Rent Regulation and the Theories of Regulation

Coursework (option 2): Rent Regulation and the theories of regulation

Rent Regulations

In a free market, inelastic supply of rental housing means landlords have a higher bargaining power, this combined with rising demand lead to upward-spiralling rents around the world in the past decade, making rents increasingly unaffordable to lower income groups. Rent control ensures rents remain affordable by keeping the them below market level, thus protecting renters. In deciding whether or what regulations to employ, regulators maximise social and economic welfare with relevant weightings on key groups. In the case of private rental market, the demand for regulations stems from social objectives more so than economic ones. In some ways landlords are comparable to a monopoly, since there are very limited close substitutes available to renters, prices can increase to dangerous levels, hence requiring some form of regulation to suppress any abuse of power. Moreover, high rents force individuals and households to relocate, incurring high economic and social costs. Therefore, private rent regulation may be needed.

As a form of price control, rent control operates as a price cap; price capping in rent can take two forms, a rent ceiling or a modified rent control. Camden Councillor Sian Berry recently proposed that London’s rents be capped or frozen (Hill 2015). With a price ceiling, consumer surplus increases and producer surplus decreases, yet the overall welfare change is uncertain due to unknown elasticities and deadweight loss, which contributes to allocative inefficiency(figure 1.). Price ceilings create shortages since demand exceeds supply at a below market prices. As the supply of housing becomes more elastic in the long run, shortage widens as constructions adjust to rent regulations, and landlords become more willing to sell at market price than to rent it out at a fixed ceiling price, as Friedman and Stigler (1946) hypothesised(figure 2.).[pic 1]

What follows a price cap is that the excess demand will be forced to move to the housing market where rent is unregulated, thus increasing demand for the uncontrolled rental units and driving prices up there. Additionally, rent regulation will deter construction investment due to the fear of rent control being imposed on them, reduce supply in new housing units, further boosting prices. Therefore, while rent control will create artificially low prices in rents, it will have an adverse impact on non rent controlled units, possibly increasing the average price of rentals overall. Gyourko and Molloy (2014) theorise that regulation reduces the elasticity of housing supply, result in larger house price increases and slower growth in housing supply. Extreme rent regulations may even result in leakages where investment is shifted to other countries that are not regulated.

The alternative to rent ceiling is rent control, which can take various forms, one of which is when the rise in rent is restricted to a decided rate, similar to the rate of return regulation, as landlords still retain some profitable return, albeit not necessarily a satisfactory one.

The benefits for tenants who have successfully secured a rent controlled house include lower-than-market rents and protection regulations linked with rent control. Rent control also corrects for some imbalances, for example, council tax payments for which tenants are obliged to pay even if they do not own the property are neutralised via rent savings. However, the following must be considered. While in general, price control regulation can lead to cost savings and higher productive efficiencies, in the private rental market, price control is conflicted with quality control. Rent control demotivates landlords to upkeep the quality of their property, even allowing their maintenance expenditure to fall to zero (Albon and Stafford 1990). Additionally the shortage in rental units mean landlords are not incentivised to compete via quality. Maintenance costs are thus transferred to tenants, counterbalancing their rent savings, and may even worsen the position of poorer households. Ironically though, market failure from any information asymmetry that previously existed is now erased, since it is now only logical to assume all units are kept at minimum maintenance.

Scenarios exist where rent control outcomes match regulatory objectives, particularly if rent is regulated for a limited period of time and/or if vacancy decontrol is imposed, as the disincentives of the landlords and the real estate firms to invest will be reduced in the expectation that they can regain market-rate rents someday. In certain events involving an influx of people into an area for a limited period of time, such as the Olympics, rent control may be effective in preventing temporary instability and fluctuations in rents and associated costs.

It must be carefully measured whether those who end up securing rent controlled housing and those who are in need of them will be the same group of people. Targeted groups like low income individuals may benefit from rent control if monitored and executed efficiently. However, situations may change in the future, and it is costly to monitor whether those who qualified for rent controlled units continuously meet the benchmark; without monitoring, the possibility of allocative inefficiency is exposed again. A report by LSE’s Scanlon and Whitehead (2014) uses New York as an example to show that those living in rent-controlled properties have higher than average income than those in market rented properties. Another key issue faced by regulators is in setting up regulations. The level of rent must be determined in a manner that benefits the renters while still above a level that minimise damages to landlords and real estate companies; an adapted RPI-X framework is one possibility though it may be oversimplified. The complexity from designing to executing and monitoring regulations implies substantial costs; issues such as regulatory lags also result in allocative inefficiency before prices are adjusted.

Propositions of rent regulations made after reviewing the substantial costs associated may carry a political agenda, according to Peltzman’s model (1976); it is plausible legislators are proposing rent regulation policies to maximise voters’ support, as a recent poll by shows that only 6.8% of respondents opposed to rent control(Stone 2015). On the other hand, Becker (1983) argues that political equilibrium depends on the pressure from different interest groups, resulting in regulations increasing the welfare of the most influential group. It is yet unclear who will win the political battle between landlords and tenants. Although a regulation’s outcome may be independent of political motifs, politicians who have genuine interests in the matter are likely to pay more attention to maximising long term welfare.