Analysis Free Market Fundamentalist

Rent Control Keeps Failing. Countries Keep Trying

What do you call doing the same thing over and over again, and expecting different results?

Madrid Spain
The sun rises over the Gran Vía of Madrid, Spain (Unsplash/Arw Zero)

So politicians understand how prices work after all.

Spain, Germany and the Netherlands are capping prices of electricity and heating for consumers. Energy providers are still paying high prices for oil and record prices for natural gas due to Russia’s war in Ukraine, so governments will make up the difference.

The price energy providers charge is based on their costs plus a profit. If they can’t pass higher costs on to consumers, they would either have to cut their own costs, for example by laying off staff; scale up, which isn’t easy in Europe’s heavily regulated energy market; or fail.

Somehow that logic is lost on many when it comes to housing. The same three countries have capped, or are capping, rents, but there is no compensation for landlords. Nor for developers, who can sell fewer rental apartments.

Landlords make up the difference by underinvesting in maintenance. Developments simply don’t happen.

Which are then used as arguments for even more regulation.

Economists agree

The economics of rent control aren’t a mystery.

Milton Friedman and George J. Stigler wrote in 1946 that capping rents would cause owners to sell their properties rather than rent them out, resulting in shortages.

Edward L. Glaeser and Erzo F.P. Luttmer found in 1997 that residents held onto rent-controlled apartments in New York even when their housing needs had changed (children moved out or a partner died). That finding was confirmed by David P. Sims in 2011, Jeremy Bulow and Paul Klemperer in 2012, and Rebecca Diamond, Tim McQuade and Franklin Qian, based on a study in San Francisco, in 2019.

Anthony Downs found in 1988 that rent control causes underinvestment in houses, a finding confirmed by Sims in 2007 based on data from Massachusetts.

Did no one in Europe read their studies?

Spain

In Spain, rents fell 10 percent during the pandemic. A left-wing government nevertheless chose that time to cut taxes for small landlords who froze rents and introduce housing benefits of €250 per month for under-35s earning less than the average salary.

Catalonia went further and froze rents altogether. That measure was repealed by Spain’s Constitutional Court, which argued the regional government lacked the authority. The national government responded by giving regions the power to cap — not freeze — rents in “stressed” markets. This year, it capped rent increases nationwide at 2 percent.

75 percent of Spanish households own their homes. Spain has one of the smallest rental markets in Western Europe. Construction never really recovered from the housing-market crash of 2008. Renters in coastal areas, like Catalonia, and Madrid increasingly compete with expats and tourists. 83 million tourists visited Spain in 2019, up from 52 million a decade earlier. With the return of foreigners in the wake of COVID-19, rents are rising again. Caps and freezes don’t fix the underlying mismatch between supply and demand.

Germany

In Germany, rents cannot exceed the local average by more than 10 percent. States cap rent increases at 15 to 20 percent per year. Renters are able to pass rent-controlled apartments on to relatives and friends. It’s almost impossible to evict renters. Landlords resort to shenanigans like classifying necessary repairs as optional “modernizations” in order to justify rent increases. Or they delay repairs for as long as possible, hoping that renters will move out.

Such abuses convinced the left-wing government of Berlin to freeze rents in 2020. Available rental apartments fell 57 percent. Owners kept their flats empty while they waited for Germany’s supreme court to rule if the freeze had been constitutional. It wasn’t.

After the freeze was reversed, Berliners voted in a referendum to put 243,000 of the city’s 1.5 million rental apartments in public ownership. Landlords with 3,000 apartments or more would be expropriated.

That hasn’t gone into effect (the national government is against it), but I wouldn’t be surprised if we saw studies in the next few years confirming what Friedman and Stigler knew in 1946: that the mere threat of rent control causes property owners to sell off their apartments. Anyone looking to rent an apartment in Berlin will have to look longer.

Netherlands

The Dutch government, a coalition of centrist and center-right parties (including my own), wouldn’t expropriate homes, but it is bringing rental apartments under €1,000 per month into regulation. With the same effect.

CBRE, a real-estate services firm, projects that 50,000 to 100,000 rental apartments will be sold before the new rule becomes law. Developers expect that fewer rental apartments will be built. Investment has already fallen 45 percent.

One in three homes in the Netherlands are rent-controlled, the highest share in Europe. Families with incomes under €45,000 per year qualify, but renters are never evicted if they make more money. Even in non-social housing, evictions are rare. Temporary contracts are limited to two years. Once a tenant has an indefinite contract, they can only be evicted if they don’t pay their rent for several months in a row.

Cities like Amsterdam require developers to set aside 40 percent of apartments for social housing and another 40 percent for “affordable” housing, meaning rented out or sold below market prices. They must get their profit from the remaining 20 percent.

The rent cap for social housing is €763 per month. Raising it to €1,000 would bring some 430,000 apartments into regulation.

Social rents were frozen during the pandemic and limited to an increase of 2.3 percent last year. In the “free” rental market, rent increases are limited to 1 percent plus inflation. Which, at an annualized inflation rate of 14.5 percent in September, has led to calls for a Catalan- or Berlin-style rent freeze.

As in Catalonia and Berlin, a freeze would help Dutch renters pay their bills this year and next, but they, and everyone looking for an apartment to rent, will pay the price eventually.

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