A Modest Proposal for an Efficient Rental Market

By Nathan Tankus, a writer living in New York City

Inefficiencies abound in our society. One major instance of such inefficiency is the residential housing rental market. As Paul Krugman wisely explained many years ago:

Almost every freshman-level textbook contains a case study on rent control, using its known adverse side effects to illustrate the principles of supply and demand. Sky-high rents on uncontrolled apartments, because desperate renters have nowhere to go — and the absence of new apartment construction, despite those high rents, because landlords fear that controls will be extended?*

This is, of course, correct; unfortunately, our usually excellent guide to the world underplays just how inefficient the rental market is.

What if real estate developers fear that rent control will be extended even further – to housing price control? After all, what is in the price of a home besides its discounted future rental value? And what if the perhaps well-intentioned but over-reaching local government extends all leases by or to five years? As we all know (or ought to know), these kinds of concerns keep real estate developers up at night. They simply have no way of knowing, let alone influencing, the plans and decisions of politicians regarding real estate. After all, surely the people with the least amount of actual or potential influence and power in Urban America are the real estate developers.

Further, why should we have tenant protections like property deeds or leases? Rent control is a horrible policy stymying the housing market, but what is rent control but a contract protecting the rights of occupancy of a tenant? It’s a piker compared to the real forces stymying the market. Even worse, future home buyers and leasees are a much stronger political contingent than future rent control beneficiaries. We won’t be able to eliminate these uncertainties for developers until property deeds and leases don’t yield any benefits (at least). It’s curious that Paul Krugman and other economists so uniformly in favor of eliminating rent control haven’t realized this.

Even if developers foolishly built housing for sale or long term lease and the government, by some miracle, didn’t impose price controls or extend the leases, problems would remain. After all, what if the value of those property deeds and leases were to rise? In other words, what if they experience a capital gain? That means they have paid/will pay less than the actual rental value of the housing! Some of those people likely wouldn’t be able to pay the market rental value, and if they had to would move, just like those in rent control! Their continued occupancy of those homes within city limits drives the rents skyhigh for everyone else. Even worse, there are so many more owners and long term leasees than rent controlled apartments. Can you imagine how much they’re distorting the market by not paying market rates? At least those with leases are eventually charged the higher prices and thus forced to leave if they can’t afford them. The homeowners, though!? They are never forced to adjust to market prices, and can even distort markets after death by letting their children inherit their home! Action must be taken.

My modest proposal for making the rental market efficient is thus this: I understand that we can’t cancel all the property deeds (on the other hand…) and all leases unilaterally. Still, what we can do is, starting the first calendar day of next year, charge all those individuals a monthly sum equal to the difference between the rental value they are/did pay and the market rental value (as estimated by a citywide index of similar apartments or ”going rents”). Those who can’t afford market rents will sell their leases to their landlords /deeds back to the city at the prices they purchased them at, minus of course the imputed rent they’ve already received by living there. Once these people leave the city, the vacancy rate will rise and rents will fall. Since we all agree rent control property rights distort the rental market, and we all agree all market distortions are bad, I’m sure my modest proposal will be quickly and speedily taken on by the Economics profession. I can’t think of a reason it wouldn’t be.

* Tto be serious for a moment, this tale falls apart from the start, even before we get to the political unreality of the story being spun. Land prices are the largest component of developer cost and land prices include the expected future rental value of the land being developed. If there were fears of rent control being imposed on newly built private housing, this would be priced into land prices and thus lower developer costs. Heck, this is true if they actually did impose rent control on all new construction. In fact, I would go further and say that since there’s always a chance that the city will bring back the boogeyman rent control, and that chance may hold back development, the only foolproof way of giving developers absolute certainty that building will be profitable is to impose rent control on all future construction (of course with passing on construction/maintenance cost overruns, which all actually existing rent control laws have allowed for decades).

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  1. PlutoniumKun

    I think any discussion of urban land economics is the best way to tell if an economist truly understands how economies work, or if they are just spouting ideology.

    Unfortunately, the intimate connection between land investments and the financial system makes reform almost impossible. Here in Ireland some sensible proposals to tax urban land in order to push underused and derelict sites onto the market for development were stopped by the banks. The reason was simple – any such tax would undermine the value of urban land, and of course this effects the asset base of all the banks as so many of their commercial loans were backed by development land as collateral. So even this simple (and Mr. free market approved) proposal to improve the property market for regular people failed.

    1. liberal

      Agreed, but it’s not at all clear that the author of this piece understands land economics either.

