This article is part of a six part series. Read the full series:
1. Government Policy & Rental Supply | Rental Housing Supply 1
2. Ottawa’s Historical Renting Data | Rental Housing Supply 2
3. Corporations | Rental Housing Supply 3
4. Individual Investors | Rental Housing Supply 4
5. Rent Control | Rental Housing Supply 5
6. Final Recommendations | Rental Housing Supply 6
Swedish economist (and socialist) Assar Lindbeck asserted, “In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing.” Gunnar Myrdal (Nobel Laureat) stated, “Rent control has in certain Western countries constituted, maybe, the worst example of poor planning by governments lacking courage and vision.” That cities like New York have clearly not been destroyed by rent control is due to the fact that rent control has been relaxed over the years. [Walter Block, Econlib]
In the first article, we discussed the high-level demand for rental housing and the areas of policy that have affected the supply side of the equation. In the second article we then further broke down the statistical data where we saw that demand for rental housing was rising faster than supply. In part 5 of this series, we will focus on the impact of rent control policies.
While researching this piece, I was trying to find evidence to support rent control policy to ensure a balanced view. My assumption was that policy makers considered the negative consequences but felt the benefits outweighed them. Much has been written and a lot of research has been done on well controlled data sets over the last 50 years. Much to my surprise, the benefits are at best short–term since they slowly erode over the long-term.
Let us begin with the benefits. The basic premise of rent control is to ensure the moderation and affordability of rents. There is also a secondary benefit in improving community cohesion with the theory being that if rents are controlled, people will not be displaced from specific communities purely based on rent increases through, say, gentrification.
Ontario’s own rent control policies essentially began in 1975. As discussed earlier, a number of tax incentives to build purpose built rental housing were removed in 1972 and at the same time there were more incentives created to focus on home ownership. Also noteworthy was the legalization of condominiums in 1967 and as discussed earlier, these present a better business case for developers than purpose built rental housing. Rental vacancy which was hovering around 6% had begun to plummet to nearly 1% by 1974. As the vacancy rate fell, discussions of rent control started in earnest in 1972 and were finally enacted in 1975.
In the late 1960s, Ontario was adding approximately 30,000 rental units per year and it peaked to almost 40,000 by 1972. It then began to plummet in 1972 until by 1975 only around 5000 units per year were being constructed. While some economists like to point to rent controls being the cause of the rapid decline in rental housing construction, we cannot ignore the other strong influences such as the removal of tax incentives, introduction of the capital gains tax and the legalization of condominiums which all occurred around the same time.
Economists will first point to this classic supply and demand model, conventionally illustrated through the following figure:
Figure 1: Apartment Supply Shortage
In essence, if rent control sets a rent ceiling of (Pc) below the point of equilibrium (Pe), you create an imbalance between demand (D) and supply (S). That imbalance (Shortage) is characterized by the difference between A2 and A1. In other words, a lower rent will generate more demand, but a lower rent will also reduce the business case to generate supply. We demonstrated earlier that builders have alternative investment strategies (e.g. condominiums) and that the cost of building rental accommodations has grown quite expensive. It is intuitive to see that strict price ceilings will cause a shortfall in supply. Vacancy control has potential to succeed, but it would need to see rent increases in line with the true rate of inflation for operations and construction cost, likely yielding a rent increase in excess of what would be politically palatable. Ironically, the very costs that impact rental housing providers are controlled or regulated by government.
Ontario has used every model, eventually settling on vacancy decontrol in 1998 as a reasonable compromise, where rental housing providers and tenants could negotiate a new free market rent on turnover whilst otherwise protecting incumbent tenants. A further compromise has appeared, disappeared, and reappeared again where newly constructed units are not subject to rent control. This mechanism correlates to a modest improvement in new construction whilst new units are not subject to rent control but not to the extent one would hope. Perhaps the issue surrounds the uncertainty of new construction being subject to rent control as has been done in the past or perhaps rent control is not a major influencer when combined with vacancy decontrol.
In all of the formal research I have uncovered, seasoned economists have concluded that overall rent controls actually hurt the very people they are meant to protect. At first, they help an incumbent tenant maintain price stability, but with the impact to supply, when the tenant wants to move, they will either be impacted by a significant rent increase or lack of quality options. New units are introduced in the high end of the market to overcome development costs and older units are not maintained as the building owners lack capital due to the rent controls (also known as stacking).
