Why rent controls won’t solve the urban housing crisis

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Jaime Luque, Professor, ESCP Business School & Kian Starsberg, Master’s student, Management, ESCP Business School

• Rent controls were at the heart of the recent Paris and London mayoral battles.
• Recent research suggests that rent controls negatively impact the amount and quality of accommodation on offer.
• Other alternatives, such as tax credits for developers, should be considered.

The dates of both the Paris and London 2020 elections have changed due to the unprecedented global outbreak of COVID-19, but the one constant is the polemical issue of the housing crisis. Among others, rent price control is one of the fundamental topics at the heart of candidates’ mayoral campaigns in both capital cities.

According to the Valuation Office Agency, London experienced a 35% increase in average monthly rent prices between 2011 and 2018. The city’s monthly 2019 average is more than double that of the rest of the country, and according to the latest English Housing Survey, the proportion of household income spent on rent was considerably higher for private renters in London (42%) than for the rest of England (30%).

As a result, Sadiq Khan, the Mayor of London now entering his second terms who called the election a vote on rent controls, urged the government to provide him with extra power to install rent caps and massively increase investment in council, social and other genuinely affordable homes. Khan also wants to establish a new London private rent commission, with renters on its board, to implement and enforce measures to control prices in order to provide tenants with more affordable housing.

Nevertheless, Jonathan Cribb, Senior Research Economist at the Institute for Fiscal Studies, argued that despite providing short-term benefits for tenants, the overall quality of accommodation will suffer in the long run as a result of such measures. Landlords will neglect maintenance in order to reduce costs in response to their lowered income, thus negatively impacting living conditions in London.

Landlords’ investment returns would be reduced and as a result many will abandon income-property investment, leading to a reduction in private rental accommodation on offer, an increase in competition and, as a result, a surge in rental prices: the complete opposite of the desired effect.

However, the government has announced plans to eradicate “no-fault” evictions (where tenants are arbitrarily evicted through no fault of their own), to ban unjust rental fees and to cap tenancy deposits, saving London’s tenants £240 million a year; a step in the right direction to ameliorate the local housing market. The Conservative mayoral candidate for the London mayoral election, Shaun Bailey, similarly criticised Khan’s proposals and claimed that construction of more homes is the only answer to the housing crisis.

Paris paints a similar picture. Ever since Anne Hidalgo was elected Mayor in 2014, she has been battling to contain the surge of Parisian real estate prices and rents, which is pushing families out of the capital and has resulted in a decrease in the population. In August 2015, she and her team introduced rental price caps in Paris to solve this housing crisis. Having been removed in November 2017 and then reinstated in July 2019, rent control remained central to Anne Hidalgo’s 2020 campaign. By contrast, Rachida Dati, her main competitor, promised to put a stop to the current rent caps if she is elected.

Since their inception in 2019, these obligatory rental price controls are formalized each year: Paris is divided into 14 geographical sectors, each with their own average reference price for each category of residential property. Owners are provided with a maximum (20% above the average reference price) and a minimum (30% below the average reference price) reference rent price. Any failure to abide by these regulations results in a monetary sanction. Their purpose? To limit the increase in rental prices, to reduce those already too high, and ultimately to halt the depopulation of the French capital.

The adverse effects of rent control

During a time of political movements and campaigns, it’s important to look back on the depoliticized research on rent control undertaken in San Francisco and Germany.

San Francisco itself was first subjected to rent control in 1994, and the effects in the short term were by and large positive: The majority of the tenants from the groups studied remained in the city, and they were 10-20% more likely to remain in their current housing situation. However, in the long run, homeowners naturally attempted to remove their properties from the constraints of the rent price caps, leading to a 15% reduction in accommodation on offer, a general increase in the rent prices, and the gentrification of the affected areas.

The reason for the increase in rent prices was two-fold. First of all, there was an increase in competition for the diminishing number of accommodations exempt from the rent control. Second, renovation works undertaken by owners in order to circumnavigate the rent control in turn improved the quality and therefore augmented the price of housing on offer. All in all, the citywide negative consequences of the rent control greatly exceeded its benefits for the tenants.

Germany more recently implemented rent controls in 2015, and itself experienced short-term problems, in particular regarding the prices of non-capped accommodation. The artificial increase of the competition for housing subject to rent control encouraged high-income households to turn to housing outside this cap, therefore also inflating their rent prices. It’s no surprise that Germany’s top court recently put an end to Berlin’s unsuccessful experiment after only one year as rents were down, but so was the supply of homes. “The ruling is a blow to Berlin’s left-leaning coalition as it prepares for elections in September,” claimed the Berliner Zeitung.

What is the World Economic Forum doing to support the Future of Real Estate?

While investable real estate has grown by more than 55% since 2012 (PwC), the COVID-19 crisis has underscored weaknesses in relation to human and planetary health along with drastic inequalities, leaving a stark reminder of the influence the built environment has on societies and the vulnerabilities that exist in times of crisis regarding how spaces perform.

As the real estate industry looks towards recovery, the need for transformation is clear. Portfolios must be rebalanced, and distressed assets repurposed. Technology must be fully embraced, and sustainability and wellness must be at the core of design and operation. The affordable housing crisis that already existed pre COVID-19 must be systemically approached to ensure access to adequate and affordable housing. If the Real Estate industry is to deliver transformation, it is more important than ever to ensure that policy, financing and business solutions are aligned in delivering better buildings and cities.

The World Economic Forum has brought together CEOs from the Real Estate industry to develop a Framework for the Future of Real Estate to help drive the industry’s transition to a healthier, more affordable, resilient and sustainable world.

As these cases indicate, voters should be aware that in the short-term rent control may be favourable for tenants. But in the long-term, it will increase rent prices and decrease the availability of accommodation, proving costly for future generations. The solution? Based on our research, we argue in favour of introducing tax credit programmes for developers to encourage their investments in income property and to prevent a reduction in the availability of affordable accommodation in the housing market, thus ensuring the tenants against surges in rental prices through the housing supply channel.