 685. Rather, a court would simply need to conclude that there is a rational relationship between the law and its purpose.
Because of the deference courts are required to give legislatures under the rational basis test, it is highly likely that a reviewing court will con-clude that banning investors from the SFR market is rationally related to the legitimate state goal of promoting and protecting homeownership for the public.
Under the system of government created by our Constitution, it is up to legislatures, not courts, to decide on the wisdom and utility of legislation. There was a time when the Due Process Clause was used by this Court to strike down laws which were thought unreasonable, that is, unwise or incompatible with some particular economic or social philosophy . . . that due process authorizes courts to hold laws unconstitutional when they believe the legislature has acted unwisely—has long since been discarded. We have returned to the original constitutional proposition that courts do not substitute their social and economic beliefs for the judgment of legislative bodies, who are elected to pass laws.
HF 685 is the type of economic legislation that, since the Lochner era, has consistently withstood scrutiny under a substantive due process challenge.
However, if HF 685 were to apply retroactively to properties already owned by institutional investors, then the outcome of a due process challenge might not be quite so obvious. A court reviewing this situation would have to determine whether the legislature acted irrationally by letting the law change existing property rights that have already been established. This kind of action, as the Court in Eastern Enterprises v. Apfel pointed out, is generally looked upon disapprovingly. Subdivision 3 of the proposed legislation reads “No Corporate entity . . . shall directly or indirectly purchase, own, build, acquire, or otherwise obtain any interest in property classified as [real estate which is residential and used for home-stead purposes]; and subsequently convert the property into nonhomestead residential real estate containing one rental unit.”
HF 685 does not explicitly state that it applies retroactively. The verbs “purchase,” “acquire,” and “build” refer to actions that can only occur in the future or the present, while the verb “own” may encompass past vested ownership. The Supreme Court has previously grappled with the question of how to interpret a law when the intent for retroactive application is ambiguous. The law must express a clear intent for retroactive applica-tion as “a requirement that Congress first make its intention clear helps ensure that Congress itself has determined that the benefits of retroactivity outweigh the potential for disruption or unfairness.” Similarly, Minnesota statute M.S.A. § 645.21 states, “No law shall be construed to be retroactive unless clearly and manifestly so intended by the legisla-ture.” Although one could conclude that the verb “own” applies to vested property rights in existence prior to the enactment of the statute, the use of the word “own,” standing by itself, does not express a clear and manifest intent for the law to apply retroactively. As such, it is unlikely a court would interpret HF 685 to allow for retroactive application.
In summary, a Due Process Clause challenge to HF 685 will likely fail. Because HF 685 does not pertain to the regulation of a fundamental right, it would undergo assessment based on the rational basis test—a standard that exhibits significant deference to government actions. Protecting public welfare through land use regulation has a long history of withstanding constitutional scrutiny. If HF 685 were to have a retroactive effect, it would potentially face a more difficult review process, but, because the current language of the bill does not express a clear intent of retroactive legislation, it is very likely HF 685 would withstand judicial scrutiny under the due process clause.
Another facet of constitutional law that will apply to HF 685 is the Equal Protection Clause. The Equal Protection Clause may be invoked anytime the government draws a distinction among people based on shared traits and enforces a rule or law against only that particular group. The essence of an Equal Protection lawsuit is whether the government’s classification is justified by a sufficient purpose.
Since HF 685 discriminates based on business type, contesting the proposed legislation for an Equal Protection violation will necessitate the application of the rational basis test. Although it is likely that the Court will uphold a law under the rational basis test, the Court has struck down land-use regulations with an application of the rational basis test to an Equal Protection Clause violation in a few instances.
