Controversial rent controls to be introduced - what next? | Nuggets

Rent controls have been a much speculated topic in Scottish politics over the Summer. While negatively regarded by most economists, Nicola Sturgeon has recently announced their potential introduction despite 70% of respondents in 2nd Consultation on a New Tenancy for the PRS stating they did not support their implementation. In light of this announcement, it seems timely to consider some of the core issues as to why economists tend to dislike rent controls, as well as considering their potential impact on the Scottish market.


What second consultation said – Individual and campaign (petition) response to whether respondents supported introduction of rent control



 


There are several types of rent control

While first generation rent controls – or rent freezes – were common in wartime or other moments of crisis, they are pretty much universally seen as undesirable. Later generations of rent control are more nuanced.

The two most prevalent approaches to second generation rent controls are; a rent cap, as seen in Berlin, which limits rents to within 10% of a regional guide price; and tenancy rent control (also known as vacancy decontrol), which allows rents to be freely increased between tenancies but restricted during the tenancy. The latter is common in parts of the Middle East, Europe and North America.


Politics versus Economics

From a market efficiency point of view rent controls – through introducing artificial price ceilings – are seen to inhibit market operation and the effective allocation of resources. The general consensus from economists is that tenants who have a rent controlled property are less likely to move as they will lose that benefit. This means they remain in properties that are unsuitable to their current situation or needs[1], or are not geographically efficient[2],[3]. There is also the contention that there is a power imbalance created, not between tenant and landlord, but between privileged tenants enjoying rent control and tenants looking to move into an area but having to meet current market values[4].

An argument that is often quoted as mitigating this negative consensus comes from the economist Arnott who made the case that the current freedom to move may be excessive and lower mobility may be “welfare improving”[5]. While often cited as being pro tenancy rent control, he has stated that the aim of his 1995 paper was to point out that blind opposition to rent control did not have a strong intellectual base and that entrenched views should be reconsidered. However, he did go on to state in a later paper that this earlier paper was not meant to support the introduction of rent control, commenting that, “most second-generation rent control programs…have on balance been harmful.[6]” In terms of market efficiency, most economists agree that tenancy rent control has the potential to have a negative impact on the efficiency of the market. There is a certain irony that given it’s said, if you ask five economists and you’ll get five different answers – six if one went to Harvard – that when there is a general consensus among this most argumentative group of academics and professionals, it is ignored anyway. Ignoring this consensus appears to be largely based on the assumption that rent controls will prove popular with the growing number of private sector tenants – a straightforward case it would appear of political necessity trumping economic considerations (and not for the first time).

Better than bombing

A second key area of discussion surrounding rent control is that it leads to the reduced maintenance and dilapidation of housing stock. While we have quoted Assar Lindbeck’s emotive line, “In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing”, this view has also been espoused with equal colour by Mr. Thach, the Foreign Minister of Vietnam in 1989: “The Americans couldn’t destroy Hanoi, but we have destroyed our city by very low rents. We realised it was stupid and that we must change policy.”

The experience of New York in the 1960/70s has also solidified a view that rent control leads to lower maintenance, building dilapidation and abandonment.

However, as usual, the issues are more complex. In its pure form, rent controls will dis-incentivise landlords to maintain their properties as they will allow the condition to retreat to match the artificial rent cap[7]. However, there is potential to mitigate this impact by passing the responsibility for maintenance onto the tenant, or using legislative incentives or punishments to address this issue. For tenants, this can mean additional responsibility and cost, which they may not recoup, depending on the duration of the tenancy, especially for larger items. The incentivisation of maintenance would also require additional legislative measures to account for this, such as in Germany, where losses against the property can be offset against tax.[8].

 

Scotland needs supply not restrictions

Perhaps one of the biggest concerns that is tied to the potential impact of rent controls, and is at the heart of the current housing situation in Scotland, is the level of new home building. A significant hope for increasing the delivery of new homes has been tied to the PRS, and the role of institutional PRS investment in the Scottish market. This is a sector that has come to the forefront recently, and has seen some activity, but is yet to reach a tipping point for volume delivery. Once again, there is a general consensus among academics that decreased profits, will inevitably lead to reduced investment and housebuilding[9],[10],[11]. There have been some arguments proposed that suggest some sectors of the market may benefit from improved access to housing. One such theory proposes that declines in the quality of middle and high income housing may make the housing stock less desirable and therefore it would become accessible to lower income tenants[12].

However, while such arguments are more theoretical, it is worth placing house supply within a real world investment perspective – if the profits from build to rent in one location are artificially suppressed then capital is likely to flow to either other areas without rent controls or to other asset classes. Indeed, being active in this market, we have had many recent conversations with institutional investors who have made such comments about the ‘Scottish Issue’. It is not hard to understand their thought processes when comparing an investment in Edinburgh or Glasgow with rent control versus an investment south of the border in Manchester or Liverpool, where there are no similar interventionist constraints. Far from being theoretical, this is an issue that is already impacting on investment and land use decisions in Scotland among our institutional and developer clients.

