Saturday, July 19, 2014

Reuben Chapple: Rent Controls Rebutted

It's an unfortunate fact of life that during periods of expanded market demand, tenants looking for housing may have to spend weeks or months in an often vain search for a suitable place to live. 

They might end up renting something smaller than they might like, and/or in a less desirable location. Some have reportedly even resorted to bribes to get landlords to move them to the top of waiting lists.  Meanwhile, they may double up with relatives, sleep in garages, or use other makeshift living arrangements.

Rent control refers to laws that set price controls on residential dwelling units with the stated intention of making life more affordable for low income renters. They typically function as a price ceiling on certain classes of residential property, such as flats or apartments, and in particular areas or suburbs of a city.

Poverty pimps claim rent controls are necessary to rescue helpless tenants from the high rents charged by "greedy" landlords, which would otherwise force those unable to afford market rents to leave an area or downsize to meet their pocketbook. Residential landlords are typically demonised as bloodsucking rack renters, but these people are rarely super-wealthy. They're usually small investors who have scrimped and saved to buy a rental property or two.

According to Harvard University Professor of Economics, Greg Mankow, some 93 percent of professional economists agree that rent controls reduce housing supply and housing quality. This is the most widely accepted position among economists across the ideological spectrum, and heads Mankow's list of facts upon which professional economists concur. This near-unanimity is based on the fact that rent controls have proved an abject failure wherever they have been tried.

Leftists are fundamentally ignorant of basic economics, have a visceral hatred of free markets, have yet to see a government programme they don’t like, and evaluate public policy entirely on the basis of whether or not it makes them feel virtuous.

Their opponents, on the other hand, evaluate public policy on the basis of whether or not  it works.

A free market is neither moral nor immoral. It simply reflects existing economic reality.

Here's how a housing market works. Like the market for any other commodity, the price mechanism allocates scarce resources between competing interests in the most economically efficient manner. Prices send signals to owners and renters to upsize, downsize, or stay put. House prices will rise in response to increased demand. And if suppliers are free to respond to this pent-up demand, they will increase the supply of housing, thus bringing down prices over time (assuming short-term supply exceeds short-term demand) to a market equilibrium.

Auckland house prices are a function of supply and demand for residential housing in that locality. Since everyone apparently wants to live in Auckland, owner-occupier and landlord pressure on available housing stock bids up prices, and thus rents. The  lead time in bringing new construction to market creates a short-term lag between increased demand and increased supply, but over time, developers will respond by building affordable new housing if government leaves them alone to do so.

Calls for rent controls in the Auckland housing market are a classic example of how government creates a problem, which then leads to calls for more government intervention to solve the problem. As we shall see below, this then creates further problems, which elicit calls for further government intervention.

On the supply side, the key driver of Auckland house prices is local government overriding private property rights.  Urban growth boundaries around Auckland and endless restrictions, obstructions, and bureaucratic delays facing anyone subdividing and building on land within the boundary prevent the market from responding efficiently to increased demand.

Urban growth boundaries cause land prices within the growth boundary to rise, along with the price of everything built on that land. Unnecessary subdivision and compliance costs increase the cost of new homebuilding still further. To keep profit margins up, developers will stop building to the lower end of the market.

Construction of low-priced housing becomes even more uneconomic in a rent-controlled environment. If homebuilding at the bottom end of the market is made unprofitable, developers and investors will switch to constructing office buildings, warehousing, and non-rent controlled housing where they can generate an appropriate return on investment.

The increased construction of luxury apartments and houses for the affluent who aren’t affected by rent controls, further harms the low income earners that the rent controls aimed to assist. The lack of entry -level new builds exacerbates housing shortages at the bottom of the market, causing house prices and rents across the board to rise well above what would prevail if the market were left alone to do its work.

Keeping housing costs down for both owners and renters means more housing. We need a variety of new supply that accommodates families at every price point. Rent controls are not the answer. What is required is a rethink of zoning restrictions, development controls, and regulatory costs so that developers can bring more low-priced development land to market.

Instead of identifying big government as the source of the problem and finding ways  to rein it in, leftists call for rent controls to make housing more affordable at the margin.  Having wrecked the supply side of the housing market, they propose to remedy the market distortions they have created by doing the same to the demand side.