In City of Cleburne v. Cleburne Living Center, Inc., the Court struck down a zoning ordinance as a violation of the Equal Protection Clause under the rational basis test. A Texas zoning ordinance required group homes for individuals with intellectual disabilities to obtain a special use permit to operate, a requirement not imposed on similar uses, such as boarding houses, fraternity houses, or dormitories. The Court concluded that the ordinance in question was not a legitimate government interest and that it rested primarily on fears and stereotypes of mentally disabled. The ruling was not without its critics. The critics were not arguing the outcome of the case; rather, the discontent was primarily over the Court’s claim that it applied the rational basis test when really it appeared to apply a stricter test than what rational basis calls for. For example, as Justice Marshall explained in his part concurring, part dissenting opinion,
I cannot agree, however, with the way in which the Court reaches its result or with the narrow, as-applied remedy it provides for the city of Cleburne’s equal protection violation. The Court holds the ordinance invalid on rational-basis grounds and disclaims that anything special, in the form of heightened scrutiny, is taking place. Yet Cleburne’s ordinance surely would be valid under the traditional rational-basis test applicable to economic and commercial regulation.
The ordinance in Cleburne is distinguishable from HF 685. In Cleburne, the ordinance discriminated based on intellectual disability. The support that the municipality cited for the justification of the ordinance focused on concerns that neighbors would be fearful and that students in a nearby school might harass the residents. Unlike the Texas ordinance, HF 685 does not discriminate against a class of people that has been subject to mistreatment or prejudice.
The Court will very likely conclude that HF 685 is rationally related to a legitimate government purpose and will thus conclude that it does not violate the Equal Protection Clause.
The Due Process Clause and the Equal Protection Clause are not the only constitutional provisions that protect property rights. This section will explore the Takings Clause and its application to HF 685.
The Takings Clause balances the rights of property owners with the occasional need of the government to acquire private land for public use. The Takings Clause prevents the government from taking private property without meeting two essential criteria. First, the taking must be for a “public use” and second, the private owner must receive “just compen-sation.” What exactly constitutes a government taking is not obvious. “The question of what constitutes a ‘taking’ . . . has proved to be a problem of considerable difficulty.” Nevertheless, two broad categories of government taking have developed through case law. The first cate-gory is a physical taking, where the government expropriates property. The second category is a regulatory taking, where government actions effectively cause a taking.
Originally, the government used its powers under the Takings Clause to take private property for public uses such as railroads, bridges, utilities, roads, parks, and schools. In the 1954 case Berman v. Parker, the Supreme Court broadened the scope of the public use when it ruled that an economic development plan to revitalize blighted neighborhoods in Washington, D.C. constituted a legitimate public use. The Court in Berman concluded that economic development of blighted areas was a legitimate exercise of the government’s police power. The Court explained:
Miserable and disreputable housing conditions may do more than spread disease and crime and immorality. They may also suffocate the spirit by reducing the people who live there to the status of cattle. They may indeed make living an almost insufferable burden. They may also be an ugly sore, a blight on the community which robs it of charm, which makes it a place from which men turn. The misery of housing may despoil a community as an open sewer may ruin a river.
The property owners argued that the government’s action of taking private property and transferring said property to new, private owners (instead of the government retaining ownership) was beyond the scope of the public use requirement of the Takings Clause. The Court rejected the argument, stating: “The public end may be as well or better served through an agency of private enterprise than through a department of government—or so the Congress might conclude. We cannot say that public ownership is the sole method of promoting the public purposes of community redevelopment projects.”
The scrutiny level that the Court employs for the public use require-ment in the Takings Clause closely resembles the criteria of the rational basis test under the Due Process and Equal Protection Clauses. This similarity indicates a high degree of deference toward government actions during a takings analysis. Essentially, if the government acts out of a reasonable belief that the taking will benefit the public, the taking will be upheld.
The Supreme Court revisited the fact pattern of the government taking private property from person A and giving said property to person B in the 1984 case, Hawaii Housing Authority v. Midkiff. In Midkiff, the Court reviewed the constitutionality of Hawaii’s Land Reform Act of 1967, which authorized the state to transfer property ownership from lessors to lessees to reduce the concentration of land ownership from a small number of individual owners. The court concluded that the state’s purpose of eliminating the social and economic evils of land oligopoly qualified as a valid public use.