      As for economists generally, they’re amazing ignorant. Even someone like Dean Baker, who puts most economists to shame on most issues (and was one of the earliest voices pointing out the US housing bubble) doesn’t appear to understand land economics. (Namely, that land is a good in fixed supply,with all that implies.)

      Henry George has been rotting in his grave for a long time now, and he still understands economics better than most living economists.

  2. Simon

    Ah, some microeconomics that makes my heart laugh and sing! Such a rare find.
    Many thanks to the excellent Nathan Tankus (and the wonderful Yves Smith) for posting that piece.

  3. sd

    I wonder if the author understands that outside of NYC there are numerous work arounds for developers/landlords to avoid any form of rent control. Designations like “mixed-use” “Loft” “live work” are not apartments. In most cities, there are no controls covering these properties, including tenant protections.

    And then of course, you have laws like the Ellis Act which pretty much allows landlords to throw tenants out on the street. Without affordable housing, the only option is to leave an area which threatens employment. So not only loss of home, but the potential for loss of job too.

    1. Nathan Tankus

      I do. I also think developers have a lot of power, hence the sarcastic link to De Blasio’s Real Estate campaign contributions….

  4. Rob Lewis

    Frankly I don’t even understand the point you’re trying to make. But your very first premise is wrong:

    “what is in the price of a home besides its discounted future rental value?”

    Actually, it’s a lot more, if we’re talking about single-family homes. A real-estate expert who used to write for the L.A. Times, whose name escapes me now, made this point over and over: a home’s price is determined by one thing: the prices of similar homes in the neighborhood. Rental value doesn’t even come close to being a major factor.

    1. JTMcPhee

      That lays out one rule for the “price” of a house (a “home,” in my little understanding, is a whole lot more than a “house.”) What is not addressed, despite use of the word in the effort to define the concept, is the “value” of a home. To the individual, the family, the community.

    2. Nathan Tankus

      If I buy a house there’s a rental value implied in the price I pay. saying that the prices of other houses in the neighborhood impact the price i pay is just to say that the expected discounted rental value is estimated using prevailing prices.

      1. JTMcPhee

        Rental “value” is just part of “price.” I was thinking more of the social, human, family, personal, community/comity kind of “value.” Pricing might haphazardly be affected by those things, but the monetizing seems to me to debase stuff that is in my little understanding a big part of what keeps “society” together so that monetizers and rentiers have a substrate to leverage off of.

    3. RepubAnon

      The whole analysis falls apart on one simple basis: return on investment. Cities don’t own the properties, they simply tax them. A landlord owns the property rented, and so would like a positive cash flow.

      On a side note: charging market rent isn’t always optimal – there’s a cost in tenant turnover. Keeping a steady, trustworthy tenant has a value.

      (P.S.: I’m a renter now, but at one point was also a landlord – I had property that I couldn’t easily sell. Finding new tenants was always a pain and a risk.)

  5. JTMcPhee

    A lot more complicated than the Swiftian “Modest Proposal,” though with maybe the same effects for the “little people,” were it seriously to be implemented.

    Discussions like this, notably without the tongue in cheek, take place all the time between our “betters.” My modest proposal is that anyone who uses the word “(in)efficien(t)(cy)(ies)” in a non-ironic semantical application in any discussion of political economy should have his or her tongue excised with a dull and rusty knife, have it ground fine, mixed with a little pesto, and fed back to the speaker with a nice Chianti.

    Anyone know any studies of the manifold externalities that the sainted blessed ‘developers” impose on the rest of the community as they pursue their rents and profits? Speaking of “(that word)…”

  6. Dan Lynch

    Nathan said of rent control screwing up the market and creating shortages: This is, of course, correct.

    Except it is not at all correct in Germany. Germany has rent control and strong tenant’s rights, and government manages the supply of housing. Germany requires 24% down payment to buy a house so it has avoided the housing bubbles that have plagued the rest of the Western world. In fact, Yves has posted on Germany’s admirable housing policy.

    If Germany can do it, why can’t we?

    1. Keith

      I wondered how Germany had avoided the speculative housing bubbles that plague the rest of the world.

      Thanks, I’ll read the link too.

      1. Penny

        German savings banks, however, as well as its international banks did NOT avoid the speculative bubble; they bought up a whole lot of the alphabet soup of mortgage related paper and….were quietly bailed out of their liquidity problem by Merkel leaving zombie banks requiring regular infusions of liquidity to keep on pretending they are solvent. Ditto French banks, Sarkozy and latterly Hollande. It is useful to view the financial invasion of Greece and the imposition of debt peonage as a chapter in the above story.

