“Second Generation Rent Control” is a Failure

Commentary, Housing Affordability, Steve Lafleur (historic), Uncategorized

The scourge of rent control was vanquished in Saskatchewan by the NDP during the 1990s. Unfortunately, the party is now promising to implement “second generation rent control.” While not as disastrous as the former rent control regime, it would merely replace one type of rent volatility with another.

Rent control has been one of the greatest public policy failures of the last hundred years. Swedish economist Assar Lindbeck famously wrote that "next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities." Preventing landlords from charging market rate rents leads them to skimp on repairs and maintenance. It also removes the incentive for construction of new units. This leads to an under-supply of rental units, which can only be corrected in the long run by rationing or higher prices. The evidence against the effectiveness of rent control is so strong that in a survey of 464 economists, over 93% agreed that “a ceiling on rents reduces the quantity and quality of housing available.”

Many policy analysts have struggled to find a way to marry the stability of rent control for existing tenants with the ability of the market to supply new units, leading to the creation of second generation rent controls. In the variant advocated by the NDP the controls don't apply to new tenants, but allows for exceptions to ensure that landlords can recover certain cost increases, such as the cost of performing maintenance and upgrades. Rather than trying to dictate the overall rental price level, the central aim is to eliminate “gouging.”

To figure out why second generation rent control fails, it is key to understand the landlords' perspective. If annual rent increases on existing tenants are limited, how will this affect rental rates? Since landlords have no way of knowing how long tenants will stay, the answer is to set initial rental rates higher to make up for the fact that they cannot raise rents to match the market rate until the tenants leave. This effectively creates a subsidy from short term to long term renters.

Second generation rent control schemes, such as the program in Manitoba, allow landlords to raise rents in order to cover repairs and renovations. This provision is meant to combat the tendency of landlords in rent controlled cities to allow buildings to crumble. Ironically, this can lead to the same types of dramatic swings occasionally seen in overheated rental markets, but the results are far less predictable. While a hot real estate market will lead to upwards pressure on rents (which can be alleviated with the construction of new units), the volatility can at least be predicted. But when individual landlords will need to undertake expensive repairs, or decide to renovate a building is less predictable. As the housing stock ages, renting can become akin to gambling. This has become a serious problem in Manitoba. Incidentally, Manitoba's rent control scheme is the “success” story that Dwain Lingenfelter wishes to emulate. In non-controlled markets, landlords can plan to finance renovations and repairs by gradually increasing rents. In controlled markets, rent increases are bottled up until capital expenses need to be undertaken. Second generation rent control simply replaces market volatility with randomness.

In order to ensure rental affordability in Saskatchewan, the province should adopt some of the tax reforms suggested by the Chamber of Commerce, such as eliminate the punitive 46.7% tax on rental income and tax rental companies as they tax other companies. Given that the small business tax rate is 13%, the savings would be enormous. Another reform would be to allow rental companies to roll over capital gains that are reinvested in new residential developments. This would reduce the cost of building new units. The municipalities should also cease to tax rental properties at a higher rate than owner occupied housing. This is an implicit subsidy to homeowners. While 'sticking it to the landlords and developers is appealing to many, these costs are passed on to renters.

In addition to cultivating a competitive rental market, the province should introduce rental vouchers for those who are truly unable to afford decent housing. This would allow people with temporary financial difficulties to continue paying their rent, and would also reduce the need for subsidized housing. The cost would be a fraction of the $320 million NDP affordable housing platform. More importantly, it is an effective method of alleviating poverty.