THE HARMFUL EFFECTS OF RENT CONTROL

 The economic implications of rent control

 Inhibition of new construction projects: By forcing rents below the market price, rent control reduces the profitability of rental housing, directing investment capital out of the rental market and into other more profitable markets. Construction declines and existing rental housing is converted to other uses. When a community artificially restrains rents by adopting rent control, it sends the market what may be a false message. It tells builders not to make new investments and it tells current providers to reduce their investments in existing housing. Under such circumstances, rent control has the perverse consequence of reducing, rather than expanding, the supply of housing in time of shortage. To illustrate, in the United Kingdom, which had imposed rent control since the Second World War, the share of all housing provided through privately owned rental units dropped from 53 percent in 1950 to less than 8 percent in 1986, reflecting the flight of investment from the regulated market. In an unregulated market, a housing shortage [the reason usually cited for imposing rent control] will be addressed in a two-step process. In the short-term, rents on the margin will rise as consumers compete for available units. Over time, these higher rents will encourage new investment in rental housing through new construction, rehabilitation, and conversion of buildings from nonresidential to residential use, until the shortage of housing has been eliminated. Without the increased rents required to attract new investment, new housing construction would be sharply limited and there would be no long-term solution to the housing shortage. Conversely, a fall in rents sends the message to the market that there is no room for new investments.

Reduced consumer mobility: The primary beneficiaries of rent control are those consumers lucky enough to find themselves in a rent-controlled unit. But even these consumers pay a price. Consumer “mobility” is substantially reduced by the reluctance of many consumers to part with the rent control subsidy. A study in New York City found that rent control tripled the expected duration of residence. Consumers who would otherwise move to smaller or larger homes or closer to their jobs do not do so because they do not want to lose the subsidy. This loss of mobility can be particularly costly to families whose job opportunities are geographically or otherwise limited and who may have to travel long distances to reach those jobs available to them. The spill over effect includes increased demand for public services, traffic congestion, etc.

 

Deterioration of existing housing: By reducing the return on investments in rental housing, rent control also can lead to a drop in the quality and quantity of existing rental stock. This may take the form of cooperative conversions or, in some cases, abandonment of unprofitable property. It can also lead to a deterioration of the quality of housing stock as providers faced with declining revenues may be forced to substantially reduce maintenance and repair of existing housing. There are marked differences between rent-controlled and other units in housing quality and the level of expenditures on maintenance and repair, especially in cities like Mumbai and New York.

5.1.4. Reduction in property tax revenues and increase in administrative costs: Rent control reduces the market value of controlled rental property, both in absolute terms and relative to the increase in property values in unregulated markets. The tax implications of this reduction can be significant, as taxable assessed rental property values decline relative to unregulated property. A study of rent control in New York City calculated the loss in taxable assessed property values attributable to rent control at approximately $4 billion in the late 1980s. There is also a corresponding increase in administrative expenses, since rent controls require the creation of elaborate bureaucratic systems. Rental property must be registered; detailed information on the rental property must be collected; and elaborate systems for determining rents and hearing complaints and appeals must be established.

The phenomenon of the rise of “Shadow Markets”: This concept was developed by Denton Marks in a paper in the Journal of Urban Economics in 1984. It is virtually impossible for a government to control and regulate the entire supply of a commodity. Once a shortage appears, alternative markets and black markets will arise. More often than not, however, governments may tolerate these markets as a way of relieving shortages. In many instances, according to Marks, governments will deliberately leave a portion of the market untouched by regulation in order to serve as a safety valve for excess demand. This unregulated portion of a regulated market becomes the “shadow market.” Economists are of the view that prices in the unregulated portion of the market will be forced higher than their normal market value by rental restrictions. This is because the limited supply in the shadow market must absorb the shortage, the excess of demand over supply, in the regulated part of the market. Since prices are pushed too low in the regulated sector, they are forced above what would otherwise be the market price in the unregulated sector. The result is that average prices in both sectors are likely to end up about as high as their free-market level. They could end up higher because of misdistributions and diseconomies in the regulated sector of the market. The crux of the issue is that unsatisfied demand is diverted into this unregulated sector and because of the shadow-market effect, people in this sector pay higher-than-market prices. The poor, single individuals, and young people entering the market are especially hard-hit by these costs. This is in addition to consumer search costs that they have to incur in order to find suitable accommodation in regulated sectors of the market.

