Rent Control: Why It Actually Does Not Work

There has been increasing demand for rental housing due to multiple factors discussed elsewhere in my blog, including high home ownership costs, demographic shifts, lifestyle preferences, burdens of student and consumer debt.  Supply has not kept up with this demand, especially in the area of affordable housing due to the increasingly high costs of construction (labor and materials), permitting, and land acquisition.  However, income levels for many people has remained relatively stagnant, especially in relation to general inflation and frequently below the specific subset of higher rent inflation.

This increasing rental demand with insufficient supply and stagnant wages has resulted in a growing percentage of household income going to housing, whether as an owner or a renter.  This disparity has increased so much that the number of renter households considered cost burdened (37.5% of renters spend 35+% of their income on rent) or severely cost burdened (23% of renters spend 50+% of their income) has become a widely perceived problem.

Government and politicians understandably view this as a valid, significant issue for their constituents.  Not only does it limit people’s ability to afford the housing they desire, but it also takes funds away from consumer spending and other mechanisms of economic growth that the government generally likes to encourage.

There have been sporadic attempts to help the supply side.  This warrants more awareness and focus than it receives, since supply side initiatives create a “rising tide raises all ships” environment where everyone can benefit and investors are incentivized to spend their hard earned money plus valuable life time creating affordable housing.  In the current environment, without incentives, investors have no reasonable reason to create affordable housing.  It is difficult to do, and the returns are paltry at best.  So, why bother unless the investor is a government or non-profit organization whose purpose is to create housing without needing to create income or mutual benefit to an investor?

It has become conceptually easier and more politically expedient to focus on the existing base of properties and investors than help drive the supply side, and regulations have re-surfaced that limit the amounts that landlords can charge.  This theoretically results in caps on increases in rent and keeps those rental increases from spiraling out of control for many income/cost constrained households, as has been occurring especially in high demand markets.  The majority of voters are tenants (or home owners) and the minority are rental property owners.  So, landlords are the easier target to place restrictions on and allow politicians to demonstrate they are “doing something” to address the affordable housing issue.

As a result, there is recent or pre-existing rent control legislation adopted in Oregon, California, Illinois, Maryland, New York, New Jersey, and Washington DC.  As a counterpoint to that, it is interesting to note that 37 states actually have laws that prevent local governments from implementing rent control measures, presumably in response to the many studies showing that rent control can be an unintentionally bad thing.  Landlord groups have recently filed lawsuits in federal court against some of these state rent control initiatives, claiming that they violate property owners’ constitutional rights.

There is extensive evidence from many different sources that rent control does not work overall or as intended.  Experts against rent control include both liberal and conservative leaning political groups (spanning from Democrats and NPR shows to conservative and libertarian think tanks), the vast majority of professional economists, and even some well-informed housing advocates who go beyond a soundbite level of solutions.

A survey of economists with the long standing National Economics Association found that 93% of professional economists agreed “a ceiling on rents reduces the quality and quantity of housing available.”  It creates a short term gain for long term pain situation.  There have actually been some prior laws that were later removed after negative repercussions were observed in the real world from the initially well intentioned laws.

Here are examples of what rent control can inadvertently create:

