Four National Housing Experts on Rent Control and New Housing Construction

[A debate about rent control and new housing.]

Seeing as there's some confusion about whether or not a strict rent control policy that applies to new housing will affect the construction of new housing, I took the liberty of reaching out to people who study this stuff for a living. I think that, when it comes to deciding whether or not the proposed Saint Paul rent control policy will help or hurt people in the city, this is the critical piece of the puzzle.

So I wrote a bunch of national researchers and institutes on housing policy to ask them the following question:

Why have rent control policies not applied to new housing in the US? Are there historical or theoretical reasons for this? 

Four people got back to me, and here's what they said:

#1. Jenny Scheutz, Brookings Institution. 

Rent control/stabilization programs almost always exempt newly built housing, because capping rents on new apartments would be a huge disincentive for new construction to occur (e.g. would hurt overall housing supply). Applying caps to rent increases on older buildings (usually 20+ years) is less of a disincentive, because the property owner is presumed to have paid down the mortgage and recouped returns from the initial construction/acquisition costs. The only way you can encourage new construction and simultaneously cap rents is to provide public subsidy (either to developer, property owner, or households).


One exception is inclusionary zoning programs, which you can think of as partial rent control on new construction, but the owner is expected to cross-subsidize the below-market units with higher rents on the market-rate units.

#2. Mark Treskon, The Urban Institute 

Q: So why doesn't rent control apply to new housing? Is it theoretical or economic or political, or what?

There are theoretical reasons, but there are also just small ‘p’ political reasons too, in that it doesn’t apply to new housing in particular because, if you’re looking at local politics, and people interested in local policies and zoning and new construction, developers are a big part of it. Anything that would potentially affect the ability of developers to charge costs appropriate for the market are very heavily pushed back against.

That’s one side of those things. [Then] there is an idea that if [rent control] applied to new housing, it would limit new housing construction. That’s traditionally been a big worry, even outside of the the "developer special interest", that by applying rent control to new construction, you’re going to limit developers, limit them engaging in new construction. Or [developers] will look only at the condo market. 

So there are two sides of that coin, why it hasn’t applied to [new construction].

#3. Brian Asquith, the Upjohn Institute

Q: Why doesn't rent control apply to new housing? Are there theoretical reasons for this, or historical reasons, or both? 

It’s a mix of politics and economics. Basically the high economics reason is that you don’t want to discourage new development. So in the bad old history of rent control  New York City famously had it, and a bunch of European cities had hard rent control after WWII. It was universally agreed that it mostly didn’t work. It was too inflexible and it discouraged developers from building new housing. This was during the baby boom, so they needed a lot of new housing.

In the 70s, when rent stabilization came to in play, they consciously tried to avoid the mistakes of RC by saying, before this point the building will be controlled, and after this point they won’t be controlled. It is supposed to send a signal to developers that they can build without worrying about their buildings being brought into the control system.

Q: Are there any examples of applying rent control to new housing? 

So both Oregon and California recently passed rent stabilization statewide laws. Probably double check this…. My recollection is that Oregon law has a rolling inclusion date; for the stabilization system, they exempt buildings 15 years or younger. Once they hit year 15, rent stabilization applies. 

Basically my judgement as an economist, based on my work and other people’s, is that the concern that policy makers have, that they will be disrupting new development, is a valid one. [For] the price of a building, one way to generate a market price of the building is to calculate the present value based on the rent flow in perpetuity. If you’re effectively stating from the get go that the rent flow of cash will be discounted or capped in some way, it will lower the price, and by lowering the price, it will make more developers say that it’s not worth it. I don’t think new supply will go to zero. Minneapolis and Saint Paul are a growing metro area, but on the margin it will probably discourage new development.

It depends on the details of the policy. The new California law is pretty loose. The rental increase cap is like 8%. Most people in most cases are not seeing 8% annual increases in rents even in California  So, if the folks in Saint Paul or Minneapolis had a relatively high cap, like 8 or 10%, it would probably cut down on most egregious increases without getting in the way of most landlords' normal course of business. But the devil is really in the details…

I would say that while correlation isn’t causation, it is interesting that New York City, DC, San Francisco, and Los Angeles have all had rent control for 50 years but are hardly synonymous with affordable housing. One might start to wonder whether rent control is helping or hurting. Generally if you institute a policy for 40 years that’s supposed to make renters affordable, and it doesn’t… well… 

But these systems aren’t going anywhere. They are very popular.

Well, should I say something positive about the policy?

A: Sure. Feel free!

If you are a tenant who is lucky enough to be living in one of these units when it switches to rent control, then there are benefits for people. They do save money relative to what they would have had to pay. That can have some benefits, though some don’t entirely believe it… 

Economists are very down on rent control. It’s not all downside, but it's definitely a policy that has a bad reputation among people who study it, like myself, for some very well-founded reasons. 

#4. A Professor at a Well-known University-affiliated Housing Policy Institute

The fourth person agreed to talk to me on background, because they didn't want to comment directly on a pending ballot question. In a way, it was the most interesting conversation because this person has experience in the finance industry. They agreed that, to answer my question, they would wear their "banker hat".

I asked them why rent control policies didn't apply to new construction. 

This person explained that, from the financing point of view, lenders provide some buildings with 30-year mortgages, but that for commercial buildings it’s often likely to be 10 years or less. After that, they'll keep refinancing the property. Especially if they're going to provide longer term financing, they need to have some comfort that the economics of the building will be sufficient to pay back the loan. 

They explained that one key thing banks look for in underwriting loans is sufficient cash flow, using a ratio called the "debt service coverage." The lender wants to make sure they're not lending to a building that can’t "throw off" enough revenue, based on assumptions about rents, the costs of running the building, taxes, etc. They look at the net operating income and make sure that it's at least some multiple of the debt service. 

The example they used, which were made-up numbers: if a building has $100 a month in debt service, it needs to generate at least $130 a month in income to meet a 1.3 ratio of the debt service coverage. 

This person said that in a world where expenses are going up all the time because of inflation, if they don’t know that the rents are going to go up to cover that, they're not going to lend against the building. It’s that simple. 

They said that lenders want loans, and that the pandemic offers another example of a possible problem. If there’s not enough money to pay the debt service, the last thing the bank wants to do is take the building as collateral. Banks hate it when they have to take the building because the property owner goes bankrupt.

The person told me that "banks don’t take risks, banks manage risks." They take your money, and if you want it back as deposited, they’re lending it out in a way that they think they'll have a good chance in getting it back. 

In sum: if they don't know that they'll be able to raise rents when the costs go up, they’re not likely to lend to that building.

Well, that's what I heard from people who study this stuff. Housing policy people are pretty consistent about the connection between this strict rental regulation and new housing construction.

[See also my short column in Minnpost about the Saint Paul ordinance and my long-read with all the research about how this rent control proposal affects housing in Saint Paul, an explainer of why a 3% rent cap blocks new housing construction, short posts on how the policy would affect rents and taxesinterviews with housing policy experts on new construction and rent controlguesses about Mayor Carter's plan, and what I recommend we do about the housing crisis instead of the rent control proposal.]

1 comment:

Steve Subera said...

I've passed your writing on to a few friends (we're all homeowners with no rental property interests) and they all said it was extremely valuable. They are planning to vote no, not because they are evil landlord loving capitalists, but because of the details of the ordinance and the problems that are likely to result.