      1. Tiercelet

        I’m really stunned to see how many people have rushed to the comments with the piece having gone at least two feet over their heads.

        1. RMO

          I’m not. It’s almost impossible to write effective sarcasm these days. No matter how ridiculous the ideas served up in the piece are you can probably find some candidate, journalist or “think tank” serving up the same thing seriously. How far away from Swift’s Modest Proposal are the positions of people who are treated seriously these days?

        2. sd

          I did not read this article as sarcasm but that’s probably because of recent experience. Mother-in-law lost her apartment, and therefor her employment, and at our previous rental, all the rates have doubled. Meanwhile wages are flat, spouse is unemployed, sister-in-law is unemployed. I could go on but I think you get the point.

  7. Jeff

    As a real estate investor (i.e. I buy an empty lot, get a construction loan, hire a contractor to build the home, then act as a landlord once it’s complete), I’ve got no interest in seeing rent control established in my city.

    If it happens, new construction of rentals will fall off a cliff here in beautiful Bozeman. I’ll be one of the investors not doing any new construction.

    I’m still in the process of renting out my most recently built units and have had to drop the asking price 10% as demand is always down in the winter. With the drop in asking price, I’ll net $300 a month after $1700 in expenses. That’s not enough of a return, but I’m betting/hoping that rent will go up in the next couple of years.

    So remind me again why more government intervention is a good thing?

    If a tenant wants to lock in a certain rent rate, they just need to commit to a longer lease term. I explain this and some folks take advantage and some don’t. It’s entirely their own decision and of course many folks don’t need a longer term lease.

    1. liberal

      So remind me again why more government intervention is a good thing?


      Given that ownership of real property is defined by government, the government is already neck-deep in the real estate market. Not to mention all the real estate value government creates by its activities.

      The solution of course isn’t rent control, but land value taxation, so folks like you can make money on your contribution to the economy (the building and maintaining of improvements) instead of collecting tolls on value you didn’t create (which is purely parasitic).

    2. Tiercelet

      Hmm, so you are netting $300 on $1700 in expenses, therefore charging $2000/mo (when you’d like to charge $2200-$2500). Let’s be unrealistically generous and assume that’s $1700 of mortgage–that would give a total loan amount of $250,000, so you’ve probably got around $60k of your own money invested, and you’re making $3600 profit pa.
      In other words, this eeeevil rent-controlled price gives you 6% annual return and a six-figure asset at the end of it.

      When rent control finally makes it to Montana, please let me know, I’d be very satisfied with less return than you’re complaining about! And do keep in touch on how your switch to treasuries treats you.

  8. Unorthodoxmarxist

    Well, short of nationalizing the land and moving to a sane housing policy after the revolution, there’s always the Swedish model where the government owns a significant chunk of property and rents it out in long-term leases at all income levels. I believe the Swedish municipal housing authorities are also able to purchase new properties as they become available. No need for rent control if the government provides a good deal of all-income housing.

    1. liberal

      Government doesn’t need to “own” property. It needs, rather, to tax it heavily (well, the land part anyway).

  9. liberal

    I don’t get the fascination with rent control.

    The problem isn’t that the rent is too high. The problem is that the portion of the rent that is land rent is being pocketed in return for absolutely nothing.

  10. animalogic

    I still believe the best market intervention is for government to build, rent and maintain a stock of public housing, sufficient to the needs of lower income groups. Such housing needs to be sensitive and progressive. Rents should be based upon household income.
    The advantage with public housing is, not only the immediate housing of the disadvantaged, but also an ongoing down wards pressure on rents generally.

    1. Tiercelet

      Indeed. But it’s not enough to just have a public option for “lower income groups”. You need to have a public housing option all the way well up into the ranks of the middle class–otherwise you have exactly the problem you get in NYC public housing, where even upwardly mobile young people are stuck because they could never afford market-rate rent, which undermines support for the system and adds to the chronic undersupply of housing for those closer to poverty.

      Of course it’d also help if we stopped paying private real estate developers half the (bargain-basement) purchase prices of housing developments in exchange for a promise to keep some of it lower-income for a while, yes Riverton I’m looking at you…

  11. Grkstav

    The problem isn’t that the rent is too high. The problem is that the portion of the rent that is land rent is being pocketed in return for absolutely nothing.

    How does that work, though? The overall rent is “too high” given that a portion of it is gratuitously allowed to be added on to it. The ‘unearned’ part is still part of the rent the renter/lessee has to pay.

    What am I missing?

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