Some governments are introducing rent controls as a response to the housing crisis. This is a hotly contested measure. Landlords and developers say rent controls discourage adding stock to the rental market. Tenants and people who are homeless generally favour them as they want security and affordability as well as more housing. This post lays out issues that shape this debate and suggests some options to change the current situation.
On the Supply Side
The argument that rent controls will restrain rental housing starts makes sense from a basic supply and demand point of view. If you put a lid on potential profit, people with money to invest will look elsewhere. This includes landlords. It also stands to reason that if you remove the lid, more housing will get built. There’s a real world experiment of this in Ontario, Canada, where rent controls had existed on private rental housing since 1975. Those rent controls were held to blame for limited new housing starts. Starting in 1991, new rental units were not subject to rent controls. Contrary to expectation, rental housing starts did not go up.
Housing starts are not as flexible as some other goods: it takes time to organize plans, obtain approvals, to build and then to rent up the buildings. Taking this into account, the increase in new rental starts might have been delayed by two or three, even five years. This didn’t happen either.
Acting on the belief that rent controls could be reintroduced at any time, housing developers and investors might have been wary about putting new money into rental housing. The rent control legislation in Ontario sets out a framework and three part system that allows rents to increase:
- Rents in controlled units are allowed to increase every year. They are not frozen. The amount of the increase is set by a guideline, which is indexed to the cost of inflation. Landlords are obliged to give tenants advance notice of the rent increase, but as long as the increase is within the guideline, tenants are required to pay the increased amount.
- The legislation allows for increases above the guideline in controlled units. Landlords must notify tenants. Such increases are mediated by a Landlord-Tenant Board. They are not automatic and it can take some time to determine the amount of increase that will be allowed. The decision, when it is made, applies retroactively to the date when the increase would have come into effect.
- The legislation also includes vacancy decontrol in controlled units. This means the rent for a unit is not fixed when a tenant leaves a unit. When a new tenant moves in, the landlord and tenant agree on a starting rent, which becomes the base for all future increases.
The Ontario rent control framework provides the opportunity to make money on a predictable basis and there are businesses that operate in this environment. One example is Capreit, which owns 64,000 rental units across the country. The rental environment in Ontario has also attracted Aukelius, a Danish company that describes Canada as a great opportunity to drive profits.
On the Demand Side
Tenants are generally considered to be ‘pro’ rent controls. In a market where supply is limited, interventions to control rent hikes can provide tenants with some assurance that they will be able to continue to afford their housing. But once again, this isn’t always as simple as it might seem.
The amount of the guideline increase can vary considerably. Legislators in Oregon are heralding the arrival of rent control legislation in that state. The guideline increase there is inflation plus 7% per year. Based on an annual 7% increase alone (without inflation), tenants can anticipate that their rent will increase by 50% in five years. Unless their annual income also goes up by 7%, their home will become progressively less affordable during the same period. If their income remains unchanged, a tenant paying 30% of their income on shelter at move in will be paying a rent that is considered unaffordable in year 1 and upwards of 50% of their income by year 5. While this does make the situation clear for prospective renters, it won’t necessarily be reassuring.
Vacancy decontrol is a significant consideration for a tenant considering a move. There are plenty of reasons why a move might make sense (e.g. work at a new location, increasing or decreasing household size). With vacancy decontrol in place, new rents are negotiated at the time of move in. The prospect of negotiating a new rent can be a significant deterrent to moving, especially in markets where there is a high demand for rental housing.
Legislating Affordability In Rental Housing
Rent controls are often introduced in markets with rapid rent increases. The rents of sitting tenants become unaffordable and vacancy rates are very low (especially in the most affordable units). Legislators debating rent regulation have a number of decisions to make. How to establish base rents? In what conditions should base rents reset? Should rents be allowed to rise and if so, by what amount? What to do about increasing supply?
Setting Base Rents
Legislators must consider whether to start with the existing rents as the base level, to roll them back (which would please sitting tenants) or to start with an increase (appealing to landlords, investors and building owners).
Resetting Base Rents
The decision here is about whether the rent of a unit should continue from one tenant to the next, or whether a new base rent will be negotiated when a new tenant moves in (vacancy decontrol). The first option relates rents to the cost of operating the housing and supports tenant mobility. The second option favours investors, as rents are allowed to float to ‘market levels’, especially in a market with low vacancy rates.
Setting Rent Increases
Decision makers need to consider whether to freeze rents or to allow them to rise. With costs generally going up, it might seem surprising to even consider a rent freeze, but the government in Berlin is currently in the process of deciding whether to implement one.
Data become very important in settling on decisions about rent freezes and rent increases. Cost indices, such as inflation, are a common source for setting criteria both for rent freezes and rent increases. The credibility of the data is also a consideration. Government statistical agencies are frequently chosen for this reason.
Legislators also need to consider the cost of implementing legislation to control rents. Increases based on cost of living plus a bonus, as in Oregon, have low administrative overhead, and hold appeal for fans of small government. Administrative tribunals, such as the one in Ontario, cost more, but provide a degree of oversight before locking in a base rent that is above the inflation rate.
Measures to Increase the Supply of Rental Housing
From this discussion, the presence or absence of rent controls does not seem to be the key to unlocking new rental supply. Legislators will need to consider other measures if this is a consideration.