Hawaii enacted the Land Reform Act of 1967 after extensive hearings and close analysis of the status of land ownership on the islands. The Act created a mechanism for condemning residential tracts and transfer-ring ownership of the condemned fees simple to the existing lessees. The Court concluded that Hawaii’s law was a valid exercise of the state’s police power and that increasing the number of private property owners in the state to break up an oligopoly constituted a valid public use for purposes of the Takings Clause. In its analysis, the Court once again concluded that the public use requirement of the Takings Clause is essentially subject to the rational basis test. “But where the exercise of the eminent domain power is rationally related to a conceivable public purpose, the Court has never held a compensated taking to be proscribed by the Public Use Clause.”
In 2005, the Supreme Court handed down a controversial ruling in Kelo v. City of New London. New London is a small Connecticut town by the coast. In the early 2000’s, the city approved an economic development plan to redevelop a particular waterfront neighborhood. The purpose of the plan was to revitalize the scenic area in hopes that doing so would draw more economic activity to the area. Through its develop-ment agent, the city purchased most of the property it intended to redevelop but the city was forced to initiate condemnation proceedings against a few holdout property owners. An important fact that distin-guished this case from Berman was that the property in question was not in a blighted area. In challenging the eminent domain proceedings, the owners argued that the taking of their properties violated the public use restriction of the Takings Clause. In upholding the constitutionality of the taking, the Court reasoned:
For more than a century, our public use jurisprudence has wisely eschewed rigid formulas and intrusive scrutiny in favor of afford-ing legislatures broad latitude in determining what public needs justify the use of the takings power. Those who govern the City were not confronted with the need to remove blight . . . but their determination that the area was sufficiently distressed to justify a program of economic rejuvenation is entitled to our deference.
In applying its precedent from Berman and Midkiff, the Court reiterated the point that it is deferential towards the states’ decisions under the public use requirement: “For more than a century, our public use jurisprudence has wisely eschewed rigid formulas and intrusive scrutiny in favor of affording legislatures broad latitude in determining what public needs justify the use of the takings power.” Again, the Court applied what was essentially the rational basis test to the takings question to conclude that the government acted within its Fifth Amendment takings power to determine that the taking was for a public use and that economic development is a legitimate government exercise.
Justice O’Connor wrote a dissent, in which she was joined by Chief Justice Rehnquist, Justice Scalia, and Justice Thomas. She argued that Kelo was distinguishable from Berman and Midkiff on the grounds that Berman and Midkiff both involved property uses that inflicted affirmative harm on society. In Berman and Midkiff, the government bodies extensively reviewed economic data and other evidence to establish the property uses did indeed have a detrimental effect. The Court’s willingness to move away from established precedent dismayed Justice O’Connor: a taking of private property from person A and giving said property to person B required a finding by the court that the original property use was harmful to society.
Under the banner of economic development, all private property is now vulnerable to being taken and transferred to another private owner, so long as it might be upgraded—i.e., given to an owner who will use it in a way that the legislature deems more beneficial to the public—in the process. To reason, as the Court does, that the incidental public benefits resulting from the subsequent ordinary use of private property render economic development takings “for public use” is to wash out any distinction between private and public use of property—and thereby effectively to delete the words “for public use” from the Takings Clause of the Fifth Amendment.
The closely decided 5–4 judgment in Kelo stirred public attention, yet it remains valid law to this day.
In addition to a physical taking and transfer of private property rights, a taking can also occur when a government regulation results in a substan-tial diminution in the value or utility of private property to the extent that it is equivalent to a physical taking. “The Supreme Court has interpreted the takings clause to protect owners from fundamentally unjust alterations of their property rights by the state, including unjust limits on their ability to use their property as they wish.”
Through case law, two broad areas of regulatory analysis have emerged. A taking can occur through a factor-based test as well as through a categorical per se taking. In the factor analysis, a court uses what has become known as the Penn Central test, named after Penn Central Transportation Co. v. New York City. Under the Penn Central test, a court weighs different variables, including (1) the economic impact of the regulation on the claimant; (2) the extent to which the regulation has interfered with reasonable investment-backed expectations; and (3) the character of the government action.
