There is no blob of “government” money, or “policy” that can make something affordable for one without making something else less affordable for another.
So if tenants get immediate relief from a rent freeze, where does that money come from?
Those outside the business may think that this will trigger a direct transfer from a wealthy landowner. Structurally this is an impractical notion. Even for those who have equity, it is just that: wealth tied up in the value of the property. It is not cash that can circulate and pay bills.
But in most all cases, the funds that come in from rent are pegged to go out to another obligation. This might be property taxes which are known to increase every year. This might be to a bank that financed the purchase of the property. And the insurance company which provides property isurance as required. This might be to a utility company. Each of these obligations have recourse for non-payment which ultimately leads to their making first claims on the income.
The funds which subsidize the rent freeze are most likely to come from monies intended for repairs and maintenance of the property. These vary from tasks that are good to do but not urgent, to things that if defrayed cause additional costs, to things that need immediate attention like a leaky pipe or a furnace outage. To give an idea of the number of routine items involved in the care of real estate, consider this post.
Over time, two things tend to occur. First, the new landlords with all their positive energy and desires to get ahead can’t maintain a financial foothold and leave. Other longer term owners prioritizes the most important fixes but let the cosemetic upgrades go. Over time more and more of the longer term components age, yards get overgrown, appliances become run down. The housing stock deteriorates.
The neighborhood at large is depreciated by blight, taking a little chunk of equity from every property owner nearby.
The Grumpy Economist has another great post, this time about rent control. For those of us in real estate, it’s an irritating topic. The errors in the use of price controls are numerous. Using John Cochrane’s article as a road map might be interesting to illustrate this point. Let’s start with this paragraph.
Sure, “sharply rising rents and utility bills wreak havoc on family budgets,” if the families don’t follow the screaming market signal to move. (Which is not painless, for sure. Incentives never are.) But the money comes from somewhere. Rent controls and energy price caps wreak havoc on landlord end electric utility budgets. The money must come from somewhere.
The claim is that rents are rising sharply. The reader pictures a Scrooge-like figure pounding on the door of a cowering family of four, announcing a ‘sharp’ rent increase (extra dollar symbols for emphasis), while behind this embodiment of the typical landlord stands an eviction notice ready to be served. I’d love to see numbers to this effect. I challenge that the ‘sharp’ rent increases are occurring at lease renewals.
Large corporate landlords might have a set policy of annual increases, but they account for only 3-4% of proprietors. Landlords must juggle the cost-benefit of increasing rent. As 80% own and manage the units, they calculate the costs, time, and uncertainty of a new tenant. This is weighed against a 3% increase on $1,100 or $33/mo in additional income. Needless to say, many landlords will forego a rent increase to keep a good tenant.
These subtleties are lost in real estate analysis, where all the numbers are averaged as if there were one typical renter, one typical landlord, and one typical property. This couldn’t be further from the truth. There are whole economies of renter groups. There are students who will have negative income before they join the workforce; there are singles with high-fluting jobs and no other responsibilities; there are single parents; there are couples with kids in a city just for a bit; there are elderly on fixed income with low mobility; there are recently divorcees looking for a glamorous downtown lifestyle.
Are all these groups to receive the same treatment? The same concern for their monthly budgets?Rent controls are initiated at the city level. Every group of renters would receive the benefit of a market-restrained obligation. Is that the intention?
Landlords are also assumed to be a certain type. The persona has tremendous equity in their property, no debt, and other cash they are stashing like squirrels do with acorns in the fall. And certainly some landlords fit this description. But more likely than not, the landlord has a mortgage and obligations against their time. The new entrants to the field, those trying to get ahead by getting a foothold in real estate, are undoubtedly the ones who need to make the cash flow.
When property taxes, utilities, or the cost of hiring labor rise, a landlord has no way to respond until a lease comes up for renewal. Rent control tightens this squeeze, leaving property owners caught between increasing public demands funded through taxation and their limited ability to recover those costs through rent. The first to be pushed out are often the newcomers—the small, aspiring owners who bring fresh energy and ambition to the market, but lack the cushion to absorb sustained losses.
Lesson number one. Averaging is a mistake. Assuming there is only one type of each actor in this economic trade of money for lodging makes for an impossible conversation.
On a trip to Manhattan a few years ago, my son and I noticed boarded-up store fronts along the best sidewalk shopping in the city. From the layers of flyers pasted on the brick wall and the thickness of dust perched on the window ledge, it was apparent that this state of disuse was a longterm thing. It didn’t make sense. What would make an owner prefer to leave a space empty instead of collecting rent from a desireable tenant looking for a desireable location?
If you were to think of this interms of a model, one might say, what are the negative implications of renting a storefront that zero out the benefit of incoming revenue from a tenant? What circumstances cause a property owner to be more interested in sitting on a vacant portion of a building rather than maximizing profit?
I say a portion of the building because the street level space of a NYC building is most always a small percentage of the entire building.
When an investor is looking to acquire new property there’s a lot of calculating to evaluate its prospects. The price of the building is mostly determined by how much cashflow the structure can generate. The lender (as in most cases there is financing involved) is also interested in the return their borrower will receive. This determines their comfort level in receiving payment on the debt.
With this in mind, a seller will often take action, prior to going on the market, to make the property attractive not only to the buyer but to all other parties involved in the transaction. For instance, an inspector will most probably make some rounds and look for mechanical flaws. The easy fixes are best done up front. Often there is a target renter in mind for the property and enhancement will be made to their structural preferences.
When a property goes for sale, there are lots of incentives to shine the place up and present it in its best light. Any salesperson will tell you this is how to generate the best offer.
Now fast forward twenty years, or thirty years, and the young investor with ambitions to build a portfolio has done exactly that. He or she is wealthy. There is a nice amount of equity in the property and the stress to recover every dollar in rent in order to pay the bank, the insurance company, the regulatory agencies and do repairs has eased. If the property is in a strong location, it is garnering a nice return year-in-year out. Often, it is better than other investments can offer.
Now, let’s consider the rental transaction for the storefront. It’s been a couple of decades since the property has had a full upgrade. Perhaps the paint is looking a little faded. Perhaps the interior tile work has more chips in the tile than some deem acceptable. A new younger set of folks want just that much more than what was available before. So for a bit more money in rent the owner is dealing with a lot more in either managing expectations or renovations. Renovations almost always means interacting with a regulatory entity as well. Once on the property, other issues may be brought to light.
There are two factors that go into the cost-benefit calculation of securing the lease. The rent received. And another important factor which we will call the engagement factor. When the owner takes on a new tenant they are agreeing to engage with their expectations, their payment and request idiosyncrasies. It’s not just the dollars. In the same way an insurance claim is not just about getting reimbursed for the repair work. You have to deal with the insurance rep, meet three contractors to get bids, and supervise the work. There’s an engagement factor. The street level activity also has an engagement factor. If the public has become more truant, than property damage or security issues create a cost on the owner’s time.
It gets to the point that the hastle of interacting with others starts to draw down the marginal benefit of the extra rent. Throw in a potential tax implication and that little benefit could shrink to almost nothing. An empty unit creates a tax write-off. A rented unit throws off income that is now taxed at higher rates, as many deductions have run their course.
The store fronts could be collecting dust because the engagement factors are simply too expensive.
Home Economics 