A review of recent international history
Vicenç Hernández Reche / Economist. PhD. in Economic Psychology / CEO of Tecnotramit and Treshabitat.
Summary
In recent years, there has been a sharp increase in residential rental prices in many of the main metropolitan areas of the most advanced economies. The impact of this growth ranges from affecting the disposable income of families to the difficulty of access to housing by certain more disadvantaged groups. That is why in Spain the debate on public sector intervention in the rental market has had more repercussion with the aim of curbing the potential negative effects that a price hike could generate on the country’s macroeconomic and social stability.
Generally speaking, the interventions from the public sector can be divided into three categories: price control by prohibiting the exceeding of a certain amount, the increase of public supply through the provision of rental housing, and finally, a set of measures aimed at both incentivising the private provision of rental housing and facilitating access by certain groups at a rental price appropriate to their possibilities. As these are not new measures and we can count on the experience and quantification of results based on measures taken in the past, we can now make an analysis of the possible impact of the consequences derived from these interventions.
The present document aims to review one of these measures, and that is the control of rental income prices.
Price control measures for residential property rentals
Economic orthodoxy establishes that when a rise in the price of a good occurs it is due to an increase in demand above the growth of supply or a decrease in demand below the decrease in supply. Be that as it may, this imbalance generates an upward impact on prices with serious consequences from a country’s macroeconomic and social point of view.
The increase in demand has been focused on different groups such as households with a lower level of income and young people of emancipation age, focusing on the geographical areas with the highest level of economic activity. Among the most important factors determining the increase in demand for rent, we could highlight the stagnation of the level of wages among the younger working population and those with less training, the greater tightening of credit conditions established by financial institutions following the last international financial crisis, the change in mentality regarding the concept of ownership by a new generation and the concentration of migratory flows in the main capitals with the highest level of economic activity. For its part, supply has remained stable, generating a relative shortage of housing in comparison with the rise in demand, providing an asymmetry in the market which has led to greater difficulty in accessing residential housing for certain more disadvantaged groups.
The shortage of rented housing not only has a negative impact on society, but also affects the proper functioning of the labour market, the level of household consumption and the financial stability of the economy. Firstly, a more dynamic and agile rental market facilitates the mobility of the unemployed towards those populations where new jobs are generated or there are vacancies between existing jobs[1]. Secondly, greater expenditure on renting reduces the proportion of disposable income destined for consumption, especially in those groups whose predisposition is higher than the rest.
When reviewing this type of public intervention measure, it should be borne in mind that transferring past experience to current environments can generate distortions for two main reasons. On the one hand, if the comparison is made for the same geographical area, we have to bear in mind that these are different moments in time, with different economic and social situations. On the other hand, if the comparison is made on different geographical areas, we must take into account diverse cultural realities and very heterogeneous geographical markets.
Policies which establish controls on the price of rents present a series of challenges when it comes to their design and implementation. For example, what is considered a standard or comparable housing from which to establish reference prices in a regulated area, from what level of price increase can a market be considered sufficiently tense for its intervention, the administrative difficulty in controlling the application of the established rule as well as the cost involved in its compliance and the generation of sanctions, or the subjective decision to set limits and the permitted growth rates.
All these difficulties have led to different conflicts between landlords and tenants, and therefore a higher indirect public cost for the establishment of control and arbitration systems to ensure the proper functioning of the control measures implemented.
A review of recent international history
Both the First World War in Europe and the Second World War in the United States marked the beginning of this control mechanism. The concentration of industrial activity focused on certain areas due to the geographical relocation imposed by the war effort, led to the first measures being taken to contain the rise in prices on the residential rental market.
This phenomenon has been called the first generation of rent controls[2], and it occurred both in cities in advanced economies and in various cities in developing economies. The preservation of this regulation led to the creation of dual markets where a market of regulated prices that experienced a reduction in real prices coexisted with an unregulated market whose prices continued to rise. Already in the 1970s the second generation of rent controls appeared, in which the main characteristic was the limitation of rental income associated with the evolution of a reference index capable of measuring the increase in the cost of living. In this way, real rental income was curbed due to the inflationary trend produced by the oil crisis of that decade[3].
