Futile rental-price competition

In his famous book, The Greatest Show on Earth, Richard Dawkins’ presents a Forest of Friendship story, which contains within it a powerful idea that has broad implications for how we develop important social, economic, and political institutions. I want to show how this idea provides clues about how to tackle excessively high home rental prices, and offer some suggestions about how to do just that.

Here is Dawkins.

Imagine the fate of a hypothetical forest – let’s call it the Forest of Friendship – in which, by some mysterious concordat, all the trees have somehow managed to achieve the desirable aim of lowering the entire canopy to 10 feet. The canopy looks just like any other forest canopy except that it is only 10 feet high instead of 100 feet. From the point of view of a planned economy, the Forest of Friendship is more efficient as a forest than the tall forests with which we are familiar, because resources are not put into producing massive trunks that have no purpose apart from competing with other trees.

But now, suppose one mutant tree were to spring up in the middle of the Forest of Friendship. This rogue tree grows marginally taller than the ‘agreed’ norm of 10 feet. Immediately, this mutant secures a competitive advantage. Admittedly, it has to pay the cost of the extra length of trunk. But it is more than compensated, as long as all other trees obey the self-denying ordinance, because the extra photons gathered more than pay the extra cost of lengthening the trunk. Natural selection therefore favours the genetic tendency to break out of the self-denying ordinance and grow a bit taller, say to 11 feet. As the generations go by, more and more trees break the embargo on height. When, finally, all the trees in the forest are 11 feet tall, they are all worse off than they were before: all are paying the cost of growing the extra foot. But they are not getting any extra photons for their trouble. And now natural selection favours any mutant tendency to grow to, say 12 feet.

And so the trees go on getting taller and taller. Will this futile climb towards the sun ever come to an end? Why not trees a mile high, why not Jack’s beanstalk? The limit is set at the height where the marginal cost of growing another foot outweighs the gain in photons from growing that extra foot.

The futile competition Dawkins describes is an ingrained animal instinct. Civilised society builds institutions to help avoid the negative consequences of such instincts, with rationing systems that foster genuine large scale cooperation.

One particularly important part of the economy where our institutions no longer prevent futile competition is in the housing market. I am not just referring the house and land asset market, where speculation runs regularly runs rife. Rather than mutant trees, it is speculators who try to bid just a little more for each home, wasting resources by overpaying for land. These always end in spectacular crashes where the greatest fool – the last speculator – makes the greatest loss. But they also bring down the real economy as well!

I am talking of something more mundane. The rental market.

Here too there is a forest canopy. It is an invisible rental price curve, a rental canopy if you will, that expands across the world’s cities, supported not by heavy wooden trunks, but by the wasted resources used by tenants to pay to access the land. While Dawkins’ trees chased a bigger piece of sky, renters chase a better piece of the land.

The diagram below shows the basic idea. The green line is the current “rental canopy”, which is higher near city centres, and falls with distance. At half the height is an orange line, which is one possible height of the rental canopy, if a cooperative institution could be developed to stop the futile price competition amongst renters. The grey shading shows the economic gains for renters from degree of cooperation.

So why don’t tenants cooperate like the Friendship Forest?

The benefits are clear. In Australia there are around 2.7 million renting households paying $60 billion per year in rent, or $22,000 per household. Halving the rental price saves $30 billion of previously wasted resources by renters, generating massive efficiency gains for them.

Large scale cooperation could happen in practice in the following way. Each renter sends a copy of their lease that shows their current rent a central organisation. The organisation tells each renter only to pay half the rental amount on the lease to their landlord, and that from now on it will set the rental prices. Because the organisation negotiates on behalf of all tenants, it is a monopoly supplier of tenants to the landlords, and can set the price.

Let us call this organisation a Tenants’ Union.

If there are no “mutant”, or “rogue”, renters who opt out of the union and outbid rental prices by negotiating directly with landlords so they access a better home for themselves, the system will work. It is a genuine Friendship Forest with a cooperative institution that drops the “rental canopy” by half, saving each renting household $11,000 per year.

This is great news. It is a perfectly possible and realistic thing that can be done.

