rent control and the rental market

Rent Control Is Bad for Tenants and Ruining Landlords

When people hear the phrase “rent control” they typically conjure up one of a few images in their minds. Tenants imagine easy street, a world where housing is ridiculously low cost. Maybe they think of rent control in NYC, where they saw the characters from Friends live in large apartments for far below market value.

If the person is a landlord or property manager, they think of reduced profits, and tenants who live in a unit for years on end, never paying market value for the property.

Economists, on both the left and the right, scowl at the thought of what is simply bad public policy.

A prime example is Thomas Sowell, a world renowned Economist who would tell you that both tenants and landlords suffer from rent control. Sowell attended Harvard for his bachelor’s degree, earned his doctorate from the University of Chicago, and currently works at Stanford.

What we’re saying is that this is a really smart guy, certainly smarter than you or me, so we should probably listen to what he has to say. His thoughts on rent control are discussed in-depth in his book Basic Economics, which inspired this article and contains much of the following information.

Rent Control and Its Effect on Housing Demand

In your typical, uncontrolled market, prices vary with the amount of demand. That is, prices rise because the amount of a product that people want exceeds the amount that is available at current prices. More simply, more people want an item than there are items to go around, so to get that item you go into an indirect bidding process with other buyers.

Imagine a fellow named Jerry and a girl named Elaine. Jerry wants a one-bedroom apartment in San Diego, but he can only afford $850 a month in rent. Elaine also wants to find a one-bedroom apartment, but she can afford $1,500 a month in rent. Because there is currently a free market in San Diego, Jerry can’t find a one-bedroom for $850 a month. There are a limited number of units and there are many more “Elaines,” who are also willing to pay $1,500, which means rents hover around that value. As a result, Jerry reluctantly rents a room in a 3-bedroom apartment with two roommates. In the meantime, Elaine seeks her one-bedroom, and indeed she finds one at market price. It is crucial to remember that this is not a unique situation, this happens over and over again throughout all of San Diego, and this is what keeps prices at their current value.

However, in an alternate reality where San Diego has rent control, Jerry is able to find his one-bedroom apartment for $850, but so can his two roommates, and so can Elaine. This happens across the city, resulting in more people trying to rent one-bedroom apartments than there are one-bedrooms that are available. This results in a shortage of housing. This effect can be illustrated by vacancy rates in the real world. Vacancy rates tend to be at about 7 percent nationally, certainly something we see here in Phoenix, a city that currently has no rent control. However, in cities with rent control, the vacancy rate is often much lower. For example, in San Francisco the vacancy rate is around two percent, and in San Jose it is about one. Ultimately, this makes it hard for tenants to find housing. While a low vacancy rate sounds good for landlords, there is no benefit when the tenant is paying far below market value.

Rent Control and Tenant Behavior

When rents are artificially low, renters will use up more of the available housing than they would in a naturally regulated market. For example, many young adults tend to live with their parents, some even stay after college. This is a practice that is more and more common as students attempt to pay off high student loan debt. However, when rents are controlled young adults will seek to find their own housing. Why wouldn’t they, now they can afford it!

And it isn’t just young adults who have a typical pattern of renting behavior; in fact, there is a normal cycle of behavior for all renters. Imagine a young married couple, Fred and Wilma. When they married, they moved into a one-bedroom apartment. Then, when they had their son Barney they needed more space and moved into a three-bedroom apartment. After Barney left for college, and became gainfully employed, Fred and Wilma moved back into a one-bedroom apartment. This way they could reallocate rent money and spend it on trips, movies, and fancy dinners instead.

However, in a city with rent control, Fred and Wilma would behave much differently. When they had their son they would move into the three-bedroom or even a four-bedroom apartment. But when Barney moved away to school they wouldn’t relocate to a smaller apartment. Why would they? They are getting a large apartment for far below its true market value. If they moved they might have to pay more money for less space. Indeed, there is no motivation for them to relocate.

Again, Fred and Wilma wouldn’t be the only people to behave this way; this behavior would take place citywide. When new, growing families start looking for a place to live, they will struggle to find adequate housing. Any housing that they would find would be prohibitively expensive. On the flip side, older couples, who are likely to be more financially stable, are still living in the inexpensive units that they no longer need.

