Rent control would be a disaster for investors

Rent control has been a disaster wherever it’s been tried. But this never stops politicians from suggesting it.

by Mark Milke, Senior Fellow at the Fraser Institute

Troy Media guest column

Rent control has been a disaster wherever it’s been tried. But this never stops politicians from suggesting it. Last November, the leader of the then-fourth place party in the Alberta legislature, now newly minted Premier Rachel Notley, argued that Alberta needed rent control.

Bad idea. To understand why, consider a simple example.

Let’s suppose a hard-working couple, Bob and Tammy, both aged 35, are thinking ahead about retirement. Suppose they have no personal defined benefit pension plan because they are self-employed.

Bob and Tammy purchase a condominium as a rental property with a 25-year amortization. Once the condo is paid off at age 60, they hope it will help fund their retirement.

According to the local real estate board, the average price of a Calgary condominium in April was $301,000. If the couple put down 25 per cent, the monthly mortgage payments on the remaining $225,750 (at a 2.7 per cent interest rate) will be $1,034.

However, condos also require condo fees. Assume a modest $300 per month. Then add monthly property taxes of $200.

In total, the couple will need, under the best-case scenario, to bring in $1,534 a month in rent to cover their costs. They must also hope their unit never sits empty for a month or more.

As the CMHC reports, the average apartment rent in Calgary is $1,219, i.e., the market rent, which means Bob and Tammy will likely already pay $315 per month extra ($3,780 per year) above their rental income to make the various payments.

In the above example, just to keep it simple, I’m not including the opportunity cost of their initial $75,250 down payment. I’m also not including any legal costs, or federal and provincial income taxes paid on rental income, or an increase in property taxes. I’m also not accounting for the possibility of a cash call on the condominium complex.

I do assume conservative estimates on condo fees (they are often higher) and that all utilities are paid by the tenants.

Now, Bob and Tammy might be fine with all that, reckoning that the value of the property increases will offset or more than match their annual subsidy. Or they might own a unit in a nicer building where they can charge more than the CMHC average. But in a rent-controlled universe, the investment becomes increasingly difficult to justify.

An absence of rent control alone does not guarantee more rental units will be built. Investments in rental units depend on whether other investments offer a better return and less hassle.

But add rent control to the risk mix, which restricts what the owners can charge, and folks like Bob and Tammy might not bother to invest in an existing rental property. And potential large-scale investors might forego building any new rentals at all — that’s where decreased supply comes in.

Lastly, on the effect of rent control, insofar as any owners, small or large, already own rentals, they will have every incentive to minimize additional spending on the property by foregoing standard maintenance if they can’t charge market rents. And that produces slums.

Given all that, investors might instead put their money somewhere else rather than face existing economic risks for rentals (higher property taxes, interest rates, cash calls, etc.), which are supplemented by political risk (rent control).

The addition of political risk to existing economic risk is why Nobel Prize winner Gunnar Myrdal, active and instrumental in left-wing political parties in Sweden in the 20th century, pointed out rent control was counter-productive policy.

Myrdal did so because rent control was (and is) lousy policy because of its predictable effects once imposed: artificially induced housing shortages, an incentive not to fix up existing rental properties, under-maintenance, and a smaller tax base as fewer than optimal rental properties equals less property tax revenue.

This is why another economist, Walter Block, once succinctly summarized the view among most economists. “There is no case for rent control.”

Mark Milke is a Senior Fellow at the Fraser Institute.

© 2015 Distributed by Troy Media

 

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