The social implications of rent control

 The adverse impact on the poor and disadvantaged sections of society: The costs of rent control fall disproportionately on the poor. Poor families suffer a marked decline in existing housing as the quality of existing housing falls in response to reduced maintenance expenditures. The middle class can move out; for many reasons, poorer families lack this option. Poor families also are at substantial disadvantages when it comes to finding new housing. In a tight market, there may be more people looking for housing than available rental units, thereby giving housing providers substantial discretion in choosing among competing potential consumers. In an unregulated market, the level of rents will govern this consumer selection process. However, by restricting rent levels rent control causes housing providers to turn to other factors, such as income and credit history, to choose among competing consumers. These factors tend to bias the selection process against low income families, particularly female- headed, single-parent households. Poor families tend to remain stuck to their houses, and have to continue there no matter how bad the living conditions are. Once they enter the unregulated market that is a by-product of rent control laws, they will be unable to afford the new rents, thus their mobility is severely restricted, if not impossible.

There is an increase in housing discrimination: This is a corollary to the first point. If the mobility of the poor is restricted, then they tend to be concentrated in certain areas, and this leads to increased levels of poverty. Also, the reduction in housing caused by rent control also can slow the process of racial and economic integration of many communities, by limiting the opportunities of certain classes of consumers to reside in rent-controlled communities. The owners of the houses know that since they cannot decide the level of rent that is to be paid by them, they may choose tenants on the basis of a potential consumer’s race, sex, family size or other improper or unlawful factors. This problem is especially serious in the United States where the rich or the middle classes use rent control as a method to exclude people belonging to the lower economic or social strata in society from residing amongst themselves. In fact, experience in the US state of California has shown that the moment new communities like Santa Monica develop, rent control limitations are imposed so that entry is severely curtailed, and these areas become exclusive and elitist zones, out of bounds to other sections of society.

Rent control invariably benefits the higher income householders more: It is indeed ironical that rent control legislations are viewed as an anti-poverty strategy in most countries and have been enacted with the intention to benefit the poor. However, the opposite is true in most cases. For example, a study of rent control [conducted in 1991] in New York City found that rent-controlled households with incomes greater than $75,000 received nearly twice the average subsidy of rent-controlled households with incomes below $10,000. It is also pertinent to note that rent control had the greatest effect on rents in Manhattan, the borough [New York is divided into five boroughs] with the highest average income. Similarly, a study of rent control in communities across the USA found that the beneficiaries of controls in those communities are “predominately white, well-educated, young professionally employed and affluent,” and that rent control had substantially increased the disposable income of these tenants while exacerbating the problems of low-income families. There are starker examples than these to be found in India. Well to do traders in Delhi’s Connaught Place pay just a nominal sum of a few hundred rupees a month as rent. In Mumbai, prosperous businessmen occupy entire apartment blocks in posh areas, but pay rents that have scarcely changed over the past six decades. Surely, these individuals can comfortably afford to pay the revised rents. It is a shame that the obstinate attitude of a few has the effect of endangering controlled and planned urban development, and more specifically new housing schemes in our cities.

Rent control imposed unfair costs on house owners/ landlords: Rent control legislations are the root cause for the current bitterness that exists between house owners and their tenants. What rent control does is to unfairly transfer income of the property owner to the tenants, or more importantly to the owners of any business that makes use of the rental property. Thus rent controls supplement consumer income at the expense of rental property providers, by holding below market levels the permissible rate of return on rental property investment. There is substantial evidence that such transfers are highly inefficient. A comprehensive study initiated during the heyday of rent control legislations in the 1970s concluded that housing consumers gained in benefits only 52 percent of what housing providers lost- this was a result of the tendency of consumers in rent-controlled units to “hoard” housing and to be over-housed. Thus rent control appears to fail the test of Pareto optimality, since it involves considerable loss to one side in the transaction. Ideally, either both sides should gain or else nobody must suffer a loss.