Why Rent Control Fails to Ensure High Quality, Low Cost Rental Housing

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

The holidays are a time when many of us count our blessings, and think of society’s least fortunate. While there are many things that can be done to help those in need, some policies designed to do so backfire. Rent control is one of them. Surveys of economists continually show a nearly perfect consensus within the profession that rent control reduces the stock and quality of rental housing. The case against rent control is so one-sided that the arguments seem like clichés. The reason that rent control is destructive is simple: if rents are held below market level, there will be less investment in rental housing. This manifests in two forms. First, fewer units are built. Second, landlords of existing units invest less in repairs and upgrades.

Manitoba’s rent-control model attempts to mitigate this problem by allowing initial rents to be set freely, and giving a 20-year window before rent controls kick in. This approach is something of an improvement over traditional rent control, but ultimately it has not solved the incentive problem facing investors in new rental housing. 

A simple hypothetical example demonstrates why Manitoba’s “solution” to the problems created by rent control doesn’t work. Suppose that a property management company considers buying an apartment building. They are allowed to rent it out at whatever price they choose for 20 years – and then the building will be torn down. It isn’t hard to figure out what would happen to the value of the property. The company would be willing to pay far less than for an equivalent building that was not scheduled for destruction, as it would be impossible to generate any new revenue after twenty years. If investors know that a property’s rental value will decline or evaporate in twenty years, its value is diminished right away.

Applying the same logic to Manitoba rental properties, capping rent increases in the future reduces the value of the property (and the desirability of investing in housing) immediately. Companies have long time horizons. They are concerned with the long long-term value of assets. If they tried to sell the property in 19 years, it would be sold at an amount that reflects the restrictions on future rent increases. The same would be true if they sold it in 18 years, 17 years, or today. Consequently, caps on rent increases, even if they won’t kick in for twenty years, result in some level of investment that would otherwise go toward the housing stock being driven to other, more profitable investments. Renting out units needs to be profitable.

One potential side effect of the Manitoba model offers negative incentives to the construction of affordable units. Since units over $1140 are exempt from controls, there is a strong incentive not to bother building anything cheaper. The only way to keep rental prices low is to ensure that developers can provide sufficient housing to meet market demand without imposing unnecessary costs. Increases in economic output and population do not intrinsically increase housing prices. The Houston and Atlanta metro areas each added over 1 million inhabitants between 2000-2010. Despite being the two fastest growing metro areas in North America, they have two of the most affordable housing markets on the continent. The median housing price in Houston for 2012 was $159,500.  So much for the argument that resource booms and population growth necessarily increase housing prices. In the absence of other constraints, lower house prices lead to lower rent prices.

How have these two metro areas kept housing costs under control? By having a sensible regulatory framework for housing development, and avoiding onerous land-use restrictions. After all, onerous land-use regulations correlate strongly with high housing prices. This relationship has been demonstrated by several studies including the Annual Demographia International Housing Survey, and several studies from Harvard economist Edward Glaeser.

Rent control fails to achieve the objective of ensuring abundant, high quality, low cost rental housing. Fortunately, there are plenty of other tools available to help promote affordable housing. By following the examples of Houston and Atlanta, and eliminating the land-use regulations that drive up housing prices, Canadian municipalities can help make housing more affordable while avoiding the now well-known but unintended negative consequences of rent control.