The economic case against rent controls

Liam Harkness October 6, 2017 0
The economic case against rent controls

“In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing.”[i]

Jeremy Corbyn’s announcement that Labour would seek to implement rent controls, were it to get into power, is not a new idea. It is, nevertheless, a terrible idea; both for those it seeks to help and for the wider population, as I explain in this article.

High rent is a signal to the market to provide more housing to let and capping rents will only lead to shortages.

Rent is a price like any other. It is a fee in return for which the owner allows you the exclusive use of his property for a given time period. In exchange for foregoing the opportunity to use it himself, or to sell it and realise the value, he demands a fee.

The critical issue is that the price is typically not an arbitrary figure. The amount a landlord will charge will be typically decided by the market. This price also acts as a signal. One of the key principles of economics is that, as the price of an object rises, so does the amount which people, acting through the market, will be prepared to supply.

High rents, then, are a signal from tenants to prospective landlords to let more property and the high rents in the centre of Edinburgh, for example, are a sign that there is a shortage of rental properties there. What is needed is an investment in the housing stock and the high rents on offer serve as an incentive to do this.

Expensive rents are, therefore, a sign of a problem and not a simply a problem themselves. Capping rents will not solve this problem. Rather, it is the equivalent of being woken in the night by the fire alarm, getting out of bed and fighting your way through the smoke; only to take the battery out of the smoke detector and go back to bed. The alarm may stop sounding but the reason it was going off is still there: your house is on fire. Silencing the signal does not solve the problem. In fact, when framed like this, it seems positively crazy.

The consequence of capping rents and blocking the signal is that the much needed investment does not occur. Furthermore, if rents are forcibly lowered, the incentive to landlords is to leave the rental market. This will reduce the rental housing stock, not increase it.

2014 protest calling for London rent controls by the Trade Unionist and Socialist Coalition (TUSC)

A good case study here is New York, where rent controls have been in existence in one form or another since the second world war. As posited above, the impact of rent controls is to reduce investment in housing. Consequently, during the 1070’s whole areas of the city were left to decay and the housing stock was badly affected. Perhaps as a result, the population of New York actually declined in this period:

“Rent control has destroyed entire sections of sound housing in New York’s South Bronx and has led to decay and abandonment throughout the entire five boroughs of the city. Although hard statistics on abandonments are not available, William Tucker estimates that about 30,000 New York apartments were abandoned annually from 1972 to 1982, a loss of almost a third of a million units in this eleven-year period. Thanks to rent control, and to potential investors’ all-too-rational fear that rent control will become even more stringent, no sensible investor will build rental housing unsubsidised by government.”[ii]

The pattern of decay continued into the 1980’s and onwards. From 1981 to 2011 the percentage of rent controlled properties fell from 45% to 32% of the total housing stock.[iii] In this period the total number of rental properties rose by only 196,590 from just under two million to just under 2.2 million (a rise of less than 10%);[iv] in comparison, the population of the city rose by over one million in the approximately corresponding period to reach 8.2 million people;[v] a rise of 16%. It can be seen, therefore, that rent controls hinder both the stock of rent controlled properties and the total amount of housing stock.

The quality of available housing falls.

This is largely because there is no reason for a landlord to maintain a property to the same standard as before. Why would you spend time and money making a 15 year old whisky if it could not be sold for any more than a 10 year old? You would reduce the quality to match the price you can get for it.

In the rental market, rental income is often measured in terms of yield to market value of the property. For example, a property valued at £200,000 may yield a rent of £1,000 per month, equal to £12,000 per year or 6%. Now, a landlord has an incentive to improve the value of his property to increase the rental value. Or he may sell a property which is producing a lower yield (say 5%) and buy one which can produce 6%. This is like moving your ISA from RBS to Lloyds to obtain a better rate.

Consequently, if the rent for the property in question is suddenly capped at £10,000 p/a (or 5% yield) there is no reason for the landlord to maintain or improve it: No amount of money spent can improve the return on his investment. In fact, it serves him better to let it fall into disrepair. If, due to poor maintenance, it falls in value to £160,000, the yield on the property has increased to 6.25%. So this is what happens: The quality of the housing stock deteriorates as there is no point in improving it. Indeed, the landlord, who is now out of pocket by several thousand pounds per annum, may no longer be able to afford to maintain the property to the same standard.

Therefore not only does the quantity of affordable rental accommodation decrease, the quality also deteriorates.

The few beneficiaries cannot be reliably predicted and may not be those targeted by the policy.