If the court analyzes a regulation as a per se taking, the court reviews the regulation to determine if the regulation falls into a particular category. The categories that constitute a per se taking include (1) permanent physical invasions of property and (2) deprivation of all economically beneficial use of the property.
There are three possible categories in which an investor could fall in relation to the proposed legislation: (1) the investor does not own any property in Minnesota, and the law prospectively prevents that investor from acquiring an ownership interest in residential homestead property for use as an SFR; (2) the investor already owns SFR property in Minnesota; (3) the investor owns property in Minnesota prior to the law taking effect but has not yet built SFRs or converted existing property into an SFR. For investors in the first category, HF 685’s restrictions would likely not present a constitutional issue, as the law does not affect any pre-existing property rights.
The second category of investors, those with a vested ownership interest in SFRs in Minnesota prior to the enactment of HF 685, could have a cause of action under a physical taking argument if certain conditions are met. This group would only have a cause of action under a physical taking if the state applied HF 685 retroactively. The situation would have to be that the state forced all current owners of SFRs to divest them-selves of their property in accordance with the enforcement section of HF 685 due to a violation of the law. The enforcement section would involve an actual condemnation hearing that concludes with a transfer of the property from the investor to a new private owner. This hypothetical situation would be similar to the Hawaii Land Reform Act of 1967, which was the subject of the lawsuit in Midkiff.
Under this hypothetical, the public use justification for HF 685 would be that private owners besides investors will put the property to a better use. This is the situation that the dissenters in Kelo warned about and is also the hypothetical that the majority in Kelo contemplated. As the majority opinion noted:
It is further argued that without a bright-line rule nothing would stop a city from transferring citizen A’s property to citizen B for the sole reason that citizen B will put the property to a more productive use and thus pay more taxes. Such a one-to-one transfer of property, executed outside the confines of an integrated development plan, is not presented in this case. While such an unusual exercise of government power would certainly raise a suspicion that a private purpose was afoot, the hypothetical cases posited by petitioners can be confronted if and when they arise.
Retroactive application of HF 685 would undoubtedly trigger concerns under the Takings Clause, as it would extend the definition of public use beyond the boundaries established in Kelo. HF 685 would apply to all property in the state and would thus amount to a one-to-one transfer of property, executed outside the confines of an integrated development plan.
The state could argue that HF 685 has more in common with the laws challenged in Berman and Midkiff than Kelo by establishing that investor involvement in the SFR market is a nuisance and a harm to the public as a whole. Then, instead of taking harmless private property from person A and giving the property person B, the state could argue that it is regulating a harmful land use in the name of promoting public health, safety, and welfare. To support its argument, the state would be wise to review economic data and other evidence to support its position, similar to the extensive amount of evidence the legislative bodies reviewed in both Berman and Midkiff.
While Kelo sparked controversy and drew nationwide attention to takings jurisprudence, it is crucial to recognize that the Court, in upholding the taking, reiterated its longstanding precedent emphasizing the need for the judicial branch to defer to state legislators in matters falling under the purview of the Tenth Amendment police power as it pertains to the definition of public use. “The disposition of this case . . . turns on the question whether the City’s development plan serves a ‘public purpose.’ Without exception, our cases have defined that concept broadly, reflecting our longstanding policy of deference to legislative judgments in this field.” While HF 685 likely would not have a retroactive application, a law like HF 685 would be afforded broad deference by the Court. It would be interesting to see whether the Court adhered to its well-established precedent or deemed the retroactive application of HF 685 to be a departure too distant from the concept of public use.
The third category of investors, the investors that have a vested ownership right in property prior to HF 685 taking effect but who have not yet used or invested in using that property as an SFR, could argue that HF 685 amounts to a regulatory taking. Factors that a reviewing court looks at in a regulatory analysis include the economic impact of the regulation, the interference with investment-backed expectations, and the nature of the government action.