But there is another side to the Tenants’ Union story. The landlords who own these 2.7 million homes, would earn $30 billion less per year. In Dawkins’ story, the landlords are the animals who benefit from inhabiting the trunks, the loggers who cut them for timber, and others in the ecosystem who lose their benefits if not for the resources contributed by the futile competition amongst canopy trees.

So that political reality would need to be negotiated.

The rest of the story happens within the Tenants’ Union itself. To avoid futile competition, they must enforce a non-price way to ration the better (and worse) homes amongst potential renters. If they can’t do that, they simply shift the futile price-competition from outside the organisation to inside it.

I should be clear that any such system would not be perfect either. We are therefore comparing an imperfect system of rationing through futile price-competition, costing renters $30 billion, or an imperfect alternative system, that might make the choices of renters more limited, but will benefit tenants $30 billion every year.

So what sort of non-price rationing system could our Tenants’ Union employ? I can think of a few.

1. Queuing

A list is made of people who want to rent a home of a particular type, in a particular location, with new people added at the bottom. Each time a property becomes available, it is offered to the first person on the list. To retain a degree of choice, each person on the list might get 3 veto choices – homes that become available at their turn, but which they could choose not to take, and stay at the top of the queue and wait for the next home.

The more effective this system is at reducing prices, the longer the queues.

2. Lottery

Each time a home becomes available, a lottery is run, with a period of a few weeks in which potential tenants can get a ticket. The winning ticket gets the home. This can be expanded to run in batches at set intervals to overcome problems of having tickets in multiple lotteries at once.

The more effective this system at reducing prices, the more people contesting each lottery.

3. Need

Homes would go to people based on assessment of the household’s needs. Criteria could include rental history, income, family status, age, other other metric deemed fair and reasonable. Such assessment can be used to determine qualification rules for lottery or queuing systems.

Other methods could of course be implemented. But to make any of them effective at undermining futile price-competition, secondary markets would need to be outlawed, and this rule rigorously enforced.

There are some final points to consider to counteract the likely arguments against this idea, all of which are inherently arguments in favour of futile price competition.

First, rationing without prices is itself futile, because capitalism. Yet in the most important areas of society in all capitalist economies, price competition is strongly avoided. In the courts we ration by queuing, and ration juries by lottery. In politics we use elections to ration positions of power. In healthcare we ration public services based on assessments of need. Spouses are allocated through non-price rationing.

Second, non-price systems limit choices for tenants, and that is bad. Yet price-competition also limits choices for tenants. The bottom half of tenants by income already are excluded from choosing the top half of rental homes because of prices. These non-price systems provide much broader choices to the lower income households.

Overall, it should be clear that price competition over nature’s scarce resources – be it the sunlight in the forest, or access to the land in the housing market – is usually futile. Human societies overcome this by developing institutions that use non-price ways to ration resources. Taking a stand against price-rationing in the rental housing market by developing institutions like those discussed here could save tenants billions of dollars a year.  We should look into it.

Comments

  1. Interesting article that touches on some very important points. A market is indeed a rationing scheme that uses price.

    But a more important issue is why does Australia have the most land per person and yet have such extremely high land prices and rents? Why is there such a shortage of housing in this country of all places?

    Instead of this ridiculous tenants union, how about the following:
    * Pauline Hanson’s policy of zero net immigration (at least for a decade or so)
    * create many new lovely small cities.
    * Allow conversion of cheaper land into urban land on the fringes of all cities.
    * properly fund necessary govt infrastructure (sewage and roads)
    * remove height limits on building near CBD’s
    * allow workplaces to be created near housing subject to sensible limits (noise, pollution, etc)
    * land tax on high-value land

    • Most of those ideas are fine and some are already being done. There are no height limits in Brisbane CBD, and lots of new land conversions in SEQ (over 70+ years of supply). We can certainly tax land values, which would be a tax on futile competition, and could fund a lot of what you suggest, and reduce taxes elsewhere. Canberra was built and funded by land value (rent) taxation, and we could do more of that to promote regional development.

      This is mostly a thought exercise. But i will follow up looking at how some countries have implemented systems quite close to this.

  2. Mining BoganMEMBER

    Yes! After dealing with idiot agents for the last five weeks it’s obvious that the market as we have it is badly distorted. I’m not going to blame the owners because of what happened to me just this morn.

