Rent controlled apartment on Friends
When laypeople hear the phrase “rent control”, they typically conjure up one of a few images. Tenants imagine easy street, a world where housing is ridiculously low cost. Maybe they think of rent control in NYC, where they saw the characters from Friends live in large apartments for far below market value. Landlords think of reduced profits, and tenants who live in a unit for years on end, never paying market value. Economists on both the left and right, meanwhile, simply picture bad policy.
A prime example is Thomas Sowell, a world-renowned economist who claims both tenants and landlords suffer from rent control. He discusses this in his book Basic Economics, and his arguments have been summarized here.
With Rent Control Comes a Greater Demand for Housing
In an uncontrolled market, prices vary with the amount of demand. That is, prices rise because the amount of a product that people want exceeds the amount that is available at current prices. Put simply, more people want an item than there are items to go around, so to get that item you go into an indirect bidding process with other buyers.
Imagine a fellow named Jerry and a girl named Elaine. Jerry wants a one-bedroom apartment in San Diego, but he can only afford $850 a month in rent. Elaine also wants to find a one-bedroom apartment, but she can afford $1,500 a month. Because there is currently a free market in San Diego, Jerry can’t find a one-bedroom for $850. There are a limited number of units and there are many more “Elaines” who are also willing to pay $1,500, which means rents hover around that value. As a result, Jerry reluctantly rents a 3-bedroom apartment with two roommates. Elaine finds a one-bedroom one at market price. This is not a unique situation, happening throughout San Diego, and is what keeps prices at their current value.
In an alternate reality where San Diego has rent control, Jerry is able to find his one-bedroom apartment for $850, but so can his two roommates, and so can Elaine. This happens citywide, meaning more people try to rent one-bedroom apartments than there are one-bedrooms available. This results in a shortage of housing.
This effect can be illustrated by vacancy rates in the real world. Vacancy rates tend to be at about 7 percent nationally, including here in Phoenix, a city without rent control. However, in cities with rent control, it is often much lower. In San Francisco it is around 2%, and in San Jose 1%. Ultimately, this makes it hard for tenants to find housing. While a low vacancy rate sounds good for landlords, there is no benefit when the tenant is paying far below market value.
Changes in Tenant Behavior
When rents are artificially low, renters will use up more of the available housing than they would in a naturally regulated market. For example, many young adults tend to live with their parents, some even stay after college. However, young adults will seek to find their own housing when rents are controlled. Why wouldn’t they? They can afford it now!
And it isn’t just young adults who have a typical pattern of renting behavior. In fact, there is a normal cycle of behavior for all renters. Imagine a young married couple, Fred and Wilma. When they married, they moved into a one-bedroom apartment. Then, when they had their son Barney and needed more space, they moved into a three-bedroom apartment. After Barney left for college, and became gainfully employed, Fred and Wilma moved back into a one-bedroom apartment. This way they could reallocate rent money, spending it on trips, movies, and fancy dinners.
However, in a city with rent control, Fred and Wilma would behave differently. When they had their son they would move into the three-bedroom apartment. But when Barney moved away to school they wouldn’t relocate to a smaller one, since they were getting the large apartment for far below market value. If they moved they would have to pay more money for less space. Indeed, there is no motivation for them to relocate. Fred and Wilma wouldn’t be the only people to behave this way; it would occur citywide. When new, growing families would start looking for a place to live, they would struggle to find adequate housing. Any housing that they would find would be prohibitively expensive. On the flip side, older couples, who are likely to be more financially stable, would still be living in the inexpensive units that they no longer need.
Landlord and Developer Response to Rent Control
As illustrated above, there is a somewhat immediate affect on the housing supply due to tenant behavior. But what is rent control’s long-term effect on the quantity and quality of housing?
First, fewer housing developments are constructed. Any investment is a gamble, and real estate is no exception. In an unregulated market there is a potential to make a great return on a real estate investment that has been properly planned. In contrast, it becomes very difficult to profit from residential housing in a city with rent control. As a result, developers will start building commercial structures instead of residential housing. As an article from The New York Times illustrates, there was more residential development taking place in New York during the great depression than in 1997 – largely because of rent control.
Rent control is the equivalent of limiting the pay of professional basketball players to $50,000 a year. Athletes would instead play baseball, football, soccer, and other more remunerative sports. Likewise, in a rent controlled market, builders turn to making commercial buildings so they can continue to turn a profit.
Furthermore, not only does rent control have an effect on the housing that would be developed, but the housing that currently exists is either reduced in quality or eliminated entirely. Because landlords no longer profit from their property, they are no longer able or willing to make necessary repairs. Normally, they would improve a property to get more profit, or because it would allow them to compete for a larger pool of tenants.
The final effect is that affordable housing isn’t built and current housing goes into disrepair. In Basic Economics, Sowell suggests that there are four times more abandoned units in New York than there are homeless people. Building owners simply abandoned the units because they could no longer profit from ownership.
Who Does Rent Control Help?
So if rent control hurts tenants and landlords, who does it help? Unfortunately, rent control is a political tool more than anything else. At face value, it sounds like it would help the poor, but often helps the middle and upper classes. As documented by Sowell and elsewhere, people who tend to benefit are well-connected, getting to the front of the queue for rent-controlled units. For example, former New York City mayor Ed Koch paid just $450 a month for an apartment. The true, market value of that apartment was close to three time more.
The Consequences of Bad Economic Policy
Void of analysis, rent control sounds utopian. Yet, the effects are unfortunate: tenants face limited housing stocks that are either run-down or unaffordable; landlords lose money, and ultimately stop investing and building altogether. And yet it is a policy now being flirted with in cities like Seattle, San Diego, and Richmond, California. The potential economic effect in those cities could be dire.