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Friday, June 3, 2016

How Germany Made Rent Control “Work”

Rent Control "Works" when It ... Doesn't Control Rents

Rent controls are a bit like communism, in the sense that they can never “fail,” in the eyes of their supporters they can only be “badly implemented.”

Rent controls have worsened the situation of tenants in New York, or in Stockholm? According to the true believers, that tells us nothing whatsoever about rent controls as such; it only tells us that this one, very specific form of rent control adopted there has its problems. Maybe they set the cap at the wrong level. Or maybe they apply it to the wrong type of property. Or maybe the cap is not sufficiently differentiated.

It would help, of course, if supporters of rent controls (or, for that matter, communism) could come up with at least one positive example. There are myriad examples of “badly implemented” rent controls, but why is it that nobody ever seems to get the implementation right?

About a year ago, it seemed that finally, one country had pulled off that feat. The German “Mietpreisbremse” showed, at last, that rent controls can work splendidly, if only they are done properly.

Germany has long had a system of “second-generation rent controls,” which restrict a landlord’s ability to raise rents during an ongoing tenancy. But when putting a flat on the market, they had thus far been free to demand any price they could get away with. Second-generation rent controls change the timing and incidence of rent increases, but ultimately, they do not affect aggregate rent levels.

This Mietpreisbremse was supposed to be qualitatively different. Under this system, state governments can cap the initial rents, set at the outset of a new tenancy, in selected property hotspots. More precisely, they can limit them to 110 percent of a reference value, which is based on average local rents for similar properties.

I can see why the Mietpreisbremse must seem attractive to rent control supporters. Most forms of rent control that have so far been tried have been quite crude and arbitrary, applying a one-size-fits-all ad-hoc cap to very different types of properties. The Mietpreisbremse is a more sophisticated system, which recognises that there can be legitimate reasons for rent variation, and which takes account of a range of local factors. Not least, it incorporates market signals, rather than ignoring them.

The first empirical assessment of the Mietpreisbremse, from the German Institute for Economic Research (DIW), is now out. The authors compare the evolution of rental markets in places subject to the Mietpreisbremse to otherwise similar rental markets not subject to it. The good news is that the Mietpreisbremse has not, as one might have expected, led to a drop in property development.

So were all those warnings about the devastating effects of rent controls just neoliberal propaganda? Have we finally found out how to make rent controls works?   

Not quite. The reason why the Mietpreisbremse has not had any discernible negative effects is simply that it has not had any discernible effects at all. Rents in controlled areas have shown the same trend as rents in otherwise similar, but uncontrolled areas, so it has not been much of a Bremse (brake) at all. Why not?

The government has tried to avoid the pitfalls of crude rent controls, which may seem sensible, but in doing so, they have produced an extremely complex system with hundreds of different reference values per area. It can be quite difficult to find out what the correct reference value for any given property would be.

I used to live in Berlin for many years, and I have just tried to work out the reference value for my own former flat, via the council’s website. I think I have found it, but I’m still not quite sure: the landlord may qualify for various exemptions, depending on what changes they have made to the property in the meantime. Now, if I could gather some additional information on site, and come up with a revised figure, would I bet £5 that my figure is the correct one? Yes. But would I sue a landlord, and enter a legal battle, on that basis? Absolutely not.

Bear in mind that, by design, the areas where the Mietpreisbremse applies are areas where demand exceeds supply. There will be more than one applicant per flat, and if you are one of them, you will want to impress your potential future landlord. Emphasising what a tidy, reliable and responsible person you are might be a good idea. Asking inquisitive questions about how the rent had been worked out, and whether it is definitely Mietpreisbremse-compliant, not so much.

So here’s the crux: if you want to make rent controls more fine-grained and flexible, you inevitably increase their complexity, and create uncertainty. Under those conditions, rent controls cannot be automatically enforced: you need proactive tenants, who insist on their enforcement. In areas where demand exceeds supply, tenants are not in a position to behave in that way. They might, in markets which are more skewed in the tenant’s favour, but of course, in such markets, you don’t need rent controls in the first place.

At the end of the day, there’s no escape from the laws of supply and demand. The Mietpreisbremse has avoided the worst effects of rent control, but only because it has so far been ineffective. But then, a system of rent controls that is merely ineffective, as opposed to actively harmful, is probably the best one can realistically hope for.

This article first appeared at the UK’s Institute of Economic Affairs.

  • Dr. Kristian Niemietz is the Institute for Economic Affairs' Head of Health and Welfare.