While studies abound as to the negative consequences of rent control on housing supply, and despite an extensive search and a plea on social media, we have yet to find any that show rent controls leading to an increase in supply.  Given that all participants in the debate agree that more supply and more choice is necessary to help Scotland with what is widely now seen as a housing crisis, bringing rent controls into the mix as part of the solution is confusing. Shelter has been vocal on both housing supply and rent controls, supporting the need to raise supply levels significantly as well as opposing rent caps.


Renters Paradise?

With a fool’s paradise being a wise man’s hell[13], we have to acknowledge that any intervention in the market will have differential and often unintended impacts.. Given human nature, it is also likely to foster preferential treatment of certain tenants over others if rents are capped and vacant possession more difficult to come by.

Under the vacancy de-controlled model, landlords are likely to prefer short-term renters, allowing them more frequent rent increases and discriminating against groups like retirees and families. There has also been bias shown towards those who offer least risk – higher income, race, class or known tenants. Such behaviours have been well documented in markets such a New York[14]

There is also the impact that rent control has on rent on uncontrolled areas. If, for example, you are unable to access homes in a rent controlled location, then bordering areas often see an increase in rental prices as people and competition move to the nearest alternative location. Furthermore, from a pricing point of view, it has been argued that landlord will ‘front load’ rents to acknowledge the deterioration of their income over time, leading to higher rents rather than lower rents from the start of the tenancy. Tenants may also be  willing to pay higher upfront rents to secure future discounts.

All these factors raise the question, whose paradise does rent control create? The rental sector has traditionally served the dynamism and vibrancy present in urban centres and measures to cede benefits to one group will naturally be at the cost of another, and not just in the expected way between tenant and landlord, but between tenants who have, and tenants who don’t.

Specialist markets  like students and Festival lets in Edinburgh may come under pressure

While we have focused on rent controls, another area worth highlighting as a potential unintended consequences from tenancy reform is the operation of student and festival lets – a subsector of the PRS market that is particularly relevant to Edinburgh.

Currently, many landlords lease their properties to students on a 10-month basis to match the academic year, securing vacant possession at a predefined date. The property is then used for festival lets, before being returned to the student market.

The inability of a landlord to secure vacant possession at a predefined date would remove their ability to offer the properties to the festival market as possession cannot be guaranteed. They can therefore not achieve the yield that they require to justify renting to students in term time.

Such consequences will have to be carefully considered in any market intervention.  A ‘one size fits all’ tenancy agreement will inevitably not fit many.

Are rents actually out of control?

Housing affordability lies at the heart of the rent control argument, with the perception that rents have become disconnected from affordability.

In part, this has been true as household incomes have remained suppressed; there has been reduced access to mortgage finance; and historically low levels of house building, which have all constrained peoples access to appropriate and affordable housing.

When we consider how rents have performed against wages and inflation (CPI), we can see that recently rents have increased above the other measures in the major cities, but not in Scotland on the whole.

However, the rise above inflation in the main cities has been relatively recent and follows a long period of below inflation rent rises. In substantial part, this has been due to the weakness in new supply. The market is therefore now signalling that it needs more supply in the cities, but the evidence from investors is that rent controls are likely to see them exiting or not entering the sector, reducing supply further. As well as the desire for tenants to remain where they are, this could see a considerable reduction in available stock to rent in our main cities, which will have serious economic and social consequences.









 

 
How do we create positive signals to the market?

The issue of rent control is divisive and complicated because how it impacts on markets can lead to a variety of outcomes, dependent on local factors and on how it is implemented.

One common theme, in many examples, is that the initial rent intervention is introduced and then changed, tinkered with and moderated depending on the politics of the time. Parts of Eastern and Central Europe, China, Japan, Malaysia and Singapore have all been repealing or reducing rent controls over the 1990s and early 2000s rather than extending them, particularly due to the sort of negative side effects discussed above.

There has also been a weight of concern voiced from industry, academics, landlords, tenants and campaign groups such as Shelter, stating their apprehensions about this form of market intervention. The risk facing the sector at the moment would be any interventionist policy that does not take into account the full complexities – financial, taxation and statutory – that would be required to prevent damaging a currently delicate market and hamper much needed investment and supply.

At the heart of the issue lies the undersupply of housing delivery. If we close by looking to Berlin once again, while they have recently reintroduced rent controls, this has been done alongside a building programme for 30,000 new apartments in the city and against a legal and tax system weighted to support PRS investment, not just to restrict rent inflation.

If investors were offered this, rent control would be much more palatable and effective.

About Andrew Meehan

Andrew re-joined the Rettie & Co. Research Team at the start of 2015 having originally worked for the company from 2005 to 2010. Andrew has an MA (Hons) from Edinburgh University and an MSc in...

Andrew Meehan
Associate Director
Edinburgh Read More