The Fallacy of Rent Control

With California Governor Gavin Newsom’s October 8, 2019, approval of Assembly Bill 1482, the state’s residential landlords will, for the first time, be enjoined from raising rents by more than a stipulated amount. The law, now known as the “Tenant Protection Act of 2019,” provides for a rent cap prohibiting rent raises exceeding five percent plus the cost of living index annually.

The rationale for the legislation was the recent soaring rental prices, in which over half of all tenants were paying 30 percent or more of their income in rent, as well as a highly publicized shortage of rental units throughout the state.

The concept of rent control in the United States is not novel. During World War II in the early 1940s, the federal government under President Franklin Roosevelt imposed it, along with both wage and price controls, as a wartime measure. It continued in effect during the Truman presidency through 1952 under the term “rent stabilization,” but was ended upon the election of President Dwight Eisenhower. Since then it’s been employed in select communities throughout the nation, most notably the City of New York, where it has persisted as a continuous feature over the past nearly eight decades.

As with virtually every statute enacted, there are invariably winners and losers. In addition, it’s rare when the functioning of a law does not result in unintended consequences. As one example, the proponents of rent control contend such controls are not the cause of rising rental rates. They use a 2016 analysis of 70 years of San Francisco rental prices (1956 to 2016) to show that both before and after the institution of rent control in 1979, rents rose fairly consistently at 6.6 percent per year. What’s ignored, however, are the many factors actually driving increases in rental prices, such as the number of jobs in the county, the total amount of housing within the area, and the quantity of money paid to everyone employed thereabouts. These and many other criteria are collectively much better predictors of trends in rental prices.

It’s obvious, of course, rent control offers potential benefits for tenants. Rent control provides a deterrence to rent increases. However, it’s not unusual for persons to reside in apartment for years with only minimal rent increases. There are actually areas where the protection extends to successive generations.

Stories abound where tenants occupy units where their parents – and in rare instances, their grandparents – once lived, at rents not greatly increased over several decades. And adding insult to injury, the later generations are often progeny with substantial wealth … far more so that the landlords who must accept little more than token rent from them for the apartment units they occupy.

We’ll now take a look at several factors affecting the value of rental property and how governmental rental control affects markets. While in the short run rent control appears to help current occupants, in the long run it decreases affordability, fuels gentrification and creates negative spillovers on the surrounding neighborhood.

Economic research highlights the potential negative efficiency consequences to keeping rents below market rates. Rent control can lead to mis-match between tenants and rental units. Once tenants secure a rent-controlled apartment they may not choose to move in the future and give up their rent control, even if housing needs change. This misallocation can lead to empty-nest households living in family-sized apartments and young families crammed into small studios, clearly an inefficient allocation. Rent control can also lead to decay of the rental housing stock as landlords may not invest in maintenance because they’re unable to recoup these investments by raising rents.

As one striking example of how rent controls or caps can impact real estate values, you might note that over the 24-year period from 1970 through 1994 all rental units in Cambridge, Mass. built prior to 1969 were regulated by a rent control ordinance, which placed firm caps on rent increases and restricted the removal of units from the rental stock. The legislative intent of the ordinance was to provide affordable rental housing. Prior to the rent control’s elimination in 1994, controlled units typically rented at 40 percent below the price of nearby non-controlled properties.

In November of that year, the Massachusetts electorate passed a referendum to eliminate rent control. This law change immediately affected the value of the units subject to such controls, enabling landlords to begin charging market rents. Understandably, the property values escalated at once. Irrespective of claims contending rent control does not degrade property values, any sensible person would know otherwise.

As you might guess, my sentiments concerning rent control are not shared by some others. The many chapters of the Tenants Union view things quite differently, with their admonition that “Criticism of rent control is often misguided and ideologically motivated.” More specifically, they announce “Rent control is good public policy. In addition to helping create stable neighborhoods and communities … including protecting our most economically vulnerable citizens from unpredictable and erratic rent increases and arbitrary eviction.” Furthermore, “rent control does not prevent landlords from earning a reasonable profit on their residential properties” maintaining “rent controlled property appreciates in value, and the law protects the profitability of rental property.”

They conclude with the assurance “Moderate rent control has no impact on new construction primarily because of the nonrestrictive nature of moderate rent controls which guarantee a landlord a fair return on investment.”

Irrespective of the Tenants Union idealized description of rent control, you might care to visit New York City to get a glimpse of how government oversight of housing metastasizes over time. With more than 800,000 units currently under rent stabilization, its operation defies description. Tenant qualifications periodically change over the years, reportedly to curb perceived abuses, allowing  the wealthy to enjoy rent increase protection intended to protect the working class.

At the other end of the income pyramid you’ll find a West Village townhouse just hitting the market for $11.25 million – and it comes with two rent-regulated tenants who are living quite economically. One tenant pays $127.61 a month for a spacious 1,000-square-foot, fourth-floor apartment inside the five-story townhouse at 59 Morton St. The other pays $627.78 a month – up from $615 a month in 2011. Yet all the while Eva Tucholka of Harlem, aged 72, retired, and subsisting on food stamps and $2,123 in monthly Social Security benefits, somehow hopes her $2,126-per-month rent can somehow be reduced.

The fact is, once rent control becomes an established reality, all sorts of irregularities occur. Landlords apply for and are granted exemptions under questionable circumstances; tenants, or their representatives, request compensation for violations by the landlord of obscure terms of the rental agreement; if, over time, the rental income of a property can no longer sustain the costs of its operation, deterioration of the property will be observed; tenants will be issued notices to vacate on the pretext the apartment owner intends to personally occupy the unit; and the owner will file for a condominium conversion permit, thereby removing the building from the rental market.

These are only a few of the devices which may be used; human ingenuity can be devious.

A final thought: Although the rent cap is now approved, it won’t resolve the housing affordability issue. California is politically incapable of housing the homeless, of substantially increasing the number of rental units, or of lowering construction prices. All the officials can do is express their indignation, pass bond measures while pretending to address the problem, and castigate those with whom they disagree.

You may be assured Governor Newsom and the members of the legislature will continue to issue grandiose predictions of the tens of thousands of affordable units scheduled to become available at some undetermined time in the future, while those tenants fortunate enough to be protected by a cap will remain in place for decades. If there’s to be a solution to the problem, it will not come from the persons we elect to public office.

Al Jacobs, a professional investor for nearly a half-century, issues weekly financial articles in which he shares his financial knowledge and experience. Al can be contacted at al@abjacobs.com.