This distortion of market forces affects not only the under-occupation of rent controlled houses. Where rent controls are implemented it is frequently to assist poorer residents to put a roof over their heads. However, it affects all those who happen to be in rent controlled properties at any given time, including those who it is very unlikely would be the intended beneficiaries of the policy. After all, if your rent is low and any increases are capped, why risk moving?

A stark example of this is Nora Ephron, a former Hollywood screenwriter. When she died in 2012 she had a wealth of $27 million.[vi] Yet, for many years she lived in a rent controlled apartment in New York for one third of the market rate.[vii] Surely she cannot have been the intended beneficiary of rent controls?

Sadly, not only do rent controls help those they should not, they often end up hindering those they should be helping, as I will now elaborate.

Rent controls act as a barrier to social mobility and can become a welfare trap.

Someone locked into a rent controlled property has less reason to move than they otherwise would in a free market because normal economic pressures which would force people to move and free-up housing stock do not apply to the same extent. This is very similar to the situation faced by tenants in social housing, where despite waiting lists, much of the social housing stock is actually under occupied.[viii]

What happened, and continues to happen, is tenancies are awarded to a family with children. Ultimately the children mature and leave home. The parents may then have a three bedroom house with only one bedroom in regular use as such. For most people, the decision to retain their house or to downsize becomes an economic decision. However with social rents set at uneconomic levels, such pressures do not exist in the same form. As a result there is a shortage of social houses large enough for families. Additionally, even if you get one, it can be difficult to move at a later date from one social house to another as they simply do not become available often enough. It is noted that:

“Only 3 per cent of those who managed to move within social housing – around 5,000-6,000 households nationally out of approaching 4 million social tenants – had done so for job-related reasons. However, 10 per cent of the moves from social renting to private renting were associated with work – again, around 6,000 moves. In summary, the figures suggest that if social tenants do want to move for job-related reasons, it is very hard indeed to do so while remaining within the sector: if they did have to move for work, most could have to leave social renting, sacrificing the advantage of low rents, and move into private renting. The resultant pattern of job-related mobility is very slow – contrasting with the one in eight moves overall that are for job-related reasons.”[ix]

Where you are a recipient of sub-market rents then you are incentivised to stay there. Since people move for work this actually serves as a barrier to employment. This becomes a welfare trap, whereby those who live in rent controlled accommodation may be worse off if they take a better-paying job somewhere which requires them to move.

It should come as no surprise that this situation arises in rent controlled settlements as well:[x] There is a far weaker incentive to vacate a rent controlled property than one in the free market.

This has consequences not only for the sitting tenant but for prospective ones as well. With sitting tenants less likely to move, rent controlled properties appear on the market much less frequently.

At what level do you cap the rents?

A practical problem also arises when seeking to cap rents. A two bedroom flat in the centre of Edinburgh costs substantially more than one in Falkirk or even one in a different area of Edinburgh, such as Gorgie. The more desirable and luxurious a flat is, the higher the rent it can command. If your cap merely gives rent a haircut, trimming a few percent off the maximum a two bedroom flat can let for, who will benefit? The only properties affected will be those at the top end of the market. In effect, it will lead to a reduction in the rents of the richest fraction of the renting populous but it will not, as is usually intended, help the poorest. If, on the other hand, you massively restrict how much you can charge, you will destroy the market by making all but the least desirable properties commercially non-viable. This will, in turn, lead the wealthier renters to turn to the lower quality housing which will drive out the poorer renters. Either way, you are not helping those you seek to help.

Gorgie in Edinburgh

What tends to happen, then, is that certain properties are classified as rent controlled and others are not. This serves to exempt “luxury” housing from the benefit of a rent cap which enabling greater targeting of caps at those whom the government consider to be the most deserving. However, as Block observes:[xi]

“In addition to allowing exemptions for new housing, regulators often do the same for luxury units, on the grounds that the rich do not need the ‘protection’ afforded by rent control. As a result, investment in lavish accommodation increases, and its price falls, while very few modest suites are built, and their price tends to rise.”

This is surely counter to the goal of the rent controllers, who seek to encourage a greater supply of affordable housing, not a shorter supply.

Conclusion

In short, rent control is second only to carpet bombing as a way of destroying the housing stock of a city. If Jeremy Corbyn were truly committed to reducing the cost of rental housing, the following steps could be taken to improve the housing market:

(i) Loosen planning laws which enforce green belts and height restrictions on buildings. This would increase the potential housing for a city such as Edinburgh.

(ii) Abolish the requirement to have developers set aside at least 25% of the housing stock for social housing.[xii] In order to recoup the costs of doing so, the developer must charge private purchasers 33.3% more (in order that every three buyers buy 133.3% x 3 = 400% or four houses). Abolishing this would therefore reduce the costs of new property by 25%.

