Why Rent Control is not a good idea

Economists tend to disagree on many subjects mostly since Economics is not an exact science and it examines people’s behavior.

However, the subject of rent control is one which has a very wide agreement.

In recent years, there are becoming more and more big cities (Berlin for example) that are joining other urban cities which imposed rent controlled housing long ago such as New York City and San Francisco.

In this article, I will argue that rent control is not efficient in the long run and therefore, not a good solution for the problem of rising rent prices in main cities.

Nevertheless, rent control does benefit some lower income families and individuals and could play as good in the short run.

In the last decade there has been a real estate boom and soaring housing and rent prices in large cities around the world which has a strong implication towards the rising inequality (which is a long subject as well that I will cover some other time). Therefore, demographics are changing, and cities try to “fight” this phenomenon.

I’ll try to make this article short and straightforward.

In order to begin I will start with the most basic economic theory of price ceilings from microeconomics 101:

Since I appreciate your knowledge, I know you probably seen this diagram before. However, in this article I will present some empirical evidence as well and expand the theory more.

Investors are profit maximizing creatures; they look to maximize their profits.

If an investor owns a house which has been rented for example for 1000 dollars and now the government impose a price control for 5 years as they did in Berlin.

Evidence show that rent control will probably cause the owner to:

1. less incentive to renovate the house, decreasing housing quality in the city and looks.

2. Sell the house to owner-occupants and therefore reduce rent supply.

3. decentivize the owner from renting the apartment and leaving it empty.

4.Decrease demand for new rental housing in the area.

5. Redevelop the building which has rent control housing to one without

However, for me, the biggest argument against rent control is that In the long run, the increased shortage and incentive will prevent many low income people to have the ability to stay or move to the city and will actually increase the amount of high-income residents to be higher than would have been without.

In order to base my point I will present you a short summary of an important natural experiment happened in San Francisco and conducted by:

Rebecca Diamond

Tim McQuade

Franklin Qian

This research examined the rent control imposed in San Francisco in 1994:

The research exploits an unexpected 1994 law change that suddenly rent-controlled a subset of San Francisco buildings and their tenants, based on the year each building was built. However, the law left very similar buildings and tenants without rent control.

So basically, due to some policy changes, they could split the tenants into two groups. The control group: tenants without rent control and a treatment group of tenants with rent control due to the new law.

How was it done?

“To examine rent control’s effects on tenant migration and neighborhood choices, we make use of new panel data which provide address-level migration decisions and housing characteristics for the majority of adults living in San Francisco in the early 1990s. This allows us to define our treatment group as renters who lived in small multi-family apartment buildings built prior to 1980 and our control group as renters living in small multi-family housing built between 1980 and 1990. Using our data, we can follow each of these groups over time up until the present, regardless of where they migrate.”

“We find that between five and ten years after the law change, the beneficiaries of rent control are, on average, 3.5 percentage points more likely to still remain at their 1994 address relative to the control group. Since only 18 percent of the control group still remained at their 1994 address for this long, this estimate represents a 19.4 percent increase in not moving (3.5/18)relative to the control group. We further find that the beneficiaries are 4.5 percentage points more likely to remain in San Francisco relative to the control group, indicating that a large share of the renters who remained at their 1994 address due to rent control would have left San Francisco had they not been covered by rent control. This would likely be viewed as a desirable outcome by rent control advocates.

We next analyze treatment effect heterogeneity along a number of dimensions. We first find that our estimated effects are significantly stronger among older households and among households that have already spent a number of years at their address prior to treatment. This is consistent with the idea that both of these populations are less likely to experience personal shocks requiring them to change resi- dence and thus, are better able to take advantage of the potential savings offered by rent control.

We then examine whether the effects we estimate vary across racial groups. We do not directly observe race in our data, so we use an imputation procedure based on renters’ names and addresses.2 We find rent control has an especially large impact on preventing the displacement of racial minorities from San Francisco, suggesting that rent control helps to foster the racial diversity of San Francisco, at least among the initial cohort of renters covered by the law.”

