A Quick Note on Rent Regulation

I really want to write about the household debt-dynamics paper, but first a quick followup to yesterday’s rant:

Even more fundamental than the arguments I mentioned yesterday, the thing about rent control is that rents contain an element of, well, rents. (Separating the two senses of the word so cleanly has got to count as a big victory for right-wing ideology in economics.) This is especially true because buildings are so fricking long-lived. The average age of a multi-unit residential structure in the United States is about 30 years. In most cities with rent regulations, it’s much higher. For instance, the building I live in was built in 1902. The significance of this is that, even if an asset lasts forever, the share of its present value — which is what matters for the decision to buy/build it — that comes from the later years of its life goes arbitrarily close to zero. Say the discount rate is 6 percent. Then 95 percent of the value of a perpetuity comes from the returns in the first 50 years. 99.7 percent comes from returns in the first 100 years. In other words, even if the exact future rents of the building over its whole life were known with certainty, the rent being paid today would have had essentially zero effect on the decision to undertake the expense of  putting up my building 110 years ago. Which means that it is not in any way compensation for that expense. Which means — apart from the costs of maintenance and improvements, which rent regulations always allow landlords to recoup — the rent I am paying is pure economic rent.

(This, by the way, is how economics classes should frame the question of rent control. Students would actually learn something! — like about discount rates, and the age of the capital stock. Just wait til I write my textbook.)

So the Econ 101 point isn’t just a gross oversimplification — tho it is that — it’s substantively wrong even in its own abstract terms. It’s analyzing the market for the services of very long-lived assets as if it were the market for currently produced goods and services. In some respects, apartment buildings are analogous to intellectual property. The difference, of course, is that charging market rents doesn’t (usually) result in apartments being left unoccupied, so there aren’t the same kind of efficiency losses from enforcing perpetual property rights in apartment buildings that there are from perpetual copyrights. But there aren’t efficiency gains, either; it’s purely a distributional question. Regulation that only limited rents in buildings older than 50 years (which, as it happens, is more or less what we have) wouldn’t have any effect on the supply of new housing, it would be a pure transfer from landlords to tenants.

Of course, the landlords are still in control of the buildings, so they’ll allocate units somehow, just not on the basis of price. The haters will say that it will be on the basis of race/ethnicity and social ties; more plausibly, it will be on evidence of  responsibility, sobriety, steady habits, etc. (which, ok, sometimes the same thing); or maybe it will just be by luck. But in any case housing will be more available to those with less income, which is pretty much what affordable means.

(And then we should really get into the actual circumstances that precipitate rent control, namely an unforeseen increase in housing demand, together with regulations that (for better or worse) make it hard to increase the supply. Obviously, to the extent that a windfall increase in demand for housing in a given area (perhaps even in part thanks to their existing tenants) increases rents, and new entry is difficult, landlords are recipients of pure monopoly profits which can be taxed or regulated away at no social cost. That rent regulations are almost always part of a second-best solution in the context of other, development-restricting regulations that boost market rents, should also be a staple of intro textbooks. It isn’t.)