Background

Rent control is one of the few things that almost all economists can agree on. It is almost universally believed to be a bad idea. And once enacted, it is almost impossible to repeal. Perhaps the old saying that the government that robs Peter to pay Paul can always count on Paul's support has something to do with this. Another way of looking at it is that it unbundles a certain property right, that of occupancy at a fixed or relatively fixed rent, and grants that to the occupants of apartments. At the same time, this right is rarely transferable, or at least transfer is problematic. So the renters so favored tend to stay put. Have you heard of destination neighborhoods? Well, rent controlled communities become something like that for tenants. The joke in Berkeley, California is that students at the University of California have to live somewhere else, because the class of 1979, the date of the inception of rent control, hasn't moved yet.

The classic argument was that rent control leads to neglect of property and the deterioration of neighborhoods. This is generally but not universally true. As a matter of fact, there are a lot of generalizations about rent control that are only true as generalizations. When specific cases are examined the impact of rent control varies because of a number of factors.The Cato Institute recently published a study aggregated at the city level comparing average rent reported to the Census and average advertised rent.* As a single cross-sectional snapshot it indicates that in rent controlled cities average advertised rent is substantially higher than average rent in the city. In cities without controls, the average advertised and average Census reported rents are about equal. The hypothesis is that in rent controlled cities two factors are at work. First the beneficiaries of rent control never move, so normal turnover of the market is interrupted. Without that turnover supply is drastically reduced, and any incremental demand applied to this reduced supply has magnified effects on price. At the city level this is a reasonable hypothesis.

Some other perspectives are interesting here. The first is that in most urban areas uncontrolled rental markets show a great variation around average rent, even when a relatively uniform product is considered. In Berkeley before rent control the highest rent for a two bedroom apartment in the South Campus neighborhood was about double the lowest. Absent inflation the tendency, therefore, would be for the beneficiaries of the lower controlled rents to cling most stubbornly to their apartments. They were probably below "market" when the rent was frozen. At the same time the properties least able to cope with the new regime would be those with the low rent units. The tactic of the owners to grant a certain rent concession in return for tenant goodwill backfired. Absent inflation the "slumlords" who "gouged" the tenants came out of the freeze with their probably above market rents established by law. Good guys finish last. Over time this led to a number of processes that reduced the number of low rent units. First was condominium conversion. When that was outlawed, there was the conversion to tenancies in common, or de-facto condominiums. And lastly, many units simply deteriorated to the point that they were uninhabitable, were condemned by the City and boarded up. Some of course subsequently became even more substandard abodes as vagrants forced entry into them. Very occasionally deterioration reached such a point that even despite the "Neighborhood Preservation Ordnance" which prohibited demolition of buildings, such structures were razed. So, gradually, the very lowest controlled controlled units left the housing stock, and the average rent rose. Berkeley rent control provided for a "fair return" to the property owner. For the most part this was either a bad joke, as the fair return and property values were was set at absurdly low levels. But in San Francisco the concept had a slight twist.

San Francisco rent control had two interesting features. The first was a Consumer Price Index escalator, which was seriously revised a couple of years ago. In the late 1980's when suburban apartment construction glutted Bay Area suburban markets, rents stagnated, as did prices, and capitalization rates climbed. The exception was San Francisco, where rent control guaranteed increasing income. The CPI provision was scaled back so that only 40% of the CPI may now be passed through, and of course inflation is down. Suburban rents are climbing again, because there has been little new construction in almost a decade. Therefore the price and capitalization rate disparity that favored the City is a footnote of history. The more interesting part of San Francisco rent control is that it decontrols rent on vacancy. So, San Francisco becomes a classic example of the Turner study. And it also presents an interesting case study of return on value. As with Berkeley, before rent control there was a wide dispersion of rents about the average for any given property type and neighborhood. And as with Berkeley, the market response was to try to convert the lowest rent buildings to condominium. When that was banned, then, as with Berkeley, the new mechanism was selling the whole building as a tenancy in common, TIC. Once so described the individual TIC units could be resold. The market prices TIC's below condos because the law does not really allow that any individual unit be transferred in that manner. Custom, however, prevails in practice. So the higher rent buildings remain. Within these higher rent buildings a stratification has occurred that is common to many rent control regimes.** There are the rent control favored tenants, at low rents. Then there are the few units in the building which might as well have "For Rent" chiseled into their doors. Seriously, how many people who would want a studio apartment can afford to pay $1,200 per month for it? So turnover is high as tenants find lower cost options: sharing with friends, moving to the suburbs, going back to their parents... In good times more people are willing to pay the elevated prices for the decontrolled units. In recessions, not only is turnover high, but the duration of vacancies is long. From the perspective of the property owner, however, these high rent units are a way to raise the average building income and value. So the pricing mechanism is partly a function of the owners' perceptions of value. Not only does any increase in demand act against a limited supply leading to rapid rent inflation for the marginal unit, but the owners' perceptions of value rise in good times. The return on that perceived higher value must be provided by the marginal de-controlled unit.

The ingenuity of people to either preserve their advantageous controlled rent or to circumvent rent control and recapture the value of the property has been intriguing. One of the more obvious examples of the transfer of property rights is where a rent controlled tenant sublets rooms for a profit. The condominium and TIC dodges have been fiercely resisted. In many cases, particularly in Berkeley, owners have taken to simply paying tenants to move. The advantage lies in the spread between the individuals' rate of return, usually high, and the usually lower real estate capitalization rate. A few thousand dollars to a tenant can yield a multiple in property value.Gradually, by many mechanisms, the low rent units are removed from the rental stock. Therefore, at least in theory, there are fewer beneficiaries of rent control, and it becomes politically possible to move on. As to whether we actually do, that remains to be seen.

*How Rent Control Drives Out Affordable Housing, William Tucker, Policy Analysis 274, 1997

**The Scourge, Gene Epstein, Barrons, May 26, 1997

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