Most countries in
the world have moved from traditional economic systems where governments had
the power to dictate all aspects of trade. Today, advancement of capitalism has
seen most governments minimise their involvement in trade to very few instances
leaving the rest under the control of market forces. However, there are
governments that have formulated policies and laws that enable them, either
directly or through their agencies, to dictate what landlords can charge. There
are various levels of rent control, classified on the extent to which the
authority, rather than the stakeholders in the market, can determine the prices
in the housing market. This paper will discuss the concept of rent control; the
losers and gainers and the likely effect of its enforcement. The paper will
fist discuss how the existing literature covers this topic then use the
insights gained from this discussion to draw inferences and recommendations on
the issue.
Literature Review
According to
Englund & Ellingsen (2003) most economists have been condemning rent
controls. Despite this criticism there still exist many housing markets around
the world where authorities have enforced rent control measures. They affirm
that the theoretical justification given for these measures are relatively
weak. However, ‘third-generation’ regulation may sometimes be necessary in
extreme circumstances but this regulation should be enforced for short periods
after which the authorities should let market forces take over. Buckley &
Kalarickal (2005) states that though rent control represents political victory
of the tenants over property owners, it leads to the loss of efficiency in the
housing market where some property owners may ship out of the market or start compromising
the quality of housing leased in an effort to maximise their profits.
Housing markets in
developing economies are characterised by distortions that have been the source
of many problems for the low income earners. Buckley & Kalarickal (2005)
state that governments that have used incentives and other transfer mechanisms
have achieved better results in solving housing crises for low income earners.
This technique is more market friendly compared to rent control. Countries like
Chile, China, Colombia, Mexico and Malaysia have enabled the consumers to
obtain whatever they want in the market rather than getting into the market
itself and interfering with the forces that are supposed to bring a balance
between the interests of the investors and those of the tenants. Munch &
Svarer (2002) carried out a research in the Danish housing market and observed
that there was less tenancy mobility in areas where there was rent control. Their
conclusion on the effect of rent control is that it compromises the efficiency
that should exist in the housing market and families will tend to remain in the
same house for as long as six years before they can move. These families are
less willing to find information the situation of the market because of the
induced standardization of prices and sometimes quality of housing. This
inefficiency in the flow of information is likely to discourage property
developers.
According to Lind
(2001), economists critique on the first generation rent control as it is more justified
than that on the second generation rent control. Arnot (1995) defined the
first-generation control as where nominal rent is frozen while the second-generation
rent control leaves some allowances for this rent to vary. The first-generation
control only takes into account the welfare of the tenants while completely
ignoring the state of the market. Due to this partial negligence, policies
enforcing first-generation rent control are likely to result in a mismatch of
the quantity of housing demanded and that supplied thus creating a crisis.
Market Forces in the housing market
The theory of how
market forces control demand and supply was first advanced by Adam Smith
through his book "An Inquiry into
the Nature and Causes of the Wealth of Nations". According to Smith, people may seem to be working towards
the progress of the society through their everyday efforts. However, this is
not the case as every person seeks to promote his own interest. This interest
is portrayed by Smith as the ‘Invisible hand’ that controls the determination
with which we carry out our daily activities. From, Smith’s explanation of the invisible
hand, we derive the theory of supply and demand where a person who renders a
certain service or supplies a certain good will only continue to do so only if
they derive financial benefit from it. Similarly, a consumer can only procure a
good or a service from which they will derive the maximum possible utility at
the least possible cost.
The laws of supply
and demand explain how the interaction between the interests of the buyer and
the seller affect the prices of goods and services. Housing is a service where
the owner of the property will let the tenant derive utility from this property
for a certain period of time as per their agreement. In return, the tenant is
supposed to meet their part of the agreement which entails a paid off amount or
periodical remittances. The law of demand states the quantity demanded for a
certain good or service is inversely proportional to the price that the supplier
is willing to offer in exchange. This means that as the prices increase, the
people will be willing and able to procure for less of that commodity or
service. On the other hand, the law of supply states that the quantity supplied
is directly proportional to the price that the market is willing and able to
offer in exchange for the goods or services. This means that as the prices of
goods and services increase, the producers and suppliers will be willing to
dispose of more quantities of goods and services.