Rent Control, New Housing Developments, and Landlord Behavior

As illustrated above, and in countless case studies, there is a somewhat immediate affect on the housing supply when rent control is introduced. But what is the long-term effect on housing when rent control exists in a given area?

First, fewer housing developments are constructed. Logically, this makes sense. Any investment is a gamble, and real estate is no exception. In an unregulated market there is a potential to make a great return on a real estate investment that has been properly planned. In contrast, it becomes very difficult to profit from residential housing in a city with rent control. And let’s get real, investors aren’t building out of the good of their hearts.

This is their livelihood and they need to be able to turn a profit for themselves and the other parties involved in their investment. As a result, developers will start building commercial structures instead of residential housing. As an article from The New York Times illustrates, there was more residential development taking place in New York during the great depression than there was in 1997 – largely because of rent control.

As an illustration, rent control is the equivalent of limiting the pay of professional basketball players to $50,000 a year. Athletes now and in the future would instead use their talents to play baseball, football, soccer, and any number of other sports. Likewise, in a market with rent control, builders turn to making commercial buildings so they can continue to turn a profit.

Furthermore, not only does rent control have an effect on the housing that would be developed, but the housing that currently exists is either reduced in quality or eliminated entirely. Because a landlord no longer profits from their property, they are no longer able or willing to make the necessary repairs to a residence. There is no reason for them to do so, they can only charge a certain amount and they are no longer competing with other landlords. This is inherently problematic. Normally, they would improve a property to either get more profit, or because it would allow them to compete for a larger pool of better tenants. Yet, this does not happen when rental values are limited.

The final effect is that affordable housing isn’t built and current housing goes into total disrepair. If it isn’t yet clear how important this is, the following should paint the sobering reality. In Basic Economics, Sowell suggests that there are four times more abandoned units in New York than there are homeless people living on the streets. Building owners abandoned the units because they could no longer profit from their ownership.

Ultimately, the housing supply sees a momentous shift. Old living spaces deteriorate and the only new housing that is built is luxury, since it is usually exempt from rent control laws. The result is a market where the only new housing available is that which can be afforded by the upper class.

Why Does Rent Control Exist?

So if rent control is hurting tenants and bad for landlords, why does it exist and whom is it helping? Unfortunately, rent control is a political tool more than anything else. At face value, rent control sounds like good policy because it is marketed as a housing solution intended to help the poor. Intuitively, it seems like it would assist individuals of lower socio-economic status. However, as previously discussed, it only limits housing options and increases the cost of available rentals. Yet, people like the way it looks and will vote for a politician who pushes for rent control, regardless of its disastrous effects.

Moreover, rent control is a policy that ends up supporting the middle and upper class, quite the opposite of its supposed goal. As Sowell suggests, and which has been documented elsewhere, the people who tend to benefit are usually more wealthy and more well connected, as this tends to help with getting to the front of the queue for a rent-controlled unit. For example, Ed Koch was the Mayor of New York in the early 80’s, and he paid just $450 a month for an apartment. The true, market value of that apartment was closer to three times that amount. Certainly, no one could rightfully suggest that the Mayor of New York would be in dire need of affordable housing. Yet, this is the type of person who typically benefits from this policy.

The Damaging Effect of Rent Control

In closing, rent control is often marketed by politicians as a way to help the lower class. They paint the landlord as an old miser who is simply out to get the poor, and rent control as a way to stop this antagonist. The public often idealizes such a scenario. When not critically analyzed, rent control sounds utopian. One of our largest expenses has now been limited? Who wouldn’t sign up for that? Yet, the effects are rather tragic, as both liberal and conservative economists agree.

On the one hand, tenants find extremely limited housing, and the housing they do find is run down or comes with a price tag that is nowhere near affordable. On the other hand, landlords can no longer profit from their investments. This results in both a loss of new developments and a reduction in the quality of current housing.

If you think this doesn’t affect you – think again. In Seattle rent control has been proposed multiple times, and this is in Washington, a state where rent control is illegal by state law. Indeed, there are several cities where rent control is currently being proposed, including San Diego and Richmond. So just because you don’t live somewhere with rent control does not mean that it can’t affect you and your local economy now or in the years to come.

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