    Im talkin to an agent about a place I want to negotiate on. Offered $410 for a $440 place that’s been sitting empty for six weeks and already dropped from $460. Told the guy I would have moved in four weeks ago. He says you lowballed so you weren’t considered.
    Owner doesn’t mind it sitting empty? Won’t negotiate?
    No, wants the price.
    The price that he’s dropped.
    Yes.
    What did he say about the lowball?
    Didn’t show him.
    He doesn’t know he’s had an offer!!??
    No.

    This is why nothing is moving my way. The agents don’t care, they don’t present any offer except asking or above. They’re artificially keeping prices high.

    It’s a rort and needs to be stopped somehow. Hopefully the carnage of the crash will bring change.

      • Mining BoganMEMBER

        That’s the second conversation like that in four days. Couldn’t for the life of me work out why places are sitting empty for more than a month when I knew mine weren’t the only bids. Just makes me wonder what they’re telling the landlords.

    • Would be great to find a way to contact owner directly to make the offer. And let him know that the agent is keeping offers secret. Title searches might do it but they cost money and information could be out of date.

    • Is that even legal?

      Surely an agent would have to report all offers to the owner? Or at the very least, report the highest offer received, and if rejected for whatever reason, then report the next highest offer and so on. Otherwise they are not performing their duty as an agent. I’d consider pointing out that you’ll report the agent to Department of Fair Trading or whatever, if they refuse to pass on your offer, though I guess you have to weigh up whether you want to really annoy the agent.

      I’m currently attending house viewings for purchase and wondering whether it would be worth handing out a letter at the viewings that I will report all foreign bids to FIRB, ATO, Australian Federal Police and Chinese State Administration of of Foreign Exchange and any other official bodies I can think of. If it knocks out a few bidders it could save me tens of thousands of dollars (at least), and also prevent them from committing an illegal act.

      • Mining BoganMEMBER

        AFAIK agents are given the right to screen tenants so as to give suitable applications to the landlord.

        He was pretty upfront so I’d say nothing illegal. Immoral and illogical yes, but not illegal.

      • @Gral – golden stuff, You have my full support. Checking FIRB compliance/advance approval during settlement process is far too late. They’ve already had the affect of driving up the bid

    • What you describe is my experience also, not just with discussing new opportunities but with current leases. Report maintenance issues (serious stuff, not what I can do myself) and nothing happens. Follow it up two months later and they’ve not spoken to the owner in the period in between. Luckily we have the owner’s phone number if something is seriously amiss so we can look after our home and help them look after their ‘asset’.

  3. boomengineeringMEMBER

    Hey Mining I thought you were still in Perth, in Melb are ya.
    If you want the place why don’t you backdoor the agent find the owner through council or otherwise and approach the owner direct. Sometimes when I go to a client owner direct it gets a better result than managers who have to abide.
    When I was to rent a factory in Brookvale 15 yrs ago I offered half. The agent was too scared to present it but after time under pressure from the owner relented and was accepted.
    Lucky I did as when it rained it didn’t flood like the neighboring factories said after I moved in, until a tsunami came through, buckets were floating etc more luck that I disconnected the floor electrical

    • Mining BoganMEMBER

      Yeah, Melbourne now. I liked the place when I didn’t have to work here. Now that I’ve picked up some part time I’m thinking I’m already sick of the crowds and bustle and spivs and wankers.

      Northern NSW looks good in a year or two. Hopefully a year in this new job here (back in the gubmint!) will enable a transfer somewhere.

  4. Interesting idea. It has the advantage that a rental union doesn’t require any action by our captured politicians.
    But it would be really hard to implement without legislation to prevent defectors (mutants). So it would probably have to be part of a government response and therefore just a thought exercise until the revolution.
    Another advantage is it reduces or eliminates discrimination against particular tenants. We could add some for tenants that damage property etc but things like race or household composition aren’t a factor anymore.

    As well as the non-price rationing we need to consider how to encourage landlords to provide a good product. Currently most of the gains from speculation come from the land value and little from the rental value so we build bad houses and often maintain them poorly. Any system we use needs to make providing good quality housing more profitable than poor housing.

