Do Rent Controls Keep Rents Low?

Rent controls rarely work to control long-term rent prices because such a policy often fails to account for and appreciate the importance of incentives in a market system. When I rented, I often would get frustrated at landlords for increasing rents and felt it was unfair or unreasonable. Now, having been both a landlord and tenant, rent controls over the long term do not help to reduce rent but rather do the exact opposite over the long term.

What is Rent Control?

Rent control is a policy tool that governments introduce to limit the amount of rent a landlord can charge for a rental unit. Such a policy is often common in places with high housing unaffordability due to the cause-and-effect home prices have on rental stocks and prices.

Why Do Rent Controls Not Work?

In a market system, incentives drive people to do certain things. People have to be given an incentive to want to do something. While most of us want to be good or do good things, the reality is that if the right incentive isn’t in place, we will end up not doing good things. A simple example of an incentive is to think of the number of washrooms you might have been in that had a dripping tap and how many times you reported the issue to the establishment or place that had the problem.

Most of us will notice the dripping tap and think, “oh, that should get fixed,” but will not report it. The lack of reporting isn’t a reflection of our character or implies we are horrible people but instead stresses the power of having the right incentive.

I doubt most of us would move along if perhaps there was a monetary payment for reporting such a problem to the establishment. Some would still carry on, but the number of people who would not report the problem would be reduced compared to when there wasn’t an incentive.

When policymakers put rent controls in place, they attempt to do something that feels good (politically) but will do nothing to resolve the issue. Politics is a game of understanding who your villain is, and politicians are there to play the hero. When it comes to the rental system, renters have been identified as the victim, while landlords have been identified as the villain.

Therefore, policies crafted by politicians are often based on the idea of them playing the hero to the renters while painting all landlords with the same brush as villains.

Rent control does not work because renting is a business like everything else. If someone is operating a business, they typically are in the business of making money. Market rentals are a form of business for many individuals or families and a means by which they provide for their families. Renting is also crucial as it provides shelter for people to have safety and a place to call home.

Rent control policy fails to appreciate that the rental sector is a business; therefore, the policy created needs to create the right incentives to motivate those individuals who take on that form of business to make money while benefiting society’s needs. When rent controls are put in place, it makes the business of renting less enticing for a prospective new landlord. As such, prospective new landlord move their money into other areas that are more profitable without the restriction and avoid going into the rental business. This behaviour is important because it reduces new rental stock entering the market, which society doesn’t want.

What are the disadvantages of rent control?

If potential landlords are not entering the rental business because they feel their investments can do better in other areas, some of you might be thinking, well, who cares? This is housing, and it shouldn’t be a business. While I don’t share that point of view, I indeed believe that renting, much like homeownership, should be at an affordable rate that enables people to live and not simply live to pay their mortgage or rent.

But to lower rent, you need more rental stock, which means you need to create an incentive for new landlords to want to construct a new rental building. When you place rent controls, you effectively are saying, I do not want more rental stock, which then means existing tenants in the short run benefit from this policy, but over the long run, everyone’s rent will go up as there will be less rental stock to select from.

Over the long run, existing landlords will have greater control of the rental market. At the same time, their pricing power will increase as they know there is little to no stock available.

Furthermore, suppose any new rental is created. In that case, the existing landlords will be in the best position with capital to finance these projects even with a rent control policy since they will have existing stocks to offset those policies.

How Do you Control Rent Prices?

You control rent rates in a market system by ensuring the demand and supply sides are in balance. If the supply side, which is the supply of available rental units, is well below the number of people who need rental units, you have an unbalanced market. In such a scenario, rents will remain high over the long term while landlord pricing power will grow over the long term.

In such a market, policymakers need to balance this market by introducing more rental units to reduce rent prices over the long term eventually. However, policymakers do not select this option because it requires many years of building before you see the reduced rent. As such, most policymakers opt for fancy slogans or things that appear to be fixing the problem when in reality, it might delay or benefit a small fraction of existing renters while hurting all renters over the long term.

As long as the supply of rental units remains far below the needs of those who want to rent, putting in place rent controls isn’t going to fix things as it creates the wrong incentives to build more rental supply, which is the key to reducing everyone’s rent and keeping pricing in check.

Another less talked about implication of rent control is it also creates fewer incentives for existing rental stocks to be maintained and updated. As stated previously, rental is a form of business. If you run a business, you typically will not put money into something that can not yield you a reasonable return. Therefore, if landlords see that fixing their building or making improvements to it will not result in them being able to make more, in the form of increased rent. They will leave the building to deteriorate as there is no incentive or reward for them to fix the building.

