There a few versions of a story floating around today about the Labor government considering price caps on private rents:
The Real Estate Institute of Australia has slammed the Labor government’s proposal to cap rents in Australia
REIA president Pamela Bennett said capping rents would be “disastrous” for rental affordability and the property market.
Earlier this week, the Labor government said it would look at monitoring the rent costs in the private rental market and examine mechanisms to maintain affordability such as the introduction of rent capping legislation.
“To cap rents in the private rental market would be counterproductive to the objectives of improving affordability. It would reduce the supply of rental housing which would be detrimental to rental affordability,” Ms Bennett said.
“If the proposal was implemented, the impact could be similar to the outcome of the Hawke government’s decision in 1985 to deny investors tax deductibility of interest payments. The market response led to an undersupply of rental property and escalating rents, before the decision was reversed in less than two years.
“The proportion of income required to meet rent payments is currently 24.8 per cent while the proportion of income required to meet loan repayments is 34.6 per cent.
“Rental affordability has been relatively stable, at around 25.0 per cent of family income, for the past three years with some slightly improvement in affordability in recent times.
“The proposal is not sustainable and when it is reversed, rents will soar. This is an extremely important issue and one that should not be taken lightly.”
It’s not a comfortable feeling agreeing with the spruikers at the REIA, and the stuff in there about the 1985 removal of negative gearing causing a rise in rents has been comprehensively debunked, but the rent capping idea is a questionable solution.
Europe has some major markets with rental controls and none sounds overly encouraging. From a report by the Royal Institute of Chartered Surveyors, first Sweden:
Social housing is predominantly owned by municipal housing companies (MHC), which are non-profit housing organisations owned by local authorities. Anybody can apply to live in a social rented dwelling, because traditionally the means-tested criteria that are common elsewhere in the EU do not apply.
The legally determined system of rent setting in both the private and social sectors requires that there are local negotiations between tenant organisations and MHCs for social housing and with private landlord organisations for the private sector. As rents have to be comparable across both sectors, and private tenants can appeal to a rent tribunal if they are not, the overall costs of local MHCs essentially set the average rent level. Rents are largely historic-cost based, dependent on outstanding debts, management and maintenance costs, and they consequently reflect the age composition of the social housing stock rather than prevailing market rent levels. One unfortunate side-effect is to limit the incentives MHCs have to be efficient, because they always know that rents will be set to cover their costs. Negotiations then determine rents for the different dwelling types and locations. There has been some change in recent years, because any subsidy element (as defined through a court ruling rather than in economic terms) in public housing cannot be used in the comparison between public and private sector rents. However, as many
MHC-owned dwellings are no longer in receipt of subsidies, the impact of the change is fairly limited in many localities. Obviously, prevailing rental values are reflected in the capital values of residential investments, so that the returns are sufficient to attract investors. The SFI/IPD Sweden residential index had average returns in 2009 of 5.2% evenly split between income and capital growth.
The regulated rent setting process means that rents in attractive urban locations are often well below market clearing levels. Existing tenants can enjoy substantial windfalls by sub-letting or by requiring undercover (‘key’ or ‘furniture’ money) payments from new tenants before agreeing to vacate the property.
The cost-based rents of the social sector are low because the stock was mainly built before the mid-1970s and most of the debt on it is now paid off. Such rent levels do not encourage efficient use of the stock. Existing tenants have limited incentive to economise on housing consumption or to move to cheaper locations. Because the criteria for entry to the tenure has been very broad in the past, people from a wide variety of social strata and income levels can end up with substantial implicit gains, whose social benefit is questionable. Queues to enter social housing are long in areas of high demand. The general allocation process has detrimental effects on labour mobility
There has been a gradual tendency for rents in nominal terms to rise, because costs are increasing. However, there are variations across regions, with Stockholm having the greatest divergence of actual from potential market rents and the rents on social housing in some of the depressed regions of the country probably being higher than open market levels. As rents have not risen to reflect prevailing market shortages in an era when house prices are rising, investment in new rental housing is, outside of the luxury sector, generally unprofitable and so does not occur.
And, The Netherlands:
With the exception of the small up-market sector, which represents 5% of all rental dwellings, rents are controlled, with the same legislation applying to both the private and social sectors. Security of tenure is guaranteed – temporary contracts are forbidden – and tenancies can be passed onto spouses, children and others. Rents bear little relation to market levelsbut rather to a points system related to amenities and to service charges. If landlords do not keep up repairs, tenants can apply for rent reductions, and rents can only be raised annually by a maximum amount decreed by the government. From 2009, tenants were also able to request ‘reasonable’ improvements to their dwellings which landlords are obliged to carry out. Despite the long boom in house prices, real rent increases have been limited and over the past decade have actually fallen somewhat in real terms.
While the freezing of real rent levels over the past decade has undoubtedly been popular with many of the 40% of Dutch households that are directly affected by them, rent controls and low rent policies distort the operation of the housing market with long-term adverse consequences. Households are encouraged to consume excessive amounts of housing, leading to greater shortages than there need be. Those that can afford to become home owners are discouraged from purchasing. Housing providers have less income for investment and less free stock to allocate to younger households and those in greatest need. Existing tenants are favoured over new households and movers, leading to regressive distribution effects and enhanced social segregation.
Households are induced to behave in ways that conform to social housing’s access rules, which often work against labour market and other welfare policies. Informal and illegal rental markets are encouraged. General mobility is reduced. Another implication is that demand shocks result in queues and intense pressures on households to become owner occupiers because that is effectively the only free market housing option in most localities. Price volatility in the owner occupied sector is exacerbated as a result. In summary, such rent control policies lead to general welfare losses rather than gains.
Given Australia already has a choked supply process, bogged down in regulation, and over-inflated prices with investors now counting exclusively on rents for a return, price controls would probably cause a run on the market.