Monday 21 February 2011

Rent Controls: Part II

You didn't know there was a part II, did you? Surprise!!

Sorry .. I know how you hate surprises. I have to warn you though: this is going to be boring. Dry whole-wheat toast boring. If you wish to flee to another blog I will not hold it against you, and I might suggest any of the fine choices in my right sidebar.

Okay. Last week's post on rent controls was not so much a critique of the government's commissioned study on the subject, so much as it was a contrast of what they were saying publicly versus what the numbers seemed to imply. This time, I will delve into the actual study. You know, many people might see that the study was written by a professor of economics, and therefore assume that it is full of wise insight, truthful, and incontrovertible. However, there are plenty of academics out there who publish crap from time to time so all work needs to be scrutinized. That's what the peer review process is for. Government commissioned studies are not subject to peer review, therefore I will do my best to fill a little bit of that gap, if I may be so bold. Just let me grab my pipe and put on my glasses here so I look all perfesserly. Alright, I've got my tweed jacket on .. I'm all set to go ..

An Analysis of Manitoba's Rent Regulation Program and the Impact on the Rental Housing Market, by Hugh Grant

Let me start by saying that Hugh does not come to any conclusions through a quantitative analysis of the data. The data is inadequate to do an econometric analysis, he says. Therefore, when he states that "there is no evidence that ..." he is really giving an opinion based on his observation of the data and what he believes is the theoretical effect of the rent control policies.

Some of those conclusions are suspect.

Conclusion 1: "there is no evidence that rent regulations have restricted rents below what would prevail in a perfectly competitive market under equilibrium conditions."

Okay, well first of all, there is no such thing as a perfectly competitive market. The point he's trying to make here is that through the rent control regulation itself and the mechanisms that allow a landlord to apply for increases in various circumstances, the net effect should be that rents increase at the long-run supply price. Not only that, but the author actually claims that by regulating rents, and putting in place additional regulations and controls to negate the original regulations, that this actually improves market efficiency. It's a stunning claim to make.

So this is essentially the goal: to ensure that a landlord doesn't lose money, but also doesn't make a profit. The author refers numerous times to "gouging" and "unwarranted price increases" when talking about rental prices higher that the cost of supplying a unit. I don't know too many people who would go into business to break even. If this is the objective of the program, than it's little wonder that developers stopped building new units.

But let's assume that he's right, and that prices are increasing as they would with the market. What's the point of spending $1.7M on regulating rent prices? The answer: stability. To remove those periods of profits and losses so that rents follow the long term trend without the short term fluctuations. Does it work?

Let's have a look at rental price fluctuations in comparison with a city that does not have rent controls, like Edmonton:

The standard deviation of rent growth in Edmonton is indeed larger than in Winnipeg, but if you exclude a 6-quarter period from 4Q 2001 to 1Q 2003, it's actually less volatile than Winnipeg. But that's a boom and bust economy. Since we are so proud of our stable economy here in Manitoba, perhaps a better comparison is a city like Halifax:

One has rent control, and one does not. At no point does Halifax have a higher rent increase than Manitoba, percentage wise, and its standard deviation is almost identical. So what's the point of all this regulation, red tape and financial cost for administering this program?

Further, there was a period of 6 consecutive years (2001-2006) where the rent guideline was lower than previous year’s rate of inflation. The following years the guideline was increased somewhat, leading the author to say 'see: prices are adjusting just as they would in a real market!'. It is a ridiculous statement to make. The only thing you can conclude is that prices went up because the government adjusted them up. There is no basis to say they are following the market when they are being manually set.

Conclusion numero dos: "There is no evidence that Manitoba’s rent regulation program has a negative impact on the supply of rental accommodation."

Mr. Grant quotes some general numbers for the country as a whole, refutes CMHC's measurement of "rental stock", and then pulls this conclusion out of the ether. Perhaps if he had actually looked at apartment construction in Winnipeg he would have come to a slightly different conclusion:

In the 1990's a pitiful number of rental units were being built each year. This only began to change after the government implemented a 15 year exemption for new construction in 2001, and increased it to 20 years in 2005. It clearly shows that the exemption was an incentive for new construction, which means therefore that the rent cap itself was an impediment to new construction.

Even still, construction lagged far behind what it once was, and failed to close the demand gap. In fact the vacancy rate continued to hover around 1% throughout the 00's. This static vacancy rate, in spite of the exemption on new construction, suggests that either a 20 year exemption is not enough, given the long-term nature of the capital investment, or that there are other barriers to building new apartments. Construction costs are sometimes sited as a factor, but these have not prevented condos and houses from being built. Perhaps the depressed prices in the existing base spill over into new construction.

Perhaps the author should have looked into these things a little more carefully. Instead he writes it off as disequilibrium, resulting from a sudden influx of immigrants:

The supply response has been slow relative to the increase in demand because of the time lag involved in the planning-to-completion of new rental projects and uncertainty regarding the likelihood that the relatively high rates of population growth in the province will persist.
However, immigration has grown steadily since 1998. That must be one heck of a lag. Further, if immigration is supported by a successful provincial program, then how much uncertainty is there really about that trend continuing?


My conclusion is that Hugh Grant's conclusions were pre-determined based on the wishes of his client. It is also possibly that the author simply has a distorted view of the world. This latter option is corroborated by an absolutely astonishing statement that he makes on page 10 of his report:
In the long-run, the high profitability of existing rental units encourages the construction of new rental units with similar features which will eventually bid down rents to the long-run supply price consistent with a perfectly-competitive market. Rent regulations, therefore, play an important role in countervailing the market power exercised by landlords in the short-run by preventing them from advancing monthly rents above the marginal cost of supplying the unit.
The first part: "profitability of existing rental units encourages the construction of new rental units which will eventually bid down rents" is basic intro economics. That's how markets are supposed to work.

However, in the view of the author this is bad and must be stopped: "Rent regulations, therefore, play an important role in countervailing the market power exercised by landlords in the short-run by preventing them from advancing monthly rents above the marginal cost of supplying the unit." What he is saying is precisely: Rent regulations play an important role in preventing landlords from making a profit and in discouraging new construction.

In two simple sentences the author manages to summarize the root of the problem with rent controls, only what is a problem to most economists is actually a solution to Professor Grant.


Anonymous said...

The interesting question that I would like to know in order to understand the conclusions of this report is to know how the request for the report was written. The way the results are torqued I would not be the least surprised to see the request written in such a way as to lead to a result such as this.

Maybe someone with some time sould do some digging....

Gustav Nelson said...

On the first two charts, does rental growth=price?
It would seem minus the recessionary periods, that prices remain rather stable regardless of controls or not.
Also, how much diving did you do into the study? What all constitutes new construction and by whom? Is it all private sector or does that include crown corporations too?

cherenkov said...

First two charts: percentage change in the average price of rent, adjusted for inflation. UBC has an on-line db with all this data, but the bookmark is on my home PC.

New construction: this comes from the City of Winnipeg ( ). They don't specify if it includes MB housing or not.

@anon: it would be interesting to know, but I think I've run out of time to spend on this. :-)

Grumpy Old Man said...

Great work. Be interesting to see hugh grants' response.

Anonymous said...

Freakin' awesome podcast!

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