“Finally, we analyze whether rent control enables tenants to live in neighborhoods with better amenities. One might expect neighborhoods with the largest increases in market prices and amenities would be ones where tenants would remain in their rent-controlled apartments the longest, since their outside options in the neighborhood would be especially expensive. However, for these same reasons, landlords in these high-rent, high-amenity neighborhoods would have large incentives to remove tenants.3 They then could either reset rents to market rates with a new tenant or redevelop the building as condos or new construction, both of which are exempt from rent control. These landlord incentives would push rent control tenants out of the nicest neighborhoods. In fact, we nd the landlords’ incentives appear to dominate. The average tenant treated by rent control lives in a census tract with worse observ- able amenities, as measured by the census tract’s median household income, share of the population with a college degree, median house value, and share unemployed”.

Thus, while rent control does prevent displacement from San Francisco, it does not provide access to the best neighborhoods in the city. The evidence above suggests that landlords do not passively accept the burdens of the law.

Effects on supply:

“To further study the landlord response to the rent control expansion and to understand the impact of rent control on rental supply, we merge in historical parcel history data from the San Francisco Assessor’s Office, which allows us to observe parcel splits and condo conversions. We find that rent-controlled buildings were 8 percentage points more likely to convert to a condo or a Tenancy in Common (TIC) than buildings in the control group. Consistent with these findings, we find that rent control led to a 15 percentage point decline in the number of renters living in treated buildings and a 25 percentage point reduction in the number of renters living in rent-controlled units, relative to 1994 levels. This large reduction in rental housing supply was driven by both converting existing structures to owner-occupied condominium housing and by replacing existing structures with new construction.”

“This 15 percentage point reduction in the rental supply of small multi-family housing likely led to rent increases in the long run, consistent with standard economic theory. In this sense, rent control operated as a transfer between the future renters of San Francisco (who would pay these higher rents due to lower supply) to the renters living in San Francisco in 1994 (who benefited directly from lower rents). Furthermore, since many of the existing rental properties were converted to higher-end, owner-occupied condominium housing and new construction rentals, the passage of rent control ultimately led to a housing stock which caters to higher income individuals. We directly test whether rent control led to in-migration of higher income residents by imputing household income as the per capita income of the census block groups in which the building occupants resided in five year prior. We find that this high-end housing, developed in response to rent control, attracted residents with at least 18 percent higher income, relative to control group buildings in the same zip code.

Taking all of these points together, it appears rent control has actually contributed to the gentrification of San Francisco, the exact opposite of the policy’s intended goal. Indeed, by simultaneously bringing in higher income residents and preventing displacement of minorities, rent control has contributed to widening income inequality of the city. For a full quantitative analysis of the welfare gains and losses due to rent control, see our companion paper (Diamond, McQuade, and Qian 2018), which estimates a dynamic discrete choice model of tenant migration and performs general equilibrium counterfactual analysis of the impacts of rent control.

Our paper is part of the literature on rent control. The two papers most closely related to ours are Sims (2007) and Autor, Palmer, and Pathak (2014), both of which study the effects of ending rent control in the Boston metropolitan area. Sims(2007) uses American Housing Survey (AHS) data to show that towns in the Boston metropolitan area in which rent control was abolished saw increases in rental supply and increased housing maintenance. Sims (2007) also shows some evidence of spillover effects on non-controlled properties. Autor, Palmer, and Pathak (2014) use proper- ty-level data on assessed values and transaction prices in Cambridge, Massachusetts to investigate these spillover effects more directly. They show that decontrol led to price appreciation at decontrolled and never-controlled units.”

I find this paper very interesting. Mostly due to the rising inequality the law led to, opposed to the main reason it was meant to do, here is a copy of that conclusion:

“We find that this high-end housing, developed in response to rent control, attracted residents with at least 18 percent higher income, relative to control group buildings in the same zip code. “

The rent control actually led to an increase of high-income tenants within the city in the long run opposed to the area of the control group who didn’t have a rent controlled housing policy.

This paper is quite different than other papers that played as empirical evidence to the economic theory of rent controls, which mostly show the relationship between rent control and decreased supply, therefore increasing rent prices in the long run. Mostly due to the wide range of data they had and therefore making it a very important one.

To summarize, I want to clarify, that although this and other research done on this subject suggest that rent control has eventually worsened the problem, it doesn’t answer the question if a city should drop its already house controlled policy.

There is evidence from different research such as the one made on Cambridge Massachusetts that deregulating rent control could actually not be a good solution and lead to an increase in prices and worsen low-income mobility in the city as happened there.

Gilad