During the 1980s, the new wave of liberalisation and deregulation that invaded European economies led to a large part of the regulations governing rental prices disappearing or being simplified due to the high level of complexity in both their measurement and control methodology. This led to smaller interventions with greater administrative simplification, such as the so-called rent stabilisation policies, which limited the maximum growth of rental income over the life of the contract[4]. Despite this, price regulations in certain segments of the rental market remain in place in different countries in both Europe and the United States, and often affect an older housing stock whose tenants have long-term contracts.
At present, the sharp increases in rental prices have promoted strong social demands that the authorities have been happy to study and legislate to set limits on the maximum growth of rental income. Many of these measures are being carried out according to administrative criteria of dubious effectiveness which, in both form and substance, infringe on individual freedom and in some cases on private property.
Let us look at the case of some reference countries.
Germany
Due to the importance of its rental housing market, which reaches 50% of households[5], the Mietpreisbremse will take place in June 2015 with the express aim of curbing the growth of home rentals. This tool gives the green light to the governments of the Länders (federate states) to allow their municipalities to establish price controls for a maximum of 5 years in those rental markets that are under stress, and this involves meeting one of the following four requirements.
- If at the local level the average income growth is higher than the national average.
- If at the local level the average ratio of rental income to income is significantly higher than the same ratio at the national level.
- When there is a strong imbalance between supply and demand in the population because there is a low rate of available housing compared to the existing demand.
- If the capacity to build housing in the observed area is lower than the growth rate of the local population.
Following the introduction of the Mietpreisbremse, 11 Länders have adopted this measure affecting more than 20 million inhabitants in 300 municipalities, and covering 25% of the country’s housing stock[6].
The maximum rental price established is the average of the rental income for comparable homes rented in the same municipality during the last 4 years, plus 10%. These average incomes are obtained from the so-called Mietspiegel, or rental mirrors, which estimates the average prices of comparable housing in a given local market. This system of mirrors has been used in Germany since the 1970s as a reference for updating rental income once an initial agreement between landlord and tenant has been established. The Mietspiegel obtains information from different associations of owners and tenants regarding the characteristics of the housing (typology, size, location, facilities, etc.) and the levels of rental income for the last 4 years, in order to calculate comparable rental reference prices. This indicator has to be updated at least every 2 years and is available for almost 300 municipalities considered representative of the market evolution at state level. If you are located in a different municipality outside the scope of this comparison, the solution is to consult an expert in the area or use the agreed rent for 3 comparable units located in the same area as a reference[7].
We found 3 exceptions within this system of mirrors.
- Rental contracts on homes built after 1 October 2014.
- The first rent agreed after extensive renovation of the property by the owner.
- In the event that the rental income from a contract prior to the entry into force of the new regulations is higher than the maximum price established, the owner has the power to maintain the price in successive contracts.
However, the Mietpreisbremse has not succeeded in curbing the problems of access to housing in some of Germany’s most dynamic cities, such as Berlin. For this reason, the federal state has passed new legislation (Mietendeckel) introducing a maximum rent for housing from 2020 and a freeze on rental income for 5 years. This system establishes a price per square metre that cannot be exceeded in those rental contracts on homes built before 2014, allowing rents to be updated from 2022 in line with the evolution of the Consumer Price Index (CPI) and being considered abusive if the rental price exceeds 20% of that maximum, generating heavy financial penalties for owners. This will allow tenants who are paying more than the maximum price established to claim the corresponding reduction.
This maximum price established is only increased in cases of high quality homes or homes located in certain areas of the city. Likewise, the regulation allows these maximum incomes to be updated in the event of significant maintenance reforms in the buildings, establishing a maximum of 1 euro per square metre in addition to the reference price established by the regulation.
The Berlin Parliament recently approved the above-mentioned Mietendeckel to freeze rents for a period of 5 years, and to set a ceiling on the price of rental housing at 9.80 euros per square metre for properties ready for occupation by 2014.
The consequences of the introduction of this regulation will have to be seen in a longer period of time in order to correctly assess its importance and impact, but everything seems to indicate that, as previous experiences have indicated, the limitation of rental prices has a negative impact on the supply of rental housing in the residential market.
United States
In the United States, the design and implementation of these types of measures are heterogeneous and reveal various singularities in terms of the local real estate market to which the regulation applies.