    We want to have a setup where there is more housing than tenants because the other way around is terrible. The union could even pay a rent on empty property that is available for tenants to encourage supply.
    I think something like the lottery system is the best. Allows people to apply for houses that fit their needs similar to existing rental market but without the price competition.
    Need some sort of safety mechanism to catch unlucky people who don’t get drawn over longer time and might end up homeless.

    It’s an interesting and difficult problem. Helps highlight how complex housing allocation is, and how useful markets are.

    • You are right that we need to “consider how to encourage landlords to provide a good product”. This is an important one, because rental prices aren’t really providing the right signals. For many investors letting the home fall to pieces is perfectly economical; there is always a tenant who is willing to pay to forgo some liveability for a cheaper price in that area. So in that way, the rental prices alone are is not enough to ensure minimum standards.

      • My usual suggestion would be to capture close to 100% of the Land Rent so all they have is the property rent which makes a good well build property more valuable than a poor one regardless of location.

        You could do something based on the number of veto’s used or number of lottery tickets opted. All with risk of corruption though.
        Or leave the price fixed but with demand determining how long it would stay empty.

  5. “It is a perfectly possible and realistic thing that can be done”

    Not exactly. There is this thing called the Competition and Consumer Act that stops people getting together and fixing prices. The penalties are severe. For really serious breaches, you can go to jail.

    But let’s assume for the sake of argument you could do it.

    The unstated assumption is that investors would just cop it sweet and accept lower rents. This only works, even in theory, if there is a fixed supply of houses of a given quality. But in practice, with a growing population, there has to be a growing supply. Investors would stop investing and wold stop maintaining the properties they already own. This isn’t a problem in health care (and other essential service markets) because it is the government that supplies the hospitals for policy, not profit, reasons. But unless you want the government to fill in the gap and supply houses, it would be a big problem.

    • Sure but as investors exit the market prices will go down. Lower land prices mean rents are more profitable for remaining investors. And it becomes cheaper for owner occupiers.
      Land prices have a very low floor, the only real limit is construction costs. Prices will fall until the rents are profitable or it becomes cheap enough for people to buy instead of rent or to build.

    • depends on how you structure it. The bulk buying consumer groups behind the massive utility discounts being achieved aren’t contravening the act/law but are achieving the same thing. Consider it an industry lobby group for buyers/customers instead of sellers/suppliers.

  6. It will never work . You touched on the reason when you stated that a few renters will pay a little more to get their choice of home. This “queue jumping’ for want of a better phrase is not in fact the exception but the rule. Human behaviour is such that people will only co-operate selflessly under the most extreme circumstances. I’ve often used the example of the airport luggage carousel to make the point. Instead of staying 3 paces away so that they can:
    a) See their luggage coming; and
    b) Be able to get their case off the carousel without hitting other people
    They crowd the carousel, achieving the worst possible outcome.
    Any number of academic games have been designed which show this aspect of human behaviour. Reward vs risk. In fact, any mass human activity becomes ruthlessly competitive very quickly. The only factor limiting the most violent competition is fear of reprisal.
    http://distributedrepublic.net/archives/2005/06/07/what-happens-when-the-police-go-on-strike/
    gives a very good description of what quickly happens in the most normal of places when the threat of reprisal is removed.
    The theoretical “fair rent” body is in fact a metaphor for the Marxist state. It collapses because humans, like trees in the jungle, cannot be made to co-operate altruistically.

  7. No need to abandon the price mechanism. Tax the bejeezus out of residential landowners who fail to get tenants – including those who fail to build accommodation on their land – and they’ll lower their rents in order to attract tenants and avoid the tax.

    Wherever you see futile competition, try to devise a way to make the counterparties compete.

  8. Well… In the words of the Supreme Soviet (quoted below) this is what we should do, Leith.

    Who cares about excessive immigration, Negative Gearing and other tax distortions.

    We can fix everything by having a command economy.

    “The organization tells each renter only to pay half the rental amount on the lease to their landlord, and that from now on it will set the rental prices. Because the organization negotiates on behalf of all tenants, it is a monopoly supplier of tenants to the landlords, and can set the price.”