(iii) Scale back the onerous requirements of planning gain. This obliges the developer to commit to building schools, graveyards, roads, libraries, and more for the council in return for planning permission. This imposes another huge burden on the developer which can only be met by recharging this to the end buyer. Savings here could again amount to a significant reduction on the cost of a new house.

(iv) Abolish HMO licencing, which imposes additional costs and bureaucracy as a barrier to entry into the rental market. This leads to fewer landlords and higher rents as landlords must recoup the costs of unnecessary building alterations.

(v) Abolish registered landlord schemes. These are an interference in the right to use one’s own property, an attack on freedom of contract and, from an economic point of view, simply another costly barrier to entry into the market. We need more landlords, not fewer.

(vi) Reform social housing which is, as a solution, worse than the problem it seeks to ameliorate. Many people are familiar with the image (right or wrong) of council estates being ghettos of crime and poverty. If these were designed to help people then surely they have failed. By removing social housing, council tax could be reduced freeing cash for tenants to pay their own bills and to stand on their own two feet.[xiii]

Sadly I do not hold my breath for such reforms even though I believe that they would benefit not only private tenants, but the whole of society. What I have written has not been purely self-indulgence but an appeal to reason that I hope people will heed. However, the continued popularity of rent controls, in spite of economic arguments stacked against them, rests as much on the desire for control by politicians as much as it does on the ignorance of the electorate.[xiv] Sadly, as Gunnar Myrdal observed:

“Rent control has in certain Western countries constituted, maybe, the worst example of poor planning by governments lacking courage and vision.”[xv]

References 

[i] Assar Lindbeck, The Political Economy of the New Left (New York: Harper and Row, 1972); cited in Sven Rydenfelt, “The Rise, Fall and Revival of Swedish Rent Control,” in Rent Control: Myths and Realities, Walter Block and Edgar Olsen, eds. (Vancouver: The Fraser Institute, 1981), pp. 213, 230.

[ii] Taken from “Rent Control”, Walter Block, http://www.econlib.org/library/Enc/RentControl.html.

[iii]Rent Stabilization in New York City”, New York University School of Law, p2. Available here at: http://furmancenter.org/files/publications/HVS_Rent_Stabilization_fact_sheet_FINAL_4.pdf

[iv] Ibid.

[v] Gibson, Campbell. “Population of the 100 Largest Cities and Other Urban Places in the United States:1790 to 1990, United States Census Bureau, June 1998. See also 2000 & 2010 censuses.

[vi] Reported in the Daily Mail, 01/10/13: http://www.dailymail.co.uk/news/article-2440053/When-Harry-Met-Sally-writer-Nora-Ephron-left-27million–double-estimated-wealth-playing-stock-market.html

[vii] Retold in the New Yorker, amongst other sources: http://www.newyorker.com/magazine/2006/06/05/moving-on-3. See also the New York Times from 03/06/06, available here: http://www.nytimes.com/2006/06/03/opinion/03tierney.html.

[viii] “Removal of the Spare Room Subsidy, p4, available here: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/330005/removal-spare-room-subsidy-july-2014.pdf.

[ix] p109, “Ends and Means: The future roles of social housing in England”, John Hills, February 2007. Available here: http://eprints.lse.ac.uk/5568/1/Ends_and_Means_The_future_roles_of_social_housing_in_England_1.pdf.

[x] “Rent Control: An economic abomination”, Block, Horton & Shorter, International Journal of Value-Based Management, 1998, Kluwer Academic Publishers, at p256.

[xi] Block, Ibid at pp254-5.

[xii] http://www.edinburgh.gov.uk/download/downloads/id/292/developer_contributions_and_affordable_housing.pdf

[xiii] Some people, for reasons no fault of their own, may struggle to house themselves. That is really unfortunate. Nevertheless, there is no reason why charity cannot take the place of the state. People who wish to support someone or some group can do so out of their own pockets, but nobody has the right to live at the expense of anyone else.

[xiv] see the Daily Telegraph article “Rent Controls: A bad fix for a problem that doesn’t exist”; 05/01/2015, available here: http://www.telegraph.co.uk/finance/comment/11325316/Rent-controls-A-bad-fix-for-a-problem-that-doesnt-exist.html.

[xv] Gunnar Myrdal, “Opening Address to the Council of International Building Research in Copenhagen,” Dagens Nyheter (Swedish newspaper), August 25, 1965, p. 12; cited in Sven Rydenfelt, “The Rise, Fall and Revival of Swedish Rent Control,” in Rent Control: Myths and Realities, Walter Block and Edgar Olsen, eds. (Vancouver: The Fraser Institute, 1981), p. 224.

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