Efficient Rental Markets

David Seymour, Housing Affordability, Publications, Saskatchewan, Uncategorized

Executive Summary

  • For several years, Regina has been the site of advocacy for a Rental Unit Licensing (RUL) scheme that would require mandatory, periodic inspections of rental properties.
  • Advocates of the scheme claim it will be expensive but effective in solving housing problems and, by association, some of the social pathologies in poor neighborhoods.
  • There is no known empirical evidence regarding the success of RUL schemes in the handful of U.S. cities where they were tried.
  • Most of the people found advocating for them in the literature that has been cited are employed as administrators of RUL schemes.
  • Conventional economics anticipates that because landlords supply rental housing voluntarily, they will react to government-stipulated standards and compliance by either exiting the market or raising prices. With landlords exiting, we should expect tenants to be left with fewer options to the same extent, that they have better options.
  • However, there is the possibility that by correcting market failures, government could increase the overall efficiency of the rental market and therefore the standard of housing available in low-income neighborhoods.
  • Conventional economics predicts that landlords and tenants face the problems of asymmetrical information and moral hazard. This is partially confirmed by the public displays of distrust between landlord and tenant representatives.
  • Asymmetrical information is a market failure wherein one party to a deal knows more about what they are offering than another. The result is that the party with less information assumes the worst, or worse than they should about the deal they are entering into. In the case of rental deals, both parties have limited information about the reliability of the tenant/landlord and so assume they are taking a bigger risk than they may actually be taking. The result is a ‘missing market’ for people who would like to pursue good rental conduct, and distrust that leads to neglectful behavior. The level of animosity between advocates of RUL and landlord association representatives recently is an indicator of the level of distrust.
  • Moral hazard is a market failure where two parties enter a deal where one or both are able to pass the costs of their actions onto the other, but cannot monitor the true behavior of the other party. The result is that both parties attempt to surreptitiously pass the costs onto the other. In rental markets it is difficult for landlords and tenants to know whether problems with a property result from poor maintenance/treatment or genuine maintenance problems. With no other incentives present, both parties will try to ‘do their worst’ so that the other party carries the cost of neglect.
  • In the world of e-commerce, these market failures were solved by giving traders an electronic profile that consists of feedback from traders in previous deals. This paper contends that a similar solution for the rental market could solve the missing-market problem faced by landlords and tenants, raise the incentives for good conduct on both sides, lower maintenance costs and ultimately improve the standard of housing.
  • Read the entire 14 page paper by David Seymour in PDF format