The economic impact factor of the Penn Central test requires a court to consider to what extent a regulation diminishes the value of privately owned property. The cases where the economic impact factor led the Court to find there was an uncompensated taking involved situations like Lucas v. South Carolina Coastal Council, where the ordinance in question barred a property owner from erecting any permanent, habitable structure on his property. The petitioner bought the property before the ordinance was passed with the intent of building residences on the property. The Court reasoned:
We think, in short, that there are good reasons for our frequently expressed belief that when the owner of real property has been called upon to sacrifice all economic beneficial uses in the name of the common good, that is, to leave his property economically idle, he has suffered a taking.
The factor pertaining to the interference with reasonable investment-backed expectations centers on finding an equilibrium between individ-uals’ entitlement to rely on the established legal framework at the time of their investment and the government’s need to adapt laws in response to changing circumstances, with the goal of safeguarding public health, safety, and welfare. Where a regulation imposes an opportunity loss that prevents the owner from realizing the benefits of a future use that the owner intended to make but did not yet invest in, a court is less likely to hold that the law is a taking.
The final factor of the Penn Central test is concerned with the nature of the government action and focuses on the fairness of the law. “The Fifth Amendment’s guarantee that private property shall not be taken for a public use without just compensation was designed to bar Government from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.” This factor is reminiscent of substantive due process. The Supreme Court has upheld government action that impacted some landowners more than others, citing the states’ police power to regulate for public health, safety, and welfare as justification for its decisions. Does investor ownership of SFRs impose some harm on society similar to a brickyard in a residential area or mining of a gravel pit? Legislators would be wise to articulate why they believe that to be the case, supporting that reason with data.
Due to the fact-specific nature of regulatory taking questions, an analysis of hypothetical scenarios is necessary. If an investor owns a single-family residence prior to the law taking effect but has not yet used that property as an SFR and the property is in an area that is zoned exclu-sively for single-family homes, is that a regulatory taking? The investor has a few options. The investor could do nothing and let the property sit vacant. The investor could invest in upgrading the home and sell it to someone who will occupy the home as a residence. The investor could sell the home as it is. These options are similar to what the property owner in Lucas faced. This hypothetical also presents an extensive interference with an investment-backed expectation. The investor would have bought the property in anticipation of generating a return through leases and in reliance on the existing law. If the investor is not able to lease the property and instead must sell, the investor may still be able to capture a return but doing so would certainly disrupt the investment strategy. In this specific hypothetical, a reviewing court might find that there was an extensive interference with investment-backed expectations and that there is a deprivation of all economic use of the property and thus the law, in this instance, amounts to a regulatory taking.
Before HF 685 took effect, if an investor owned property in a natural, undeveloped state with the intent to develop the property for SFRs, the investor would experience a missed opportunity similar to the develop-ment company in Euclid. The property would lose some value to the investor, but the investor could still use the property for other uses, such as building single-family homes to sell instead of rent. In this particular hypothetical, it is less likely a reviewing court will find that HF 685 amounts to an uncompensated taking.
In summary, investors who do not own any property in Minnesota after HF 685 takes effect will not have a cause of action under the Takings Clause because they do not own a vested property right. If the state were to retroactively apply HF 685, compelling existing investors who own SFRs to divest their properties in accordance with the enforcement provi-sions of HF 685, the law would be subject to a physical takings analysis that could render it invalid. Investors who possessed property in Minnesota before the law came into effect, but had not yet utilized the property for SFR purposes, will face a reduction in property value and potential disrup-tion to their investment-backed expectations. The outcome of a regulatory taking analysis would be fact driven and specific to each case.
Another area of the Constitution that has been the basis of lawsuits involving government regulation of property rights is the Commerce Clause. The Commerce Clause gives Congress authority “to regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.” Although the phrase “dormant Commerce Clause” appears nowhere in the United States Constitution, courts have interpreted the language of the Commerce Clause to mean that Congress’s ability to regulate interstate commerce implies that state governments may not regu-late interstate commerce when doing so excessively burdens commerce among the states. Thus, the Commerce Clause has two different functions. One, it allows Congress to pass laws regulating commerce. Two, it places a limitation on state regulation that excessively burdens commerce among the states.
