Tuesday, 2 November 2010

Some Notes on Rent Controls in Jersey

The problem of high rents in Jersey and how it should be controlled is problematic. A free market means that the rent soars towards those most able to pay, and the higher salaries of the finance industry drive rents upwards. With insufficient social housing, one means of addressing the situation has been a "rent rebate" scheme, to incorporate more rental units that are provided for social housing outside that housing stock. Just as with social housing, the States are subsidising rentals in the private sector. But social housing is for those residentially qualified, and outside this umbrella, rents continue to increase, often with substandard accommodation falling to those who can afford least.

What about rent control? America has has various forms of rent control for some years, and can therefore be seen as providing a larger evidential base for seeing what occurs economically when some kind of rent control is introduced, such as a rent control tribunal. While the situation is not exact, because of course Jersey has much greater pressures on land, nevertheless, I think that some of the key components of rent control also would apply, because they are basic economic consequences of imposing controls.

In a detailed study of rental controls in Los Angeles over several decades, "Analyzing Rent Control: The Case of Los Angeles.", the authors point out that rent control brings with it various unexpected consequences, all of which offset the impact of the control.

Undermaintenance of Housing Stock

Firstly, they point out that rent control is not price control. By restraining the degree to which rents can rise, landlords seek to claw back more income than they might have done with higher rents by reducing the amount of maintenance upon a building. All buildings need maintenance, either as a preventative measure, or as they deteriorate, and within a rent control situation, the landlord saves money by reducing this.

Rent control ordinances restrict the revenues a landlord can receive from a particular dwelling. If the controlled landlord undermaintains the unit, the flow of "housing services" provided will decline, and the reduced rent may eventually be fully offset by a reduction of quantity; in the interim, the rent reduction will be divided between a lower price for housing services and a lower quantity of services provided. For the tenant, this distinction between price reductions and quantity reductions implies that the gain from rent control is less than the total reduction in rent paid; some of the reduced rent payment is offset by reduced housing services. For the landlord, this distinction implies that the loss from rent control is less than the total reduction in rent received; some of the lost rent is offset by reduced maintenance expenditures.

Landlords will choose to undermaintain their dwellings until their output of housing services declines to a level that is supported by controlled rents. For example, if rent control reduces rents by 10 percent, landlords realize that they are, in effect, selling 10 percent of their housing services for nothing, and they will stop maintaining that portion of their output. The unmaintained portion of their output deteriorates, and eventually disappears.

This means that over time, the quality of the housing stock will deteriorate. It has been noted in Israel, for example, that this can be taken up by the tenants themselves, but this is dependent upon the length of the tenancy. A long tenancy means any remedial work or improvements can be amortised over the length of the stay. Shorter stay tenants, or those whose tenure is dependent upon a renewal in a short term (so that they don't know if they will have their lease renewed), will be less inclined to spend on maintenance. Moreover, the common areas fall to the landlord, and will be subject to the same problem of undermaintenance:

Common areas of Israeli rental buildings are often in a ruinous state, but individual units are well kept up. This reflects two features of tenant substitution for landlord maintenance. First, free rider behavior will lead to undermaintenance of common facilities. Second, tenants will make investments in their units.

Game Playing Strategy for Optimising Rents

The imposition of rent controls also leads to higher rents for newer tenants. Because the rental increase is limited, the best game playing strategy for the landlord is to take the highest rent he can at the start, because the return on rent will fall with controls on increases as the years go by. This may mean some housing stock is priced out of the market:

The landlord will be reluctant to accept the tenant unless the expected present value of future rent receipts is adequate, while the tenant knows that future rent increases will be limited by the rent control ordinance. The result will be that the landlord will demand a higher initial rent from the tenant as "compensation" for the lower rent increases permitted in the future, and the tenant will acquiesce in anticipation of limited future rent increases due to rent control. This strategic behavior yields curious results for both tenants and landlords. Tenants who stay longer than anticipated will reap benefits from rent control in the future. Tenants who stay a shorter time than anticipated, however, will confer windfalls on the landlords by paying higher rents than in the absence of rent control.

Shepherd and Macdonald, in their study of rent control, also pose the problem of how rent controls should increase, and whether that will increase the likelihood of the landlord to get rid of the current tenant in favour of a new tenant paying a higher initial rent. Is the market to be regulated to stop this kind of unregulated rent increases when a tenant moves (which is called "vacancy decontrol")?