Rent, just like
the prices of other commodities and services, is mostly determined by the
market forces. This is to mean that in cases where there is scarcity of houses,
property owners are likely to charge high rent on individuals who wish to
settle in their houses. In addition, these
individuals will be willing to pay this price since there are not many houses
that they can choose from. This is likely to give the property owners an
opportunity to exploit these individuals. However, market forces will often
come in to and bring a balance. In this case, companies and individuals will
acquire land in neighbourhoods with housing shortages and construct houses in
the hope that they will capture the growing market and be able to make profits
from their property. As the number of houses that are available for rent
increase, it is likely that the property owners will start demanding less rent
to attract tenants into their housing. This decrease in price will also
discourage other investors from constructing more property. These forces
continue interplaying to ensure that there is a balance between the number of
tenants in a certain metropolis, prices and availability of housing.
Most government
policies are meant to protect the interests of the majority of its citizens. Therefore,
policymakers will tend to mind the welfare of the tenants and prioritize it
over that of the property owners. It is also important to note that policies in
a certain economy are mainly influenced by politics and the politicians in
power. These politicians will often seek
popularity among the electorate through the policies that they formulate.
Therefore, their policies will tend to favour the tenants while ignoring other
players and factors in the housing market. According to Basu & Emerson
(2002), most rent control policies and measures allow various authorities to
place a ceiling on the rent that the landlords under its jurisdiction can
charge.
Rent control laws
and policies are put place by a government to ensure that its citizens are
protected from exploitation by property owners. However, the overall effect of
these policies may be shipping out of real estate developers from the market
resulting in a housing crisis. Metropolitan governments should allow free
contacting and ensure that there are no barriers to access of information by the
landlords and the tenants on the prevailing prices, supply and demand in the
housing market. By doing this, the government will
see that tenants and landlords only enter into those agreements that they see
fit and the market forces of supply and demand will help achieve a balance
between the demand, supply and quantity of housing available in a given
location. In addition, this will also ensure that the landlords uphold the
laid-down quality standards I an effort to attract more tenants at a good
price.
Basu & Emerson
(2002) observe that the most common rather than the standard rent control is set
by the landlord when leasing their property to a new tenant. In this case, the
tenant has the right to accept or reject the offer and move around until they
settle on that property which they see fit. Most countries that are emphasizing
on free market employ this technique where the market forces determine the
prices. The tenant is likely to accept higher prices in cases where there are
fewer choices. In this case other people will come in to put up thus bringing a
balance.
In jurisdictions
where the mechanism of rent control explained above is applied, the landlord
has a ceiling above which their prices may not shoot beyond. As a result, there
is excess demand for housing. Given that the rent is set low, the landlord is
not able to increase their price with this increase in demand. It is likely
that these individuals may move out to other jurisdictions where property can
fetch higher returns in form of rent. Alternatively, this rent control may
discourage people from the real estate industry. As a result, the demand for
housing cannot be overcome through the market forces. Demand is likely to
increase and overwhelm the supply leading to a gap that cannot be solved by the
market forces due to the barriers created by policy frameworks. This results in
a housing crisis.
It is important to
examine the factors that have stimulated the authorities into formulating rent
control policies and laws in the recent past. One major factor is exploitation
of the tenants by the landlords. This happens in places where there exist no
free housing markets. There may be situations where there only exists a single or
a limited number of property owners. In other cases, these individuals or
companies may form a consortium where they standardize prices. The supply of
land is limited and thus once all or most of the land in a neighbourhood has
been developed, there are no chances that other developers can come in to compete
with the existing ones. This creates a monopoly
where property owners can choose to set high prices and alter them as they see
fit. The authorities have a responsibility of coming in to ensure that the
consumers are protected from the existing monopoly. These authorities will come up with policies
on procedures that will be used to determine the price ceiling that will be
enforced.
Conclusion
Despite this justification, rent control is likely to affect the
consumers. First, it will discourage the setting up of more property. As a
result, this increases demand for housing and will not be met by the supply. Another
most likely effect of rent control is poor quality of property disposed by the
landlords. Since the interest of these individuals is maximising their profits
it is likely that these property owners may neglect costs on maintenance in
order to minimise their costs. Other investors are entering housing markets
that are controlled and likely putting up inferior property at lower prices to
minimise their costs and maximise their returns. Therefore, the overall effect
of rent control is deterioration in the quality of housing that is offered for
lease by the landlords. However, second-generation rent control can be
implemented in order to protect tenants from exploitation and ensure that the
leased property meets the quality standards.