The regulatory limits established are intended not to be totally detrimental to the owner, establishing limitations on the growth of income above inflation, but below the growth observed at the time of the establishment of the regulation. This allows for real rent growth by providing economic viability to the investment made by the owner.
In the case of California, increases in rental income for 10 years from 2020 are limited to 5% per year plus inflation for homes over 15 years, excluding rentals to small single-family owners. If the property is owned by legal entities or institutional investors, rent control is not conditioned by the age or size of the property. This regulation is in addition to others of a local nature such as in the case of New York City, which is particularly significant as it has maintained controls on price levels, as well as on price increases from the 1940s to the present.
Controls on rental levels for older housing are gradually disappearing, as they only apply to housing in buildings constructed before February 1947 and to housing occupied by the same tenant before 1 July 1971.
But with regard to controls on maximum increases in renovations, these apply to all buildings with 6 or more dwellings built between 1947 and 1973 and to those dwellings whose tenants change and which were subject to rent limitations. In addition, the controls are limited according to one of these 3 parameters.
- The duration of the contracts.
- The maximum increase in rent when there is a change of tenant in an already rented property.
- The increase in income in cases of housing reforms.
France
Since 1989, France has had an automatic instrument for updating rental income in the case of contracts already in force and their corresponding updates, which is associated with a reference index of rentals that progresses in accordance with the cost of living. This reference index, known as the IRL (Indice de Référence dels Loyers), has been linked since 2006 to the CPI excluding the rent and tobacco component.
The Alur law (Accès au Logement et à un Urbanisme Rénové) passed in 2014 allows for rent limitations in cities with upward price pressure on the rental market. This law establishes a limitation of 20% in relation to reference price indices per square metre by comparable type of housing and area of location. However, the Alur Law allows a series of exceptions depending on certain characteristics of the property.
This system was implemented in Lille and Paris until the Paris Administrative Court suspended the regulation in November 2017 on the grounds that it should not only be applied in the Paris municipality. With the aim of resuming the regulation for the control of rent ceilings, the French Constitutional Council approved the Elan Law in 2018, which came into force in the summer of 2019. This law will be in force until 2023, at which time its effectiveness and repercussions on prices will be reviewed, and it affects new rental contracts, both in the case of homes that are already rented out and first rentals, and renewals that can be made at a later date. Cities that wish to make use of this regulation will limit rent increases to 20% above an average reference price level that will be determined according to the area where the home is located, quality and number of rooms or the year of construction, among other variables.
Spain
In the case of Spain, the 1946 Urban Leasing Law introduced the freezing of rental income and the indefinite nature of contracts[8]. Previously, the Royal Decree of 21 June 1920, known as the Bugallal Decree, had already established the freezing of rental income, generating a strong impact on the country’s main cities[9].
Royal Decree-Law 2/1985, better known as the Boyer Decree, established freedom to set the price and duration of new rental contracts, as well as the elimination of forced extensions, which gave rise to a dual market where new rents coexisted with those already in force known as “old rentals”, which remained at significantly lower prices than the new ones.
With the aim of eliminating the differences between the two types of rentals, the 1994 Urban Leasing Law[10] established mechanisms to alleviate the effects of this duality, as well as the establishment of the CPI as a reference index to determine the maximum updating of rentals during the four years following the signing of the contract. With this law, in the absence of an express agreement between the owner and the tenant, no updating of the rental income was applied during the term of the contract. Years later, Law 4/2013 dispensed with this maximum revaluation clause associated with the CPI and established that, in the event of not reaching an agreement on the criteria for annual updating, the CPI would be established as a mechanism for automatic annual updating of rental income.
The Netherlands
In the Netherlands there is price regulation in both the private and “social rent” markets, implemented through a system of points that are allocated according to the size of the house, location, facilities, physical characteristics, and the environment surrounding the house. The maximum monthly income is determined according to the number of points. There is a limit on the number of points on which the maximum price is set. Once the contract is signed, the tenant has 6 months in which to complain about the price they are paying to the rental commission (Huurcommissie), which resolves disputes between landlords and tenants in the event of discrepancies regarding the maintenance of the property and the distribution of responsibilities.
