How Economists Understate the Damage from Rent Controls: These policies may lower rental payments, but they hurt the quality of rental housing.

Author:McKenzie, Richard B.
Position::PROPERTY
 
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Rapidly rising rents in the Los Angeles and San Francisco metropolitan areas have once again produced calls for government rent control. This November, Californians voted on Proposition 10, which would have overturned a state law prohibiting local governments from imposing controls on units built after 1995. The measure was defeated, with 61% of voters giving a thumbs-down on the measure. However, rent-control advocates will almost certainly undertake other efforts in the near future, especially given that 39% of Californians favor rent controls, a sizable political base from which to launch another campaign.

Rent-control backers' reasoning is straight-forward: "The rent is too damn high!" Renters are being priced out of economically dynamic big cities, driving them out to the suburbs, out of state, or onto the street. And rising rents and proposed controls seem to be destiny in the Golden State.

The backers' working presumption is that rent control (or its less onerous variant, "rent stabilization") will benefit a substantial majority of (if not almost all) renters, especially low-income tenants. Conventional economic analysis tends to support this view, at least in the short run: though the controls may discourage the addition of new units, they will benefit current renters by giving them a break on their monthly payments. But this view is too circumscribed and doesn't recognize that even renters who keep their apartments and houses in the near term and long term will be made worse off by the controls, even with lower rental payments.

CONVENTIONAL RENT-CONTROL ECONOMICS

To understand this, we must understand the economics behind landlords' search for the best combination of rent and unit "amenities" (e.g., carpet, painting, maintenance, cabinets, lights) and "features" (e.g., air conditioning, security systems, balconies, showers, window treatments, upscale appliances) that augment the value and costs of the units they offer for rent. The negative consequences for renters emerge because controls on rents force landlords to reconfigure their units' combinations, taking away these amenities and features or reducing their quality even though the takeaways are worth more to the tenants than the money saved by rent controls. Even in the short run, landlords can reduce the amount of living space available for, say, tenant storage, limit the number tenants in each unit, and convert units into condos. In the longer run they can let rental units deteriorate at an accelerated rate, reducing the count of rent-controlled units.

Figure 1 captures the supply and demand for basic rental units, which amount to a given square footage with minimal amenities and no features. This is an intentionally simple starting point to draw out the logic of adding features and, concomitantly, determining unit rents.

As in conventional rent-control analytics, the market forces in Figure 1 will lead to a monthly rent payment of [R.sub.1] with [U.sub.1] units made available--absent rent controls. Under conventional rent-control analytics, a controlled rent, Rc, will be set below [R.sub.1]. (There is no market effect from a rent control at or above [R.sub.1].)

This figure illustrates how rent control alters the market equilibrium of rental housing in troubling ways:

* The controlled rent leads to a greater number of rental units demanded, U2, than would be demanded if the market rent were allowed to stay at [R.sub.1].

* The supply of units will shrink from U1 to U3 as landlords take their units off the market, convert them to condos, fail to maintain them, and shelve plans to build more rental units.

* As a result, a shortage of rental units will grow over time, ultimately equaling the difference between U3 and U2.

Given the shortage, landlords can be choosier in selecting tenants. This means they will be more inclined to discriminate on whatever basis they like, including veiled discrimination for age, race, gender, or sexual orientation. Landlords can use a host of other characteristics to choose tenants, including physical attractiveness, whether the applicant has children or pets (and how many), criminal history, and credit scores. In short, rent control will boost various non-price forms of discrimination and will likely lead to an upgrade in the average "quality" of tenants from the landlords' perspectives.

RENTAL UNIT FEATURES AND RENT CONTROL

Rental units typically come with an array of features. Even the most basic units have toilets, sinks, stoves, and carpet. In adding features beyond basic amenities, landlords follow a fundamental economic rule: add features (and/or upgrade their quality) so long as their prospective value to tenants is greater than the costs landlords incur in adding them.

Consider the addition of air conditioning to basic units. If tenants value the air...

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