Rent controls not only exacerbate an existing supply side housing shortage, but act upon the demand side to reduce housing quality, deter investment, and raise the price of unaffected rental dwellings. If rents are kept artificially low, there will be higher demand for low-priced rental housing and less people willing to supply it at the government-mandated price ceiling.

If builders and landlords are restricted in the rents they can charge as well as slapped with high development costs and lumbered with red tape, they are even less willing to construct more housing. Residential landlords unable to generate appropriate rates of return will move their money out of rental property will switch it into more profitable alternative investments. As in any other market in which demand exceeds supply, these entirely rational actions create a shortage in the low-priced housing market.

Landlords holding uneconomic rental properties they can't unload have no incentive to fix up or maintain, since rates of return are already lower than alternative forms of investment. Where supply is perpetually low, landlords don't have to worry about tenants leaving for somewhere better. They can get away with skimping on maintenance to mitigate the lower rental income received. If all the rent goes towards paying one's mortgage and other property outgoings, why bother maintaining the place? 

Rent controls create a vested interest class of protected tenants, meaning they become a political hot potato, and an untouchable entitlement. Rent controls entrenched in this manner, as in New York and San Francisco, make rent controlled buildings unsaleable at any price due to negative returns on investment and decades of deferred maintenance.  Property owners end up walking away, leaving local authorities to take over ownership in lieu of unpaid rates and taxes.

In these and other cities, the number of abandoned rent controlled buildings now runs into the thousands, turning whole neighbourhoods into drug- and crime-ridden slums inhabited by non-rent paying squatters. This forces government to step in using taxpayers' money for slum clearance projects. The derelict buildings are then demolished and taxpayers forced to pay up again for the construction of social housing in their place.

Renters lucky enough to be a dwelling when rent control are put in place  effectively make money at the expense of the landlord.  They almost never leave and why would they? Low income earners who weren't in a rent-controlled property when the clock struck midnight are the ones who miss out.

In New York and San Francisco, many people who started out in rent-controlled accommodation move into their own homes as their economic fortunes improve. It is not uncommon for a rent-controlled tenant to move out while retaining the lease in their name, thus preventing the landlord from legally raising the rent. They will then illegally sublet at a higher rental to a third party, who is charged a rent well above that paid to the landlord. This creates an unregulated sub-market in which those desperate to find a home are trapped.

Rent controls mean that people who  wouldn't normally be renting -- such as young adults still living with their parents, or elderly people living with relatives -- are encouraged by artificially low prices to move out and become renters. 

Artificially low prices also incentivise others to seek or continue to occupy larger housing units than they would ordinarily be living in.  When a new family is created, people need more space and are usually prepared to pay for it. As they age and children leave home, they require less space. Post-retirement, household incomes typically decline, throwing accommodation costs into sharper focus.

Rent controls don’t force people to economise. Under a rent control regime, an elderly couple can afford to occupy a larger dwelling than they actually need, and have little incentive to sell out or to rent somewhere smaller. This means families are often unable to find somewhere suitable to live, causing more scarcity and overcrowding.

Rent rises in a free market are a response to actual market demand, which incentivises people to make economically appropriate decisions. Families economise by moving into smaller dwellings to save money. Childless couples renting or owning three bedroom houses may decide that they can live in two-bedroom apartments.  Families with children who need the space will move in. Young adults may decide to continue living with their parent a little longer, until they are earning enough to go flatting.  The net result is that the price mechanism allocates the available rental stock to those who are prepared to pay the market price for it.

In summary, rent controls do not work. All they achieve are higher rents and a decreased supply of lower-priced housing than would prevail in an unregulated rental market. This obliges central government to step in and build more social housing, thus chaining an ever-increasing number of people to the state, a sure-fire vote-getter for leftist politicians. After all, anyone promising to rob Peter to pay Paul can always count on Paul's vote.

Rent control advocates are either well aware of this fact and should come clean on their underlying agenda of stealth socialisation of housing markets, or economic illiterates who need to do a lot more reading before running their mouths.

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