This regulation excludes those homes of higher quality and which, therefore, have a rating that exceeds the points associated with the maximum income. In 2019, the maximum rent was set at 720 euros per month and it is estimated that more than 70% of rent within the private market sets its prices on the basis of this point system. In recent years, due to the emergence of parallel markets or inefficiencies in rent setting, there has been a gradual liberalisation of rents by changing the point threshold to reduce the scope of regulation on higher quality housing or for households with a higher income level[11].
Sweden
In Scandinavia, free agreement between landlords and tenants is conditioned by a system of collective bargaining at municipal level involving representatives of private landlords, municipal housing companies and representatives of the tenant community (Swedish Tenant Unions). A rental reference price is established annually for different types of housing with equivalent utility values, and the maximum increase in rental prices.
The utility value system is the set of variables that reflect the value given by the tenants to the homes according to a certain number of parameters such as geographical location, quality, location of the home within the building and value of the environment where the property is located.
Therefore, there is freedom for private negotiation between owner and tenant to freely agree on the initial price of the rent. However, if the landlord considers that the rent established for his property differs by a high percentage from the reference price estimated in the collective bargaining, he has the right to report his situation to the regional rental court.
This reference pricing system affects almost 90% of the total rental housing stock in the country. In the rest, the agreed prices are below this system of collective bargaining.
Positive and negative effects on price control
In the face of the different measures implemented both to control rental prices and their increase over time, there are diverse opinions where in some cases social welfare and the common good prevail, as in others where individuals’ freedom of negotiation and respect for private property predominate as the fundamental norm.
Advocates of the first argument argue that these control measures are particularly relevant when tenants face more strained housing rental markets and when these policies favour lower income tenants. Conversely, several authors have highlighted that the setting of controls on the price of residential rent can create inefficiencies in the housing market that can ultimately harm social welfare.
Several authors[12] consider that social welfare gains are produced when regulations on rent increases protect the tenant from an asymmetric contractual situation where the owner has some market power against the tenant, whose mobility is costly. In addition, price control reduces concerns about tenants’ labour and consumption decisions.
These same authors defend certain contexts where policies to secure rental income produce significant welfare gains. Specifically, they consider that redistributive policy in the form of income controls can generate social welfare gains in the face of income increases when regulations affect households with a more unfavourable income distribution situation. In those metropolitan areas with the greatest inequality of household income, price controls are a tool for reassurance in the face of upward price dynamics.
While the immediate effect of these policies is an improvement in the welfare of affected tenants, the implementation of these regulations generates consequences that pose potential losses to social welfare in the medium and long term. Let us look at some of these negative effects.
Economic theory predicts that the administration’s setting of a rental price below the market price generates a reduction in the supply of rent. This is due both to the lower investment in the construction and/or rehabilitation of rental housing, and to the greater incentives for owners to sell their rented property, so that the quality of housing in the long term would be adversely affected.
Additional efficiency losses could be generated if such regulations favour the emergence of dual residential rental markets, where price controlled housing coexists in different areas of the same city with housing under freedom of establishment of rents. In housing rental markets where this segmentation occurs, negative externalities can be created, negatively affecting labour mobilisation, and leading to a deficient allocation of housing supply.
The reduction in returns from housing investment and the population segmentation resulting from such regulations adversely affect the aggregate value of property asset values in a market with regulated rents. In addition, the reduction in the aggregate supply of residential rent due to non-investment in this type of asset will inevitably lead to an increase in prices in the non-regulated segments.
In the medium term, the response of landlords leads to a reduction in the supply of rent for households with lower purchasing power. Therefore, there is an increase in the construction of new housing for households with higher income levels, the reform of housing to escape regulation or even its sale, thus generating a greater segmentation of the population and a reduction in the supply of housing for rent, putting upward pressure on rental prices in the city.
Evidence from different studies[13] shows how rent controls have had a negative impact on the value of both rented housing and property and equipment in those areas where regulated housing is concentrated.
The empirical analysis shows that in areas where prices were regulated there was a significant drop in prices while in non-regulated areas the upward impact of prices was more than proportional. This last fact has generated an inefficient allocation between households’ dwellings producing an evident loss of social welfare.
