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Impact of rent control on tenant quality
Source : The Hindu Property Plus Published On : 2007-12-22 City : Chennai

Having seen some reforms in the age-old urban land ceiling regime, there is now an expectation that rent control laws too should soon change for the better.

 

First, what is rent control? It refers to laws or ordinances that set price controls on the renting of residential housing, as Wikipedia defines. “Its functions as a price ceiling. In the US during world War I, rents were ‘controlled’ through the efforts of local rent anti-profiteering committees and public pressure.”

 

But there are arguments both for and against rent control. On the one side, it is contended that the government, by forbidding increases in rents, “protects tenants from extortion and exploitation without doing any real harm to landlords and without discouraging new construction,” as ‘Economics in One Lesson’ by Henry Hazlitt explains, on http://jim.com. The rival argument is that new housing is not built because there is no incentive to build it . “With the increase in building costs (Commonly as a result of inflation), the old level of rents will not yield a profit.”

 

There are two types of rent control laws, writes Kaushik Basu in ‘Efficient pricing, tenancy rent control, and monopolistic land- lords’, an essay co-authored with Patrick Emerson and included in ‘Collected Papers in Theoretical Economics’, Volume III (www.oup.com).

 

The first type is the standard, or first generation, rent control, which places a ceiling on the rents that a landlord can charge, and thus commonly leads to ‘excess demand for housing’.

 

And the second, the more common type, the authors say, is ‘tenancy rent control’ that allows a landlord to set the rent freely when leasing to a new tenant, but prevents the landlord from raising the rent or evicting the tenant.

 

Though the second method seems to be the opposite of the first, the essay shows how ‘through the workings of the market, tenancy rent control can result in an outcome which looks as if there is standard rent control’, in a situation where you have monopolistic landlords.

 
 

Typically, a monopolist with a fixed supply (as in housing) may not sell all of his goods; however, under certain parametric conditions, we can have the opposite case,       “where the landlord sets the rent so low as to give rise to excess demand for housing.”

 
 
 
 
 
 
 
 
 

Do we have examples of monopolistic housing? The book cites many US instances where rental markets are far from competitive. Such as: an average 70 percent of all rental housing units in the suburbs of Virginia(Washington D.C.) controlled by one owner; 6 per cent of the city’s house holds in Cambridge, Massachusetts, controlling 70per cent of rental housing units; over 50 per cent of rental in Santa Barbara owned by sixty owners, and seven of them accounting, for 20 per cent of the rental stock; ten owners controlling close to a third of rental housing in Orange, New Jersey; and just one owner controlling over 30 per cent of the rentals in Thousand Oaks, California.

 
 

Apart from the empirical finding that housing markets are less than perfectly competitive, Basu and Emerson see reason to believe that ‘landlords do not always respond to housing shortage by increasing initial rents and the supply of apartments.’

In Canada, for instance, when the Ontario provincial government relaxed Toronto’s rent control laws in 1998, giving landlords the right to raise rents to market levels whenever a tenant moved out, “land lords did not respond with an expected building boom- fewer than 600 new units were built over the subsequent 2 years while Toronto’s population increased by more than 1 lakh.”

 
 

A section titled ‘the algebra of rent’ in the paper, considers the effects of rent control when the supply of rent-controlled housing is limited, as in New York, inner city Mumbai, and Delhi.

 

Given tenancy rent control, the presence of even a small positive inflation gives rise to an adverse selection problem, the authors postulate.

 

“Landlords now prefer short staying tenants to long-staying tenants (as long-stayers impose greater costs on landlords because of the erosion of real rents during a single tenancy), but they have no way of telling the types apart.”

 

As is human nature, ‘long-staying tenants know their type but have no interest in revealing this information to prospective land-lords’. Meanwhile, the short-staying tenants no longer find it worth-while to rent in this market, because they do not see as much benefit from the erosion of real rents as do long-stayers.

 

With the result that the process of adverse selection ensures that only tenants of a certain type seek housing. You don’t need to guess long to decipher which type.

 

Landlord, therefore, realizes that a higher rent worsens the ‘quality’ of the tenant, and arrives at R*, the efficiency rent,’ as the authors describe.

 

          A helpful thought that should come handy when you face a rental situation, be it as a landlord or a tenant.

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