If the relative price of housing increases, should real rents be allowed to adjust upward at that time, thereby giving the landlord an incentive to get rid of the current tenant? Or should the adjustments be prohibited, thereby creating a black market, waiting lists, and key money payments?

Related to this strategy for landlords, based on higher rental values at the outset, can be "overmaintenance", where a landlord refurbishes housing stock to reposition it into a different market, and thus have a much greater initial rent:

Rent control laws can cause landlords to overmaintain a dwelling. For example, rent control provisions that exempt luxury units may give some landlords an incentive to upgrade their units to luxury status and to maintain them as such. Similarly, cost pass through provisions that allow landlords to amortize, say, carpets over a three-year period, may give landlords an incentive to invest in higher quality carpets (with a longer economic life) than they might have otherwise selected. In general, if the provisions of a law permit the landlord to raise rents by more than the cost of some maintenance activity, that activity will be undertaken more under rent control than in the absence of rent control.

Removal from Rental Market

The other option for landlords seeking a better return on properties whose rental value is restricted is to remove them from the rental property market by various means, but where the end result is taking the property out of the rental market and onto the buyers or developers market. The study of Los Angeles showed this was occurring alongside the other ways in which rent control was effecting the market.

Landlords could remove their dwellings from the rental market by abandoning them or converting them to other uses, such as condominiums. We call this the "quantity loss due to removals and conversions."

This is also noted in another study by Richard Epstein who notes that rent control may see landlords "want to take their units off the rental market, either for owner-occupancy or for sale as a condominium."

Legal Problems

The problem of undermaintenance and the removal of housing stock from the rental market can be dealt with by adding exclusion clauses. However, the problem is the balance between the landlord and tenant, as this means that funds expended can be regained in various forms from the tenant, essentially making a loophole in the rent control.

Second generation laws go beyond the mere prescription, "thou shalt not raise rents." They add exceptions and exclusions that mitigate rent control's most deleterious effects on landlords' incentives to construct and maintain dwellings. We find that second generation adjustments in rent control laws increase landlords' incentives only by eating into tenants' benefits. In the extreme, second generation controls are no controls at all.

Basically, once rent controls are hedged around with loopholes, landlords will take advantage of those, but the benefits to tenants will be minimal.


The authors' conclusion is as follows:

We believe that two of our empirical findings apply to other communities with rent control. First, the bulk of the transfers from landlords to tenants achieved by a rent control law are realized early in the law's life, but the bulk of the economic cost of the law--the housing stock lost through the inefficient working of the market under rent control--is incurred later in the law's life. Second, legal provisions that ameliorate the deleterious effects of rent control on landlords' incentives to maintain their dwellings reduce the benefits of rent control to tenants.

The studies done in America make one wonder why rent controls continue at all, given the problems that can occur. But the main principle remains the same, to prevent excessive increases by greedy landlords and protect people renting who could be driven down to subsistence levels by high rents:

The stated objectives of rent control were the prevention of "excessive" rent increases while allowing landlords a "just and reasonable" return on their investment in rental housing.

This does not mean that some form of rent control is not desirable, but it does show how complex the situation is, and that unintended consequences can result to go against the main aims of rent control, and any strategy to bring in rent control must be aware of those. I am personally in favour of some kind of rent control in Jersey, which may seem surprising when I have been highlighting the problems that are faced by that strategy.

But against that must be placed the status quo, where the rental market, much as the housing market has been, is driven up by the high salaries of those working in the finance industry, and the less maintained properties, some extremely badly kept, are rented out to those outside that comfortable level of income.

Rent control of some sort would certainly be better than the current situation, and an awareness of the pitfalls shows that it will not be a universal panacea, but may help as long as it is regulated carefully enough to prevent the problems outlined above becoming too prevalent.

"Analyzing Rent Control: The Case of Los Angeles." by MP Murray , CP Rydell, CL Barnett, CE Hillestad, K Neels, Economic Inquiry. Vol 29, Issue 4 (1991)
"The Moral and Practical Dilemmas of an Underground Economy." Richard Epstein, "Yale Law Journal. Vol: 103. Issue: 8. (1994)
"Rent Control with Rent Discrimination Revisited." A. Ross Shepherd, John F. McDonald, "Journal of Economic Education." Volume: 28. Issue: 4., 1997

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