Another study[14] shows evidence of how these same regulations have impacted on the price of developable land, since in order not to discourage investment in new housing for rent, the regulation left out housing built from October 2014. The authors of the study show how investment in new housing construction would have increased in the municipalities that adopted the regulation to escape the established limitation. This increase in investment raised the price of land, as well as the rental price of new unregulated housing, so that regulation on the one hand encouraged the construction of new homes, but on the other hand pushed up the rental prices of part of the housing stock. The opposite of the proposed overall objective.
In short, although there are certain common conclusions in very diverse contexts, the efficiency of policies in the residential rental market is subordinated to interaction with the current macroeconomic situation, the local casuistry of the market and a set of regulations and standards that affect the income of households that demand rental housing, such as fiscal or labour policies.
[1] “Unemployment: Questions and Some Answers”, Economic Journal, 108 (May), pages 802-816. Nickell, S.J. (1998)
“Housing liquidity, mobility, and the labour market”, Review of Economic Studies. 79(4), pages 1559-1589. Head, A., and H. Lloyd-Ellis (2012)
[2] “Rent Control”, Palgrave Dictionary of Economics. Malpezzi, S. (2017)
[3] “La intervención pública en el mercado de alquiler de vivienda: una revisión de la experiencia internacional”, Documentos ocasionales no. 2002, Banco de España. López-Rodríguez, D., and M.ª Ll. Matea (2019)
[4] “Assessing the Evidence on Rent Control from an International Perspective”, Housing Supply & Rents, Occasional Reports, Regulations & Enforcement Reports, Residential Landlords Association. Whitehead, C., and P. Williams (2018)
“Policies to promote access to good-quality affordable housing in OECD countries” OECD Social, Employment and Migration Working Papers, no. 176, OECD Publishing, Paris. Salvi del Pero, A., W. Adema, V. Ferraro and V. Fréy (2016)
[5] “EU Statistics on Income and Living Conditions”. Eurostat (2019)
[6] “Empirics of the causal effects of rent control in Germany”, Friedrich-Alexander University (FAU) Discussion paper in Economics 24/2017. Mense, A., C. Michelsen and K.A. Khlodilin (2017)
[7] “La intervención pública en el mercado de alquiler de vivienda: una revisión de la experiencia internacional”, Documentos ocasionales no. 2002, Banco de España. López-Rodríguez, D., and M.ª Ll. Matea (2019)
[8] “La intervención pública en el mercado de alquiler de vivienda: una revisión de la experiencia internacional”, Documentos ocasionales no. 2002, Banco de España. López-Rodríguez, D., and M.ª Ll. Matea (2019)
[9] “La transformación del mercado de alquiler de fincas urbanas en España (1920-1960)”, Biblio 3W. Revista Bibliográfica de Geografía y Ciencias Sociales. Barcelona. University of Barcelona, 15 August, vol. XVII, no. 988. Artola, M. (2012)
[10] (Law 29/1994)
[11] “La intervención pública en el mercado de alquiler de vivienda: una revisión de la experiencia internacional”, Documentos ocasionales no. 2002, Banco de España. López-Rodríguez, D., and M.ª Ll. Matea (2019)
[12] “Time for revisionism on rent control?”, Journal of Economic Perspectives, 9(1), pages 99-120. Arnott, R. (1995)
“Affordable housing and city welfare”, NBER Working Paper 25906. Favilukis, J., P. Mabille and S. V. Nieuwerbourgh (2019)
[13] “Out of control: what can we learn from the end of Massachusetts rent control?”, Journal of Urban Economics, 61(1), pages 129-151. Sims, D. (2007)
“Housing market spillovers: evidence from the end of rent control in Cambridge, Massachusetts”, Journal of Political Economy, 122(3), pages 661-717. Autor, D., C. J. Palmer and P. A. Pathak (2014)
“The Fall of the Labor Share and the Rise of Superstar Firms”, NBER Working Papers, no. 23396. Author, D., D. Dorn, L. K. Katz, C. Patterson, and J. van Reenen (2014)
[14] “The effects of second-generation rent control on land values”, AEA Papers and Proceedings, 109, pages 385-388. Mense, A., C. Michelsen and K.A. Khlodilin (2019)