Gibbons v. Ogden is a landmark case in which the Supreme Court interpreted Congress’s authority to regulate interstate commerce. The Court ruled that the Commerce Clause provides Congress with broad authority to regulate interstate commerce. The Court reasoned:
The subject to which the power is next applied, is to commerce ‘among the several States.’ The word ‘among’ means inter-mingled with. A thing which is among others, is intermingled with them. Commerce among the States, cannot stop at the external boundary line of each State, but may be introduced into the interior.
The Court further clarified the type of internal state activities that amount to interstate commerce in the 1942 case Wickard v. Filburn. Wickard established what is known as the “aggregate effect test” also known as the “substantial effect test.” In short, Wickard established the principle that even small-scale, individual activities within a single state can be considered interstate commerce if, when combined with similar activities on a larger scale, the collective activities have a substantial effect on the national economy.
The Eighth Circuit Court of Appeals, in South Dakota Farm Bureau, Inc. v. Hazeltine, analyzed the Commerce Clause to determine whether a state law, similar to HF 685, was constitutional. In 1998, as the result of a referendum, Amendment E was added to the South Dakota Constitution. The amendment prohibited corporations and syndicates, subject to certain exemptions, from acquiring or obtaining an interest in land used for farming and from otherwise engaging in farming in South Dakota. Thirteen plaintiffs joined together to challenge the legality of Amendment E, claiming that it violated the Commerce Clause.
As the court in Hazeltine summarized, an analysis of a law’s constitu-tionality under the Commerce Clause requires a two-tier approach. To begin, a court must ask whether the challenged law discriminates against interstate commerce. The Supreme Court has held that a law can discriminate against interstate commerce in three different ways: (1) a law can discriminate against interstate commerce on its face; (2) a law can discriminate against interstate commerce when evidence in the record demonstrates the law has a discriminatory purpose; or (3) a law can discriminate arbitrarily against interstate commerce when it has a discrim-inatory effect. If a court finds that the law is not discriminatory, it must move on to the second tier of the analysis where it will evaluate whether the burden the law imposes on interstate commerce is clearly excessive in relation to it putative local benefits.
The Hazeltine court concluded that Amendment E violated the dormant Commerce Clause because of the law’s discriminatory pur-pose. In supporting its conclusion, the court looked at various evidence that established the drafter’s intent for Amendment E to discriminate against out-of-state businesses. Most significant was a “pro-con” list created by the then South Dakota Secretary of State. In describing the list, the court wrote:
[T]he “pro” statement informed voters that, without the passage of Amendment E, ‘[d]esperately needed profits will be skimmed out of the local economies and into the pockets of distant corporations.’ Further language from the “pro” statement explains that ‘Amendment E gives South Dakota the opportunity to decide whether control of our state’s agriculture should remain in the hands of family famer and ranchers or fall into the grasp of a few, large corporations.”
Furthermore, the court found indirect evidence in the record that established discriminatory intent. The court held that irregularities in the drafting process can indicate a discriminatory purpose. In Hazeltine, the drafters of Amendment E did not review any evidence that confirmed that a ban on corporate farming would further the law’s stated objectives—to preserve family farms and protect the environment. The court was also dismayed that the drafters made little to no effort to discover any evidence that would confirm that a ban on corporate farming would further the law’s purported purpose.
Because the court concluded that Amendment E discriminated against interstate commerce, the court applied a test akin to strict scrutiny, which required the court to strike the law as unconstitutional unless the govern-ment could demonstrate that it had no other method by which to advance its legitimate local interests. The court concluded that the law was unconstitutional because the record contained no evidence that the state suggested, evaluated, or critiqued alternative solutions.
Because HF 685 is facially neutral and applies to all corporate entities equally without giving preference or special privilege to domestic corpora-tions, the only way it could be found to discriminate against interstate commerce is if it has a discriminatory purpose or a discriminatory effect. For the purposes of this analysis, discriminatory purpose and discrimina-tory effect have been combined into one category. The Court in Hazeltine rested its decision on the discriminatory purpose category.
