Statement on the Decision to Partially Eliminate Rent Control

Originally posted on Housing Matters

The Government of Ontario announced in its fall economic outlook this past week that they were removing some restrictions on rent control. While rent control remains unchanged for existing tenants, new rental units will not be subject to any price controls whatsoever.

This policy change is a response to the previous government’s “Fair Housing Plan”, introduced in 2017. Prior to the Fair Housing Plan, only homes built before 1991 were subject to rent control. In 2017, rent control was extended to all rentals regardless of the year of construction.

Following the introduction of the “Fair Housing Plan”, 1,000 units originally slated to be purpose-built apartments were converted to condos. That, in a city with a rental vacancy rate of 0.7% — a sixteen year low for the city, and one of the lowest rates in the world.

As a partial reversal of a one-year-old policy, the short-term impact of the new government’s change will likely be small.

However, as we will explain below, this policy has long term impacts that affect the quantity, quality, and price of rental housing, as well as the kind of individuals likely to be affected. In particular, this new policy averted a future of extreme rental shortages, declining rental housing quality, rapidly increasing rents, and discrimination against low-income renters.

While many housing advocates believe that rent control is an effective tool for ensuring housing affordability, the economic science and evidence speaks contrary to this. In fact, in a 1988 survey of Canadian economists, 95% agreed (fully or with some provisions) that rent control decreases both the quality and quantity of housing available. A comprehensive review of the economic literature in 2009 found that both specialists and non-specialist economists have the same views on the effect of rent control.

A review of the basic economics of rent control

Basic economics is about the laws of supply and demand. The law of supply is that as the price of something increases, more of it will be supplied. In other words, as something gets more expensive, more people will try to sell it. (In the graph below, it is the upward-sloping line.)

The law of demand says that as a particular thing gets cheaper, more people will demand it. In other words, as the price of something falls, more people will be able to afford it. (In the graph below, it is the downward sloping line.)

While these laws may strike you as simple, they are in fact powerful tools of analysis. For example, these laws imply that there will be one price where precisely every unit made available for sale will be bought. The price is called the equilibrium or market-clearing price, and the corresponding quantity bought and sold is called the equilibrium or market-clearing quantity. (In the graph below, this price is marked P*, and the quantity is market Q*.)

But the market is not always at equilibrium. It is possible, for example, that the prevailing price is below the market-clearing rate. In this scenario, where prices are too low, there will be more buyers willing to buy than there are sellers willing to sell. The technical economics term for such a scenario is a shortage.

If a shortage arises on a market — say it’s a new product and sellers underestimated demand, or if demand for the good in question increased because of a news report that it could fix a broken heart — we would expect alert and enterprising entrepreneur to step in and fill this excess demand with goods sold at a higher price.

It’s also possible that the below-market price is a consequence of a government policy. Since the policy legally limits the price from rising any higher, economists call this a price ceiling. Here, no entrepreneur can fill the shortage by offering the good at a higher price, since doing so would be illegal. Since the laws of government do not supercede the laws of supply and demand, supply will remain fixed, and the shortage will persist. (On the graph below, a price ceiling is represented by the horizontal line at PR.)

Rent control has many aspects that makes things worse for those with low incomes

Rent controls are a textbook example of a price ceiling. As such, simple supply and demand analysis tells us that the quantity of rental units demanded will exceed the quantity supplied. Rent controls will cause a shortage in housing. This is usually achieved by existing rental units being converted to condominiums, and some future rental units never being built in the first place. But this effect has at least four negative consequences for renters.

First, since the government-set price is below the market-clearing price, a property owner has less incentive to repair and maintain the unit. This because of several reasons. Firstly, in a world of inflation, buying replacement parts, and hiring skilled tradesmen to do necessary repairs, is continually getting more expensive. Secondly, if the market rate for a house is $2,000, but the unit is currently being leased at $1,400, the landlord may feel so inclined to let the unit deteriorate until it reaches $1,400 in value. And thirdly, if new profits are alluring enough, a landlord of a condo or other secondary rental may let the unit deteriorate to the point where it becomes uninhabitable; at which point she’ll raze the old unit, and replace it with a much more expensive property.

Second, as the quantity of available rental units is dwindling, this will create upward price pressure for new rental units. So new rentals will become more expensive as renters become more desperate to find a place to live. This of course exacerbates the affordability problem.

Third, as the shortage implies that renters are becoming more desperate, landlords can become more choosy with whom they rent to. Since landlords are limited in their ability to discriminate with prices, they must now discriminate in other ways. Typically, this is done through requirements for credit checks, references, and income statements, all of which prefer higher income tenants. Perversely, rent control will make low-income individuals more likely to be discriminated against.

Fourth, it incentivizes tenants to stay put in their current homes. While it’s true that tenants will save money in terms of rent increases, not only will they suffer the declining quality over time as detailed above, they will be locked in to their current geographic location. This can limit their job opportunities, may necessitate increased commuting times (and the associated costs of gas, maintenance, and insurance for a personal vehicle, or public transit costs), and as such may even result in increased unemployment.

All of these effects result from earnest efforts to make rents more affordable, especially for low income individuals and families. However, the laws of economics will limit this policy to rising rents, declining quality, and overall making it harder for anyone — especially those with a low income — to find suitable housing.

While there have been many econometric studies of rent control over the last five decades (virtually all of which find evidence for the above theoretical conclusions), a recent study of San Francisco has had unprecedented individual tenant and landlord data. As the authors themselves conclude that between 1994 and 2016, “impacted landlords reduced the supply of available rental housing by 15%.” This led to a “25% decline in the number of renters living in units protected by rent control, as many buildings were converted to new construction or condos that are exempt from rent control.” They conclude their study unambiguously: “Rent control appears to have increased income inequality in the city by simultaneously limiting displacement of minorities and attracting higher income residents.”

Removing rent control is a necessary action to make housing more affordable — but it’s not enough

As we have demonstrated above, rent control is an impediment to making housing more affordable for existing and future residents. From this perspective, the Government of Ontario’s recent action is a move in the right direction to safeguard low- and even middle-income Torontonians from a future of higher rents, declining apartment quality, rising income inequality, and more.

But this reversal of a one-year-old policy is not going to have a large impact in the short and medium term. The major issue today is that there is simply not enough housing being built to satisfy demand. This problem is exacerbated by land use rules that constrain new housing supply, including zoning provisions that have set aside 40% of the city for detached homes only.

To really move the needle on housing affordability, landlords will need to face increased competitive pressure from new entrants providing Torontonians with new housing options. The Government of Ontario has noted that this partial elimination of rent control will be paired with a Housing Supply Action Plan. We’ll be following that process closely and look forward to seeing more bold action to address our housing crisis.