Both economic theory and empirical evidence demonstrate that rent controls are a bad idea.
Housing is expensive. As a London renter myself, I feel the pain. The UK is suffering a chronic housing shortage, and the Government’s refusal to meaningfully reform the planning system means that we are terrible at building new homes.
In 1995, a homebuyer earning the median salary would have to spend between 3.2 and 4.4 times his or her annual salary on a house, depending on their location. Currently, the average house in the UK costs more than 9 times the average income.
The economics are rather simple. If we want more affordable housing, we must increase the supply of housing. Unfortunately, as is the case in many parts of the world, the Government is hell-bent on pandering to perverse political incentives. Namely, the NIMBYs, or “Not In My Back Yard-ers”, who oppose housing development in their local areas.
Instead of tackling the root of the problem by solving the supply issues, there is increasing speculation that London Mayor Sadiq Khan plans to obtain further power from Westminster to implement controls on the cost of rent. In 2019, Sadiq Khan claimed that the “arguments for rent controls are overwhelming.” Is he right?
Economists rarely agree on much. The fact that rent controls have disastrous economic consequences is a unique area of consensus. Rent controls may have well-intentioned aims that are politically desirable—making rents affordable—but they have significant economic consequences. Across the literature on rent controls there is a strong academic consensus that they produce harmful consequences.
They distort the market by capping the possible revenue a landlord could obtain, reducing incentives for landlords to improve their rental properties, and reducing the supply of housing on the rental market over time. This artificial suppression of the price of rents simply exacerbates housing shortages, and reduces the overall quality of housing.
As argued in the 1972 Institute of Economic Affairs publication “Verdict on Rent Control,” these distortions result in various negative economic consequences:
- Perpetuating housing shortages by driving landlords out of the rental market.
- Encouraging immobility in the labour market by increasing incentives to stay in properties for longer periods of time.
- Overriding the natural choices that renters would make, causing a misallocation of housing.
- Reducing the quality of housing.
- Distorting the natural allocation of scarce resources, and potentially preventing areas that could be developed for more profitable or socially beneficial uses from development.
Rent controls are disastrous, but that doesn’t stop politicians from implementing them. Let’s consider a few examples, and their dire consequences…
1) Berlin
In 2015, landlords in 313 of the 11,000 German towns and cities could not set rent for new tenants any higher than 10 percent above the average locally over the four-year period prior.
In 2020, the city government of Berlin brought in a freeze on rents. The supply of new rental properties entering the market fell by a quarter compared to the year before. In the same period, other big cities such as Cologne, Hamburg, and Munich saw an increase in housing supply by a third.
In the areas where the latter cap was applied, it resulted in supply falling by almost half. The number of properties up for sale, which remained uncapped, increased significantly.
2) San Francisco
In 1979, San Francisco introduced rent controls on buildings with five or more apartments, but excluded new-builds. In 1994, these controls were expanded to cover all buildings with more than one apartment, but still excluded new-builds.
A Stanford University study of these rent controls, conducted by Rebecca Diamond, Tim McQuade, and Franklin Qian, found that it created both winners and losers. Between 1994 and 2010, people who lived in rent-controlled properties benefited from lower rents. However, renters who moved to the city later paid an additional $2.9 billion in higher rents over the same period.
Essentially, the expansion of rent controls had resulted in a shortage of available housing, pushing up the cost for newer (generally younger) renters.
The Stanford study also found that many landlords demolished their properties in favour of new-builds, which remained exempt from the controls.
3) Stockholm
Sweden has championed some form of rent controls for almost a century. As far as rent controls go, they have had the real deal.
Rents were capped temporarily during the Second World War. From 1978, Sweden allowed landlords to negotiate general rent increases with tenants. In reality, these negotiations are done on a national level between the Landlord Association and the Tenants’ Union. So, Sweden still has de facto controls on the price of rents in all attractive housing markets.
The consequences in Sweden have been rather disastrous. Due to these rent controls, demand far outweighs supply, and so queuing for housing is commonplace. In central Stockholm, equilibrium rents are estimated to be 70 percent higher than regulated rents. As a result, there is approximately a 27,000-apartment shortfall.
The Government’s heavy-handed intervention did away with the natural price mechanism, meaning that an equilibrium in the housing market is unachievable. The queuing system allocates housing instead, and so thousands of Swedes are left waiting for years. As of 2019, some 670,000 people were listed in the housing queue.
The repercussions are more far-reaching than housing shortages. According to a 2020 paper published by EPICENTER, the regulation has opened up a black market for rental agreements with an annual turnover of 100 million Euros. In Stockholm, one in five young tenants had admitted to paying for rental contracts illegally.
Whilst long-term residents enjoy lower rents, younger Swedes often have to wait over a decade for rent-controlled apartments. Stockholm’s “housing for all” has turned out, in reality, to be housing for the few.