Courts will review laws for a discriminatory purpose/effect on a case-by-case basis. Unfortunately, there is no set standard for the type and amount of evidence of discriminatory purpose/effect that is enough to tip the scale in favor of a finding that the law discriminates against interstate commerce. However, a court is more likely to find discrimination if it believes a law is motivated by protectionist purpose, helping in-staters at the expense of out-of-staters.
HF 685 may have a discriminatory purpose or effect if the aim is to help in-state citizens at the expense of out-of-state investors. The Federal Reserve Bank of Minneapolis recently published an article analyzing the extent of investor ownership of SFRs in the Twin City area. The authors identify “very large investors” as investors with fifty or more properties in their Twin Cities portfolio. The article opens with “Investor ownership of single-family rental homes has risen in the Twin Cities area over the last fifteen years, and one driver is the increasing presence of very large, and in many cases, out-of-state investors.”
The article goes on to provide data on the four very large investors with the largest market share of SFRs in Minneapolis. Those investors are Home Partners of America (an Illinois company), Invitation Homes (a Texas company), Progress Residential (an Arizona company), and Bridge Investment Group (a Utah company). Interestingly, the authors also provide a pro and con type list reminiscent of the one the court relied on in Hazeltine:
On the one hand, the single-family rental market provides households that are not interested in or ready for homeownership more options in terms of style of home, living space, and location. On the other hand, the growth in ownership by out-of-state and large investors in the Twin Cities market has raised concerns among policymakers and community advocates alike. Out-of-state ownership may make owners less responsive to tenant and community concerns about property maintenance. Or, on the flip side, it may provide the resources for more responsive property management.
Although this article is not written by the legislators who drafted the proposed law, the article does indicate the sentiment of state policymakers and how they might view out-of-state investors in the SFR market.
In addition to targeting investors, HF 685 also indirectly impacts renters. Aimed at restricting investors from utilizing homes as rental properties, HF 685 may inadvertently impact renters who are more likely to be transient than homeowners. It is easier for a renter to move from one state to another than a homeowner. If the state expresses a preference for homeowners over renters, it could potentially lead the court to conclude that protectionist motives exist.
Because HF 685 is a proposed law that has not yet made its way out of committee, it is hard to determine with certainty if the drafters have a discriminatory purpose. Key evidence that could indicate a discrim-inatory purpose would include statements by the drafters of their wish or intent to exclude out-of-state investors from the SFR market. Proponents of this type of legislation often cite distant and uncaring landlords as a policy consideration that supports the law.
Other evidence that could indicate a discriminatory purpose is the type of evidence the legislators rely on in making their decision to support the proposed law. Ideally, the legislative process will include testimony and evidence that establishes the law will further its purpose.
Evidence and testimony should establish a connection between investors in the SFR market and discouragement and a threat to home ownership and the single-family home as a basic housing option. It should also establish that investors in the SFR market decrease access to housing through homeownership and the ability to build equity and wealth through housing and that investors in the SFR market hurts the stability and well-being of families and society in Minnesota. A lack of evidence or testimony establishing that connection could lead a reviewing court to determine there were irregularities in the drafting process that can serve as indirect evidence of a discriminatory purpose.
If a reviewing court finds that the HF 685 does not discriminate against interstate commerce in its purpose or effect, it might still find that the burden HF 685 imposes is “clearly excessive in relation to the local putative benefits.” This determination requires the application of the balancing test established in Pike v. Bruce Church, Inc. In Pike, the Supreme Court struck down an Arizona law that required cantaloupes grown in the state to be packed and labeled there before shipment. The Court concluded that the law placed a significant burden on interstate commerce by forcing a company to construct a costly packing facility in Arizona, even though its existing facilities outside the state were sufficient. The Court held that when a state law regulates even-handedly to effectuate a legitimate local public interest, it will be upheld unless the burden imposed on interstate commerce is clearly excessive in relation to the putative local benefits. The balancing test set in Pike gives the court discretion in its decision because there is no formula or standard for how to compare the burdens on interstate commerce with the benefits to the state or local government. Generally, once a court has found that a government action does not discriminate against interstate commerce, it will uphold the law.
