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Rent Control Toxic

DARWIN 2 December 2011 A debate that pops up from time to time, generally in times of financial downturn where rents remain high, has raised it ugly head yet again.

Earlier this year the Northern Territory News carried a letter from a reader espousing the value of rent control through legislation and making a large number of claims of sustainable rent control programs around world. On 1 December 2011, journalist Robert Harley wrote in the Australian Financial Review that, “The Labor Party is poised to make rent control part of its national platform”.

In fact Mr Harley went on to quote an unbelievable statement that was drawn directly from the draft platform to go to Labor’s national conference which states, “Labor will monitor the rent costs in the private rental market and examine mechanisms to maintain affordability such as the introduction of rent capping legislation”.

Also on 1 December 2011, as part of a media release in response to the announcement by the Labor Party, the Real Estate Institute of Australia (REIA) President, Ms Pamela Bennet, stated, “To cap rents in the private rental market would be counterproductive to the objectives of improving affordability. It would reduce the supply of rental housing which would be detrimental to rental affordability."

It was also noted by the REIA that if the proposal was implemented, the impact could be similar to the outcome of the Hawke Government's decision in 1985 to deny investors tax deductibility of interest payments. The market response led to an undersupply of rental property and escalating rents, before the decision was reversed in less than two years.

The solution is not legislated rent control, but rather better planning by State and Territory Governments on sustained and long term land release to allow developers to maintain an appropriate level of building, which in turn creates adequate rental stock and the market naturally then prices accordingly.

Allow me to quote Prince Christian Cruz, Senior Economist with the Global Property Guide, who wrote in January 2009 when talking about rent controls imposed in Qatar, “The Gulf has moved in the opposite direction to the rest of the world. Elsewhere, rent control regimes have generally been dismantled or softened since the mid- 1990s. Rent control has been removed in most of Eastern and Central Europe. Asia has also followed the trend:

China, Japan, Malaysia and Singapore have lifted rent controls since the early 2000s.”

He goes on to clearly state, and I quote, “rent control is generally harmful”.

The writer of the original letter to the Editor some months ago made a reference to rent control in Sweden, which is actually an interesting example. A study by the European University Institute (EUI) has shown that controlled rents in Sweden are set far below reasonable returns-on-investment. This study calculated that to make a 5% return on investment (the average rental yield in Darwin), a Swedish developer would need to set rents 70% higher than allowed by the Rent Tribunal.

The principal arguments against rent control are that it tends to distort economic incentives, leading to inefficient distribution of resources. Research produced by the Global Property Guide has shown:
•Rent control reduces the incentive of landlords to supply rental properties. Rental properties then tend to be in scarcer supply under rent control. Vacancy levels tend to be relatively low and available properties tend to be rented only under strict conditions.
• Rent control discourages landlords from maintaining and repairing properties till the end of a tenancy.
• There is also an incentive for landlords to discriminate against tenants likely to stay for a long time, like retirees or couples with children.
• In some countries, landlords collect key money to offset the losses occasioned by rent control.
• Rent control has been shown to lead to bullying and illegal behaviour by some landlords. If rent increases are allowed between vacancies, some landlords have been known to evict tenants in any way possible. This generally translates into demands for greater government protection for tenants, i.e., into a further layer of bureaucracy and policing.

And there is a point made that has a much greater impact on the Australian economy, in that tenants in rent controlled properties are less willing to move to other places, despite the possibility of earning higher wages or even taking up a job if they are unemployed, because they want to maintain their rent controlled property.

Our research has shown that across the world, in the few places where it does still exist, the most common form of ‘rent control’ is where rents are initially freely negotiable but there is a limit on the amount of rent increase.

The letter writer in this case also quoted rent control being successfully implemented in Hong Kong and most US states. During my many years as a resident of Hong Kong I was never exposed to Government enforced rent control and in fact it was such as failure it was officially abolished in Hong Kong in 1998.
As for the US, Washington DC has controls on rent increases only, and these only affect a small sector of the market. Local governments in New Jersey, such as Jersey City and Camden, impose maximum rent increases.

The San Francisco Rent Board limits the allowable annual rent increase by prescribing maximum allowable rent increases with strict conditions applied but with the ability for the landlord to gain the maximum rent increase of 10% if the premises is vacated.

For the state of New York, rent control applies to building constructed before February 1947 in 51 municipalities including New York City. Generally, the amount of tenants under rent control is getting smaller each year. Rent control in New York ahs proven to be an abject failure as it has severely decreased the quality and quantity of rental housing.

The Concise Encyclopaedia of Economics, in an article by Walter Block on rent control, states, “Rent control, like all other government-mandated price controls, is a law placing a maximum price, or a ‘rent ceiling’, on what landlords may charge tenants. If it is to have any effect, the rent level must be set at a rate below that which would otherwise have prevailed. But if rents are established at less than their equilibrium levels, the quantity demanded will necessarily exceed the amount supplied, and rent control will lead to a shortage of dwelling spaces. In a competitive market and absent controls on prices, if the amount of a commodity or service demanded is larger than the amount supplied, prices rise to eliminate the shortage by both bringing forth new supply and by reducing the amount demanded. But controls prevent rents from attaining market-clearing levels and shortages result.”

“With shortages in the controlled sector, this excess demand spills over onto the non-controlled sector, typically, new upper-bracket rental properties. But this non-controlled segment of the market is likely to be smaller than it would be without controls because property owners fear that controls may one day be placed on them. The high demand in the non-controlled segment along with the small quantity supplied, both caused by rent control, boost prices in that segment. Paradoxically, then, even though rents may be lower in the controlled sector, they rise greatly for uncontrolled units and may be higher for rental housing as a whole.”

“As in the case of other price ceilings, rent control causes shortages, diminution in the quality of the product, and queues.”

The Institute of Public Affairs is quoted as saying, “Rent control is a classic example of where government interference with the free price mechanism can do almost irreparable damage.”

And even the Affordable Housing Institute of the US has said, “The astonishing thing about rent control is that economic empirical analysis — in other words, real experience — demonstrates that there is no policy case for it. Rent controls, designed to lower the cost of housing for renters, may have the perverse effect of increasing rents for tenants in the unregulated sector.”

Studies have found that while rent control may hold down the price of controlled properties, uncontrolled properties in the same city will have rents 13-15% higher than they would have been if rent control were absent.

The fatal problem with price controls is that when an artificially reduced price is imposed, the market will naturally move to adjust the actual amount of supply to reflect the reduced price. In other words, over the long run, setting an artificially low price on a product (in this case, properties) guarantees that the supply of that product will diminish. Among other things, when people are unable to move — due to excessively high rents — they tend to stay in one place, that is, to hoard their apartments, effectively removing these properties from the market.

Studies have shown that rent control’s harm lasts 20 to 30 years after it stops growing. Even if rent control applies only to properties constructed before a given year, it will take 20 to 30 years of no further encroachment of rent control before uncontrolled rents will lose the risk premium. After a smoker stops, it takes his lungs fifteen years to recover. Rent control takes longer. It’s more toxic.

Food for thought.

Quentin Kilian
Chief Executive Officer
Real Estate Institute of Northern Territory Inc. (REI