Furthermore, the lack of supply disproportionately impacts the more vulnerable and poorer in our society. Tucker (1991)[2] demonstrated that the distribution of rents offered to the marketplace in rent-controlled cities became skewed towards high rents as a result of the shortage. Interestingly with the softening of rent controls (vacancy decontrol) in Ontario in 1998, there was a significant increase in vacancy rates at the lower end of the rental market. With certain politicians encouraging a move back towards vacancy controls, it is more likely to hurt those in which they intend to protect.
Source: CMHC
Figure 2: Toronto CMA Vacancy Rate Units Renting Under $800
When it comes to community cohesion, there is no doubt that rent controls initially had some effect. In the Stanford study[5], it was shown that San Francisco saw 20% less mobility with rent controls in place. However, after about 10 to 15 years less than 10% of those tenants remained in the community. Hence, the community cohesion aspect doesn’t really hold over in the long–term. In fact, there is a counter point which suggests that people who would have otherwise moved will instead remain, as they could no longer be incentivized to move. Take for example, a person who has lived most of their life in a three-bedroom apartment with their family. Over time their children move out and their spouse inevitably passes away. There is disincentive to move as a smaller apartment would be more expensive, so instead they close-off the unused rooms in the unit to save on utility costs. Ergo, the end result is further erosion of residential rental space. One study found that 21% of renters in New York City lives in an apartment that has either more or fewer rooms than they would choose if they lived without rent controls.
Maintenance was also impacted on rent-controlled units as it limits available capital for housing providers to invest in rent-controlled apartments. More often than not, the rate of rent increases (where allowed) was insufficient to keep up with recurring operational expenses. In Ontario, rent increases (pre-pandemic) were limited by the Ontario Consumer Price Index (CPI). The CPI is meant to represent a broad–based cost increase and is a convenient metric since most pensions are indexed to it. However, the principal operational costs for a rental housing provider are: taxes, utilities, insurance, materials, and labour. Most of these costs have far exceeded CPI and are largely government regulated. As a result, there is continued pressure to reduce costs, usually in areas of maintenance and renovations, in order to remain profitable with long term tenants. There are capital investment increase exceptions in Ontario but in most cases the process is onerous relative to the investment to be made at any given point in time.
As an interesting aside, when the Ontario provincial government caused rapid increases in energy costs in the last two decades, it also removed the ability for rental housing providers to pass this onto tenants. It could be concluded that governments enacted this policy to protect themselves from what would have been a backlash when the Above Guideline Increase (AGI) process would have drawn a straight line to the root cause.
There was also evidence that the restrictions imposed by rent control led to tensions between tenants and rental housing providers. For example, if a tenant wants certain items improved in their apartment, the housing provider has little to no financial incentive to conduct this work. In fact, there is more incentive to not do the work and hope the tenant moves out. While we do not condone this, it is an inevitable situation with the current policies.
In 1994, Cambridge Massachusetts repealed their rent control laws. The end result was a reinvestment in properties and interestingly the crime rate dropped substantially. Unfortunately, it did not in itself create new supply so removal of rent control on its own may not be the solution. It must be coupled with other incentives to create supply.
There is an ironic twist to rent control regulations. With the lack of supply and the fear it caused with rental housing providers, those who persevered benefited. Fearful providers let their nervousness drive them to sell their properties at a discount. Rent control, likely in combination with other influences, drove the vacancy rate down to nearly zero percent. Today, providers could point to perceived government mandated annual increases, whereas before, providers did not always raise the rent annually. Minimal new supply was created but there was a definite consolidation in ownership amongst the purpose-built stock and when there is no new supply, the incumbents continue to benefit while the tenants see a degradation in quality and availability.
Rent controls should ultimately be removed in a balanced market. However, it will not on its own create an environment which will make more rental housing available. In part this is due to the political uncertainty around future decisions. While this an important part of rental housing improvement, it will need to be combined with other incentives.
In the interim, the following can be done:
In the next section, we will conclude with a summary and recommendations on the short term and long-term recommendations to alleviate rental housing supply.
[1] Cruz, Christian (19 January 2009). “The pros and cons of rent control”. Global Property Guide.
[2] Tucker. William (1991). Zoning, Rent Control, and Affordable Housing. Washington: The Cato Institute.
[3] Block, Walter. Rent Control: https://www.econlib.org/library/Enc/RentControl.html
[4] https://economics.mit.edu/files/9774
[5] https://web.stanford.edu/~diamondr/DMQ.pdf
[6] https://mru.org/courses/principles-economics-microeconomics/rent-controls-economics
[7] http://okayfail.com/2018/rent-control-great-security-of-tenure.html
[9] https://freakonomics.com/podcast/rent-control/
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