Enlightened Capitalism

Essays about how to harness people's natural desire to create wealth and improve their quality of life to solve global problems such as war and poverty.

Wednesday, August 31, 2005

Rent Control

Rent control is intended to solve the problem of people getting priced out of their homes and communities. The idea is that if you already live somewhere, even if you are renting, you have a right to stay there, as long as you pay your rent on time and follow the rules. The landlord has the right to raise the rent, but only at a "reasonable" rate.

In Los Angeles and many other cities, the "reasonable" rate is something like 3% per year. On the other hand, housing in Los Angeles has been appreciating at many times that rate, for the past 5 years. The data understates the discrepancy, because when a duplex is sold with tenants, the price is going to reflect the current rents, because the tenants usually can't be evicted.

To give an example, a client of ours owns a classic old 4-plex on a nice residential street near the Staples Center in downtown Los Angeles. The previous owner was a slumlord who neglected the property for about 20 years. It shows. He didn't raise the rent, either, so the tenants are paying around $280/month for each 1 bedroom apartment. Since my client has owned the property for a year, he gets to raise the rents 3%, or $8.40 per month.

You might be thinking, "Hooray for the tenants!" But this is really a lose-lose situation. The landlord figures, with annual rents at $13,843, the place is worth around $200K (about 15 times the annual rent). Hmm, but vacant? The apartments across the street rent for $1500/month. It would take $20,000 to renovate these units, but then they would easily go for $1500/month too, and using the same math the place would be worth over $1 million (a more conservative estimate is around $800K).

So, if the tenants move out, and the Landlord puts $20K into the property, he makes a quick $600K. OK, but the tenants aren't going to move out. So the landlord isn't going to put $20K into the property, and the place remains an eyesore.

I got a bright idea. Since the tenants have the power to make or break this deal, why not split the profit with them? Sell the property to the tenants for $500K, making a profit of $300K, and the tenants get a property with $300K instant equity, or they could sell it an pocket the $300K profit. I actually proposed this to the tenants (I had to explain it about 20 times to all the different family members, in English and Spanish) and gave them a written contract which included $20K for renovations, but they turned it down.

So the landlord is simply watching their every move and hoping they make a mistake. One of the tenants is planning to go to college, and I assume another one (they are all related) plans to use her room while she is away, but this will violate the guest provisions of the lease, and she could be evicted.

This is not a good situation for anyone.

How could rent control be made more neighborhood-friendly? Well, for one, there should be a time limit -- I propose 5 years per tenant per property, after which the rent can be reset to market rate. There is nothing wrong with renting, but it is supposed to be cheaper than owning in the short run and more expensive in the long run. When it becomes cheaper in the long run, it sets up reverse incentives for creating wealth. We want people to invest in their future, and in the future of the neighborhood. Tenants paying decade old prices are not doing that.

Another idea would be to apply it in phases. After 1 year the rent can be raised 3%, after two years it can be raised 4%, and so on, until the cap no longer has any impact. This would give the tenant a predictable below market rent pattern and allow for planning, but would not be so severe as to disincentivise them from ultimately buying, or disincentivise the landlord from improving the property.

The first objection to this would likely concern the elderly or disabled on fixed incomes with no assets. This is a minority of the urban population (or we are in big trouble), and it would be much less expensive to simply pay these qualified needy people some monthly amount to offset rises in the cost of living.

In the context of wealth being created by behavior, I want to take a moment to extol migration. The richest nation in the world is a nation of immigrants. All the richest cities in the world are teeming with people who come from somewhere else, and who migrated to improve their lot. In all the neighborhoods that declined in the past decades, the people who left were better educated and earned more than the people who remained. Moving to a new place is a wealth-creating behavior.

We should encourage this, especially for people who are currently economically below average. Every time real estate prices have doubled in a particular place, nearly all my friends and relatives who lived in that place have left. They go to another place, less desireable on the surface -- that's why it's cheaper -- but more desireable in the sense that they will have a better life there, because it's cheaper and poised to grow faster.

This is how people get wealthier, by constantly taking steps to improve their lot. It is counterproductive to incentivise people to stay in a place where they are less economically successful than they would be somewhere else.

So, my alternative to rent control is to allow the markets to work, and spend some more time effort and money helping people take advantage of the best opportunities available for them right now. That means looking at housing and jobs across the whole country (or why stop there, why not the world?), and picking the best ones for each individual.


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