For years, thriving cities in coastal regions of the US have become increasingly expensive to live in. As cities such as San Francisco, New York City, Los Angeles and Seattle became more attractive, thanks to booming knowledge industries and falling crime, rents soared.
And for almost as long, people have been hotly debating what to do about the problem. Many have called for an increase in housing construction, especially by loosening zoning laws and reducing the ability of legal challenges to halt construction. Evidence shows that this approach can be effective in easing rent pressures.
But the movement for more housing is up against the formidable foe of local politics. Homeowners, seeking to prop up house prices and preserve quiet, low-density neighborhoods, wield disproportionate power in the US’s small fragmented suburban municipalities. And although building more housing can keep rents from rising, the results have been unimpressive -- a huge construction boom helped Seattle accommodate a larger population, and led to some rent moderation, but the city is still an expensive place to live.
Given the limited effectiveness of increasing supply, political leaders at the state level are trying a new tactic -- simply banning the rent crisis. New York state recently passed a law making it much harder for landlords to evade local rent control laws. Oregon, meanwhile, enacted a statewide law limiting annual rent increases to 7 percent plus the rate of inflation. And California’s state senate just approved a similar bill limiting rent hikes to 5 percent plus inflation.
Will the rent-control revolution work as intended? The levels set by California and Oregon are not very stringent -- most of the cities mentioned above have rarely if ever seen a single year of rent increases larger than 5 percent plus inflation. So although some landlords will be constrained by the new laws, on average their profits won’t be crimped.
Statewide rent control may instead end up moving landlords toward the business models of utility companies, many of which have limits on their rates of return.
Rent increases aren’t the same thing as utility profit caps, but there are similar reasons for doing both. Utilities benefit from a network effect; it doesn’t make sense for a town to have two competing power grids or sewage systems, so there will tend to only be one utility for each area. But because that makes utilities a natural monopoly, profit caps are used to counteract their market power.
Landlords, meanwhile, derive profit from the network effects of cities themselves. Knowledge-based industries like technology, entertainment and finance tend to cluster where there are large reservoirs of talented workers, and these workers tend to go where there are the most employers. This snowball effect creates huge demand for housing in superstar cities, which generates a windfall for land owners. That tends to be inefficient, since it sucks money away from actually productive industries and hands it to those who are simply lucky enough to own an advantageous location. The classic solution to this problem is a land value tax, but rent control can also limit the size of the windfall.
The problem is that rent control can also exacerbate housing shortages. Basic economics suggests that price controls lead to shortages. A study of rent control in San Francisco found that while it gave protection to longtime tenants, it resulted in reduced rental housing supply because it gave property owners an incentive to convert apartments into condos.
Meanwhile, if limits on rent increases are set too low, it could discourage construction of new rental properties; without the possibility of selling to landlords who expect to be able to make significant long-term profits, developers may simply not be willing to build in some areas. That would exacerbate the shortage of housing in big cities. So far, the California and Oregon laws don’t look restrictive enough to cause a collapse in construction, but it’s possible that other states may become overzealous and set limits that end up hurting local markets.
States need to be cautious when implementing universal rent control. It’s possible for governments to set unrealistic price levels that backfire and hurt economic activity. States should make sure to use zoning deregulation and land taxes as much as possible, reducing the need for rent-control laws. And they should monitor rent caps carefully for signs that construction or renovation is being discouraged. A little rent control is probably fine, but too much is too much.
Noah Smith is a Bloomberg Opinion columnist. -- Ed.