To appreciate this, think of owning a home and then doing upgrades only to find out that while potential buyers are willing to pay the price you want for your home, the Government has capped the price you can sell your home for. If you knew there was a cap on the maximum price you can sell your home for, would you still do upgrades to it? This capped incentive will likely cause most people to pause or only do upgrades to their homes that will be profitable within the cap restriction.

The same rule applies to landlord and their building; it’s just when it comes to landlords, there is a tendency to accept this restriction while using the homeowner example; most of us would find this ridiculous.

The Importance of Purpose-Built Rental as Effective Rent Controls

There are many reasons why rental housing stock is low, but a rent control policy isn’t the sole reason; indeed, it doesn’t help the problem.

A significant reason why rental supply is low is our preference for homeownership and our view of seeing rental as a poor person’s option for shelter rather than an option to provide shelter.

If you’ve never rented, it’s possible you’ve never experienced the look people give you or how some people look at you differently because you do not own a home. In my book Master Your Mortgage, I discuss that as humans, we tend to want to treat each other fairly, but often we create systems that do the exact opposite.

The rental system is a perfect example of this. Most homeowners do not view themselves as better than someone renting. However, the rental and homeownership system does say you are better if you own than if you rent.

To see this, look at where purpose-built rentals are built compared to homes for buying.

A purpose-built rental is a building designed and built from the start to be a rental building. A non-purpose-built was not designed or built to be a rental building but is now a rental.

The most common non-purpose-built supply you will see today is the basement suite. Most basement suite supplies available today were designed to be principal homes and not intended to be rentals; however, the lack of purpose-built rentals has created an opportunity for homeowners with the right building type to rent their excess space while earning a profit. Again, incentives play an important role in a market system.

While on the surface, this appears to be a good thing, it’s not. Non-purpose-built supply creates a greater eviction possibility for renters as homeowners attempting to make a profit from their home are not necessarily the same as a landlord whose business is renting.

It often means that homeowners will sell their home, or an investor who enters the residential renting space will sell their home once it goes up in value. They are making a quick profit and are not looking to be landlords but rather cash in on the lack of purpose-built rental supply.

For rentals to be an equally viable option for providing shelter, making more purpose-built rentals as part of any new development would help. This is occurring now but not at the level it needs to, as some homeowners may object to rental buildings within their neighbourhood or their building.

But perhaps the biggest thing that would help the rental shortfall is a change in our mindset about renting. Renting or owning a home should be viewed as a personal preference. As such, there shouldn’t be a preference for one over the other by policymakers. Instead, they should ensure both markets are balanced.

Policymakers and society need to stop the perception that renting is only for poor people and stop building rental buildings only in the wrong part of town. This continues to fuel a false belief by some homeowners that rental projects will bring problems to their neighbourhood, resulting in them objecting to any such project.

If you have a healthy rental market, you will likely have a balance ownership market. If you have a balance homeownership market, you will likely have a healthy rental market. Both are required to keep each market balance and stable. If one is out of balance or worse, both suffer from low supply, then renters and those looking to buy a home will find it increasingly difficult to do either.

Supply matters a great deal, and policymakers and all of us must appreciate the importance incentives play in our economic system.

The Bottom Line on Rental Controls

In short, rent controls don’t work over the long term. If you genuinely want rents to be kept at an affordable rate that reflects people’s income levels, you have to look for policymakers who can create policies to create the right incentives for individuals who want to enter the rental business.

In the short run, prices will likely not go down, but over the long term, as supply increases, the landlords will lose their pricing power as renters will have more options. Therefore, you can negotiate as if one landlord charges too high of rent; you can go to another. When landlord knows there is a balanced rental stock, they are less likely to increase rent in fear that it could result in their tenants moving to another rental; as such, the rent increase naturally is more reasonable.

The challenge with rent control is the same as obtaining affordable housing to buy. Existing renters and homeowners have to sacrifice now to make the system more affordable for everyone in the long term. Since we are speaking of rent control here, it means current renters have to seek policymakers that not only craft policies to eliminate abuse by landlords or renters. But also ensure such policies do not incentivize fewer rental stocks to be built.

It’s challenging for current renters, and counter initiative as eliminating rent control doesn’t feel like it will help, but from an economic perspective, that’s how it works. Rent control is a terrible incentive system for renters looking for a more balanced rental market over the long term.