Short Read

Rent Control: Housing populism meets economic reality

With rent prices increasing far faster than wages, the problem of affordable housing in many Western countries is at its highest level in years. Combined with a failure of low priced social housing to keep up with rising demand, it is not surprising that affordable living has become one of the most important voter issues to urban dwellers.

One “solution” to this growing problem that has made a comeback in recent years is “rent control.” London Mayor Sadiq Khan, for example, has made wide-ranging rent controls intended to address soaring rents the key plank of his 2020 re-election bid. Senator Bernie Sanders, currently the leading Democratic candidate for President, has similarly called for new nationwide rent-control laws.

For many people, especially the young and those who are struggling to “make rent” in large cities like London, New York and San Francisco, rent control is appealing. It provides sustainable housing for those already living in rent-controlled flats, and because the rent cannot be increased beyond a legal limit, existing tenants become largely insulated from skyrocketing rent prices.

Despite its popular and political appeal, it is important to analyze rent control from an economic perspective in order to determine whether such proposals make sense as a solution to the housing affordability problem.

Rental housing follows the same basic laws of economics as other consumer goods: when the demand consistently exceeds the supply, prices will rise until the quantity supplied expands to equal the amount demanded. As shown in the chart below, the resulting equilibrium occurs at a price (P1) where the supply (Q1) meets demand (see Figure 1).

While rent control may split politicians along predictable conservative and liberal lines, it has actually unified virtually all economists, from both the left and the right, in opposition to it. This is because rent control, which is a government program or law that places a limit on the amount that a landlord can charge for leasing a home/flat or for renewing a lease, distorts the law of supply and demand. More specifically, economists generally cite three reasons why rent control is a flawed idea.

First, the quantity of affordable housing almost always decreases in practice under rent control, thus exasperating the underlying problem.
Specifically, when landlords cannot earn a “market” rate of return on their property because of rent control, they are incentivized to pull their rent-controlled properties off the market by either selling them to owneroccupiers or converting them into condominiums (if they are in a multi-unit building). For example, Many landlords in San Francisco, which implemented rent control in 1979, converted their properties into condos, which decreased the rental supply by 15%. According to LSE Professor Kath Scanlon, London “landlords would simply decide they were no longer going to rent their properties” under Sadiq Kahn’s proposals.

In economic terms, rent control sets an artificial price below the equilibrium price. Generally speaking, landlords selling their rental units and/or converting them into condos results in a supply (Q3) at the rent control price (green line), that is actually less than the original supply under the free market (Q1). Over time, and in some more extreme cases, the lower rent controlled price causes the supply curve to shift to the left, and the new supply line (S2) results in a dramatically lower level of supply (Q4) at the rent control price compared to the original free market level (Q1). Demand, however, skyrockets under rent control, shifting from Q1 to Q2 (see Figure 2).

The distortion shown in the above chart can also come about when builders of new rental properties react to the introduction of rent control laws by building fewer new rental units (the new S2 curve, above). If builders cannot make a sufficient profit to justify the cost of construction, landowners/builders will look to build more profitable alternatives, e.g., storage buildings, offices, or other commercial developments, rather than rental housing.

Simply put: rent control tends to reduce the number of affordable rental units in a city over time while simultaneously increasing the demand for rental housing.

Unfortunately, this is the exact opposite to what most economists would advocate as the best solution to the lack of affordable housing: building more affordable units.

Second, economists also object to rent control laws because they tend to worsen the quality of low income housing over time.

Since landlords cannot earn a “market” rate of return under rent control, they typically react (assuming they don’t sell or convert their properties) by refusing to reinvest in maintenance and upkeep so as to maintain their profit margin. A study by Professor Paul Niebanck on the effects of rent control on the quality of the housing stock in New York City found that 29% of strictly rent-controlled housing had deteriorated, compared to only 8% of the non-rent-controlled units. A similar result has been found in Great Brittan, Austria, France, Sweden and Canada.

Finally, third, and perhaps not surprisingly, renters tend to stay in rent-controlled units for a very long time, often for life (and then pass them onto their children), notwithstanding their deteriorating quality, and even after those individuals can afford a better, non-rent-controlled, flat. In large rent-controlled cities such as New York, thousands of apartments sit empty because, although their renters don’t actually live there, they keep paying the rent on the property because its price is so far less than its real value.

On a city-wide scale, the introduction of rent control over time tends to cause the city’s housing stock to degrade and even disappear, with some areas degrading to slums with abandoned houses.

Rent control has been tried repeatedly across the globe, from Asia to Europe to the Americas, in big cities and in small, because it has an undeniable populist appeal. With the rise in inequality and so many people questioning capitalism, it is no wonder populist politicians are once again turning to the rent control playbook.

But as discussed herein, rent control is, without a doubt, a quintessential example of what the Germans call a Verschlimmbesserung: an attempted improvement that actually makes things worse than they already were.

Economists are as unequivocal as they are unanimous in their assessment of rent control: it is a poor idea. Rent control tends to bring about exactly the opposite of what the politicians promise: it reduces the amount of low-income housing and it leads to a deterioration in the living conditions of those lucky to secure a rent controlled flat.

But since these inevitable effects on the housing supply are likely to hit only after a politician either moves onto higher office or retires, rent control is likely to continue to be proposed again and again. It is therefore up to us to learn the lessons of economics and use them to resist rent control’s appealing Siren’s Song.

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