• Landlords more likely to raise rents now even when did not plan to do so: Some landlords that did not plan to raise rents are now actively planning to raise them to the maximum allowed by new laws.  This allows them to not get too far behind in the future, by taking incremental steps on a consistent basis rather than no or minimal rent increases for a while to encourage good tenants to stay.  There is evidence that this is already happening in California, for instance.
• More likely to terminate leases that would otherwise be extended: Landlords are incentivized to terminate and not provide extensions for tenants who have leases well below market.  If landlords feel trapped by their lower rents and ability to raise them closer to market rate at some point in the future, then the only way to get them up closer to market rate in some states is to completely end the existing lease and start fresh with a higher market rate lease and a new tenant.  Different markets and legislation address this aspect differently, and it is considered a current plus future risk factor by property owners regarding potential future legislative change.
• Leases more likely to go month to month than long term: Instead of locking landlords into lower rate rents, they are more likely to be short term month to month leases which increases flexibility for landlords to get higher rate rents by starting fresh with a new tenant.  This reduces landlord risk while increasing tenant risk of location disruption and moving costs.
• Currently excluded properties may proactively increase rents as a preemptive move before more legislation.
• Landlords must increase rents if they want to sell their property in the near future: If a landlord has below market rents and wants to sell their property, they will need to increase their rents as much as possible since the value they will get for selling will be based on their current income plus a maximum addition of the delta above that regulated by law.  Without rent control, a new buyer has the option to bring rents all the way up to market and they plus their lenders can provide an offer priced accordingly.  With rent control, a new buyer can only bring rents up to market if the rents are already very close to market.  So, the seller is incentivized to raise rents as much as possible.  This is usually the case anyhow on a sale, but it becomes even more important now.  Also, lenders will only underwrite and lend on the lesser of the actually obtained market rate or the maximum amount that property can get under rent control.
• In some cases a tenant willing to stay and pay market rent will not be allowed to do so: If a landlord wants to get market rate rent and yet has been providing significantly under market rent to a good tenant, that tenant does not even have the option to stay and pay the market rate rent since the landlord cannot legally raise it to market rate.  The tenant has to move and be replaced.
• Deterioration of existing properties: With lower return on investment and less potential to leapfrog beyond steadily inflating maintenance and construction costs, landlords have less incentive plus budget to improve the properties where tenants live.
• Biases against poor: Rent control results in more stringent selection criteria beyond rent itself, where household income, credit scores, etc. come more into play.  These tend to work against poorer households.  Inadvertent discrimination is also more likely to occur, especially for single mother households with historically lower than average incomes and other factors.  In addition, more affordable housing with poorer residents are more likely to experience the deteriorating conditions mentioned above.  Multiple National Economics Association studies and other sources have shown that higher income residents actually benefit more from rent control than lower income residents.
• Rent control can exacerbate local crime rates: Economists performed a comparison of crime rates during rent control and after rent control was removed in an area of Massachusetts, and found that crime went down after rent control was removed.
• Reduced mobility of tenants: Tenants become locked in to their below market rents and know they cannot replicate that low rent when they move to a market rate rent elsewhere.  So, it can become a Catch 22 where the tenant enjoys current economic benefit though it limits their life and job opportunity choices.  A study of New York rent controlled housing found that rent control tripled the expected length of residence.
• Less future supply (new construction or rehabs): Investors are already getting apprehensive about a potential economic downturn at some point.  They are getting stricter in their investing criteria and planning.  If there are upside and investment return restrictions such as rent control in place, then it further reduces appeal for further investment in producing new units to meet renter demand.  This results in an even larger gap between supply and demand, and all the issues above spiral outwards.

Are there examples that can provide a counterpoint to some of the many downsides to rent control above?  Yes.  In addition, there are many occurrences where the legislated caps are not bumped up on, or the caps only protect a smaller subset of renters who have been paying well under market though the majority of renters may be paying closer to market.  Nonetheless, the issue remains that a relatively small group of people (landlords) are being targeted to provide and solve a societal need for the majority of others, at the small group’s personal expense without offsetting compensation for taking on the societal burden.  In a supposedly free market, these interventions cause the real world break downs and unintended ripple effects outlined above (and there are even more issues than on this list).

The stronger solution appears to reside on the supply side.  Government can increase incentives for investors, enable low interest construction programs, provide low cost rehabilitation loans for existing affordable housing candidate properties, streamline permitting processes, build housing on its own and through affordable housing non-profits, provide appropriate zoning flexibility to enable cost effective building, etc.  These types of efforts will both help balance the supply side and create win-win scenarios where investment toward affordable housing could actually occur.

There is a cost for all of these supply side solutions, especially if they involve subsidies or incentives.  Nonetheless, the cost is spread out among all people who are advocating for it, instead of targeting a select few and then inadvertently causing all of the undesirable after-shocks described above.

This is not an easy or simple black & white issue.  However, politicians and voters need to better understand that rent control is a politically expedient “do something” solution that actually has long term negative implications that only come to light after the politicians and advocates have claimed initial victory and moved on.