Why Rent Regulations Don’t Raise Market Rents

“If rent decontrol would mean a fairer, less insane market, then it is a just cause,” the libertarian-conservative Cato Institute argues.

In every debate over rent regulations, someone—often an angry tenant paying outrageous rent—argues that regulations are responsible for pushing market-rate rents way up. If those regulated rents were brought into the free market, the market would level down, allowing a fair rent for all.

This argument has had wide currency among conservatives in their effort to undermine rent regulation and promote developers and landlords, the market suppliers in the real-estate industry. It appeals directly to people who, bitter over their heavy rent burden, welcome a convenient scapegoat: their own neighbors. And the authority, the landlord, is conveniently exculpated.

This argument is false. It is based on these premises:

1) Rent regulation discourages housing construction, restricting housing availability;

2) landlords make up their losses on regulated rents by gouging market-rate renters; and

3) deregulation would level the playing field, lowering high rents

Its conclusions have been demonstrated to be empirically, factually untrue. It is time to put this claim to rest.

Let’s start with the basics. Not only conservative think tanks like the Cato Institute, but the consensus of economists, even the liberal Paul Krugman, accuse rent regulation of discouraging new housing construction. Without new apartment units, the supply can’t keep up with demand, and fierce competition for the few remaining units pushes market rates up.

Their observations are true where rents for new construction are regulated. But in New York, it isn’t.

New construction is exempt from rent regulation in New York. Building new affordable housing is entirely voluntary in New York, and developers only provide it where the city gives them special incentives, such as allowing construction beyond the zoning restrictions or giving tax breaks. In fact, rent regulation encourages new construction, as the Citizens Budget Commission has pointed out, since new units can garner far higher rents than older regulated units. If landlords can’t cash in on regulated units, the only other means to make money is to build new, unregulated units. Rent regulation is an incentive for construction.

The difficulty of building in the city has many causes—the cost of land and construction, restrictive zoning laws, building codes, permits and bids, and, not least, the private and political graft involved. Nevertheless, New York continues to see housing construction. Even during the recession year of 2008, the city issued 33,911 permits for new housing, the greatest number since 1972. In a city of obstacles to construction, rent regulation is one of the few encouragements to build.

The second premise contends that if landlords can’t raise regulated rents, they will raise rents on unregulated units to make up for the lost revenue. Unfortunately for the landlords, the free market doesn’t work that way.

Market rates depend on renters’ willingness to pay, not on owners’ costs or losses. Rents can’t rise above what renters are willing and able to pay, and the nature of the profit motive ensures that market-rate rents will rise exactly to that level of renter willingness, regardless of what other renters are paying.
In a city where construction lags behind demand, it may be legitimate to ask whether deregulation would free up apartments and ease the market down—the third false premise. Quite aside from the consequences of displacing individuals or even whole communities, the answer is a surprising no.
Rent deregulation, believe it or not, raises market-rate rents. The conservative Manhattan Institute, in its 2003 study of deregulation in Cambridge, Massachusetts, found that, following deregulation, landlords invested in improvements to attract the highest possible market-rate renters. The result of the 1994 deregulation in Massachusetts has been better-quality housing, but higher market rents across the board.

That shouldn’t be surprising. A tight housing market implies that many renters can’t find apartments in their preferred locations. That’s the meaning of a housing crunch. Renters can’t find the spaces they want, and the ones they have to live in become overpriced. But when vacancies appear, those renters are willing to pay exorbitant rents for the locations they prefer, and landlords will meet their willingness.

The market value depends on three general factors: demand, supply, and the aggregate available funds for rents. If regulated renters are paying less than their available rent funds (the excess of which presumably goes into the goods and services economy), when they are forced to pay more, it will increase the aggregate funds going to landlords as rents, since most of those renters are tied to the metropolitan area by work, family, or preference. If their rents are deregulated, these people will force rents up wherever they go in the metropolitan area.

That’s a recipe for disaster. When renters can’t afford their location as a result of deregulation, they move to lower-rent neighborhoods, where they create a tighter rent market, raising the rents there and even gentrifying the area. Some of the longtime renters in those neighborhood will be priced out and move to even lower-income neighborhoods, tightening those locations in turn.

More affluent longtime renters will see their rent increases as an opportunity to move to a more desirable location. But wherever they go, landlords will raise their rents as high as they are willing to pay. If the market is tight and people are not leaving the metropolitan area, the market rates will remain high.

Market rates only go down if demand goes down—if people leave the city entirely or excess housing is built. But New York’s population is increasing, not decreasing, and construction is costly and difficult. Deregulation here will not ease the market any more than it did in the Boston area.

It’s not even certain that in a tight market like New York, landlords would invest widely in improvements, as they did in Boston and Cambridge. Unregulated renters have few rights, so if they complain to the city about lack of services or repairs, the landlord can retaliate by refusing to renew their lease when it expires. Regulated renters can compel repairs without that fear. So it is possible that deregulation in a tight market would result in lowered quality of housing and a degrading of services, as well as higher market rents. That’s exactly what happened in New York when vacancy decontrol was imposed in 1971.

Regulated rents actually help to depress market rates. Renters who pay exorbitant rents may think it’s unfair that regulated tenants pay so much less than they do, but the source of exorbitant rents is not regulation. It is landlords’ profit motive and New Yorkers’ desire to live here. We are the market that sustains high rents.

So what is the effect of deregulation? It provides a cheaper means of placing money into landlords’ hands than construction does. The chief effect of deregulation is an increase in the aggregate funds available for rents. It doesn’t ease the market, it won’t improve the quality of housing in New York, and it won’t create more housing. It will give more money to landlords, it will raise rents all over the city, and it will wreak havoc on communities as markets are tightened even in low-income neighborhoods, causing a spike in gentrification and displacement.

Rent regulation does create an unfairness—the lucky get to spend their money on the local economy, not just on rent, while their market-rate neighbors have to suffer. But forcing everyone to suffer doesn’t solve the suffering of the overpriced. It just makes life worse for everyone. Two wrongs don’t make a right. Deregulation is a lose-lose.