In summary, if the Minnesota legislature aims to enact HF 685 while minimizing judicial scrutiny for potential dormant Commerce Clause violations, it should be clear during its hearings and testimony that the intent behind HF 685 is not to prevent out of state investors from entering the market, but rather the intent is to apply the law equally to all investors whether in state or out of state, and it should be ready to demonstrate that such a law will further the law’s purpose.
If the supply of housing consistently matched demand, issues like affordable housing shortages and escalating home prices would not be an issue. However, systemic constraints prevent the achievement of this balance. As illustrated by Figures 1 and 2, in the spring of 2006, new privately-owned housing units reached a peak point of production. From there, the number of new, privately-owned housing units drastically declined, reflecting the impact of the housing crash and subsequent chal-lenges in recovering to pre-crash production levels.
Potential constraints on the supply of new homes include the availability of land, labor, credit, and construction materials. Another frequently cited source of supply constraints is housing regulation. In particular, zoning laws have recently received attention for their potential to contrib-ute to the increasing costs of new construction and the housing supply issues. The argument is straightforward: stringent housing regulations prevent builders from building enough new homes to meet demand, which then drive up the price of all homes.
Limited empirical evidence exists regarding the extent to which owner-occupied homes versus investor-owned SFRs affects local housing conditions. As researchers Ingrid Gould Ellen and Laurie Goodman note in their single-family rentals policy proposal:
Our review of the evidence shows that single-family rentals have long represented an important segment of the rental market. Large institutional investors own a small share of these rentals in most markets, though that share has grown. Their impact on these housing markets remains uncertain. It is unclear whether institu-tional investors crowd out individual home buyers, and evidence about whether they behave differently than other landlords is thin.
The lack of robust empirical evidence on the impact of institutional investors on housing markets highlights the need for further research to inform effective policymaking.
HF 685 not only prevents investors from buying existing homes and using them as rentals, but it also prevents investors from building single-family homes for the purpose of renting. Institutional investors play a role in increasing the housing supply by financing and constructing single-family homes. Although investors initially rent these homes, they may eventually sell the homes to individual homeowners, contributing to the long-term availability of housing stock. By restricting such investments, HF 685 risks slowing the construction of single-family homes, further constraining the housing supply and potentially making homes even less affordable.
Alternatively, proponents of HF 685 may point to recent legal developments that underscore their concerns. For instance, the Department of Justice recently accused seven major corporate landlords of illegally colluding to increase rent prices. The DOJ accused the corporate landlords of sharing confidential rental data through RealPage, a top software provider to the multifamily rental industry. RealPage then utilized an algorithm to recommend higher rental prices based on this shared information, which allegedly reduced competition and led to increased housing costs for renters across the country. These allegations bolster proponents’ claims that corporate landlords' unchecked practices contribute to rising housing costs, justifying legislative intervention to stabilize housing markets.
While these concerns are valid, HF 685 also risks unintended consequences. By restricting institutional investment in SFRs, HF 685 may discourage capital investment in the housing market overall, slowing the development of new housing supply and exacerbating affordability challenges. The challenge lies in balancing efforts to curb exploitative practices while ensuring adequate housing production to meet demand.
In conclusion, laws aimed at restricting institutional investors’ entry into the SFR market underscore a juncture at the intersection of legal and economic considerations. While the intent of such laws may be to address housing concerns and protect local interests, such legislative measures will not be immune to legal challenges. Notably, if these laws are crafted with retroactive application, they are susceptible to serious constitutional scru-tiny. Retroactive enforcement raises concerns of due process violations and potential violations of the Takings Clause. Moreover, these laws may face problems under a dormant Commerce Clause analysis if they are designed to discriminate against out-of-state investors. While legislators seek to navigate the complex landscape of the SFR market, the legal viability of their efforts remains contingent on a delicate balance between addressing their concerns and ensuring adherence to constitutional principles.
