4 ms·

Deadweight loss: Developers want to build places that people would benefit from renting, but they don't, because it's illegal to charge rates that would make th

by kspaans 10y ago

Deadweight loss: Developers want to build places that people would benefit from renting, but they don't, because it's illegal to charge rates that would make them money. Is this because rent control would drag down market rents below the profitability level for developers? Why can't the developer charge the rent they want for new builds? Or is it because most developers expect some high amount of rent inflation when the puts units on the market?

closeparen 10y ago
It's not that they couldn't make any profit by building in rent-controlled areas, but why would you allocate the capital for construction to a rent-controlled area when you could take it to a city without rent control?
- ubernostrum 10y ago
  Why would anyone build anything anywhere in California, when they could take it to a "business-friendly" state instead? The answer is the three things that matter in real estate: location, location, and location.
  - WalterBright 10y ago
    Business-unfriendly just translates to higher costs and higher prices.
bhickey 10y ago
There are projects that are teetering on the edge of profitability (in terms of cap rate.) Increase permitting times, shave off a few stories, force more units to be below market rate, and all of a sudden those projects evaporate. Suppose you have a project that's viable if you can rent the units at $X and then raise rents along with inflation. Then the rent control board comes in and limits increases to a sub-inflationary level. Great, just compensate for it by increasing your initial rents. Now it takes you 4 months to fill every unit in our hypothetical property rather than 2 months.
ThrustVectoring 10y ago
Deadweight loss doesn't affect things that are already obviously good ideas or obviously bad ones. It only affects things on the margin - the least profitable units that developers would still be interested in building. Suppose a developer can build as tall as they wanted to, but each additional floor is more expensive: the break-even point is that each extra floor needs $100/month additional rent per unit. If you use law to force prices $100/mo lower, then the tallest floor doesn't get built anymore, because now it's not worth building. (And if rent controls don't actually reduce the rents that people pay, then the controls aren't actually doing anything, so why have the overhead of the law? If you're reducing prices by law, things that people want to buy at or above the reduced price and sell at or below the market price don't get traded.)
- candiodari 10y ago
  Here's a lesson from a finance course that I thought was thoroughly non-obvious: all change happens at the margin. For instance, interest rate changes cause real estate appreciation or crashes by changing the decision of buyers that are just on the cusp of being able to afford a home or not. This is not a 100% rule, just 5 or 6 nines.
  - WalterBright 10y ago
    Such as with the $15 minimum wage - it's the marginal businesses that will shut down, and the people with marginal job skills who will be shut out of the job market.
    - kvb 10y ago
      In a toy economy that's definitely true, but the empirical results are mixed in the real world, where there are lots of complicated dynamics.
      - JoeAltmaier 10y ago
        Thanks for saying that! Its common for folks to play what I call 'dot to dot' where they draw a thin line from one action to some chain of results. They say "I proved its a bad idea!" Its like sketching in 3 or four lines in a dot-to-dot puzzle and saying "See! Its a dog!" when it might be the Sistine chapel. Thinks are complicated. All the dot-to-dot statements are somewhat true, but they're all going on at the same time. Higher minimum wage means more spendable cash, which means more small businesses see an uptick in sales, so more profit. See! I can do it too.
twblalock 10y ago
It's not just that. Actually, most rent control policies allow new or unoccupied units to be rented out at the market rate. The problem is that the legal increase in rents is generally capped, so if the tenants who move in today remain in the rental units for many years, eventually they will be paying far below market rate. On the other hand, the cost of insurance, maintenance, etc. for the landlord will continue to increase at the market rate, so the landlord's profit on rent will continually shrink and may become negative. That's obviously going to make developing new rental properties less attractive.
- spoonie 10y ago
  Why are the landlord's costs going up "at the market rate" (which we will assume is higher than inflation)? Because the plumber lives in a market rent apartment and has to charge twice as much as a few years ago? Why would their insurance costs go up that fast? It's not like their property taxes are going up that fast. ;) I believe the arguments that rent control is distortionary and poorly targeted (maybe they should make it means-tested rent control! I'm sure that won't have any effect on poorer people trying to rent! :P). But I don't see how market-rate rent increases, that happen fast enough for people to reach for rent control, are because the landlords are maintaining the same margins and seeing their costs increase. I do get the opportunity costs and reduced resale value costs though.

by kspaans 10y ago

closeparen 10y ago

It's not that they couldn't make any profit by building in rent-controlled areas, but why would you allocate the capital for construction to a rent-controlled area when you could take it to a city without rent control?

ubernostrum 10y ago
Why would anyone build anything anywhere in California, when they could take it to a "business-friendly" state instead? The answer is the three things that matter in real estate: location, location, and location.
- WalterBright 10y ago
  Business-unfriendly just translates to higher costs and higher prices.

bhickey 10y ago

There are projects that are teetering on the edge of profitability (in terms of cap rate.) Increase permitting times, shave off a few stories, force more units to be below market rate, and all of a sudden those projects evaporate. Suppose you have a project that's viable if you can rent the units at $X and then raise rents along with inflation. Then the rent control board comes in and limits increases to a sub-inflationary level. Great, just compensate for it by increasing your initial rents. Now it takes you 4 months to fill every unit in our hypothetical property rather than 2 months.

ThrustVectoring 10y ago

Deadweight loss doesn't affect things that are already obviously good ideas or obviously bad ones. It only affects things on the margin - the least profitable units that developers would still be interested in building. Suppose a developer can build as tall as they wanted to, but each additional floor is more expensive: the break-even point is that each extra floor needs $100/month additional rent per unit. If you use law to force prices $100/mo lower, then the tallest floor doesn't get built anymore, because now it's not worth building. (And if rent controls don't actually reduce the rents that people pay, then the controls aren't actually doing anything, so why have the overhead of the law? If you're reducing prices by law, things that people want to buy at or above the reduced price and sell at or below the market price don't get traded.)

candiodari 10y ago
Here's a lesson from a finance course that I thought was thoroughly non-obvious: all change happens at the margin. For instance, interest rate changes cause real estate appreciation or crashes by changing the decision of buyers that are just on the cusp of being able to afford a home or not. This is not a 100% rule, just 5 or 6 nines.
- WalterBright 10y ago
  Such as with the $15 minimum wage - it's the marginal businesses that will shut down, and the people with marginal job skills who will be shut out of the job market.
  - kvb 10y ago
    In a toy economy that's definitely true, but the empirical results are mixed in the real world, where there are lots of complicated dynamics.
    - JoeAltmaier 10y ago
      Thanks for saying that! Its common for folks to play what I call 'dot to dot' where they draw a thin line from one action to some chain of results. They say "I proved its a bad idea!" Its like sketching in 3 or four lines in a dot-to-dot puzzle and saying "See! Its a dog!" when it might be the Sistine chapel. Thinks are complicated. All the dot-to-dot statements are somewhat true, but they're all going on at the same time. Higher minimum wage means more spendable cash, which means more small businesses see an uptick in sales, so more profit. See! I can do it too.

twblalock 10y ago

It's not just that. Actually, most rent control policies allow new or unoccupied units to be rented out at the market rate. The problem is that the legal increase in rents is generally capped, so if the tenants who move in today remain in the rental units for many years, eventually they will be paying far below market rate. On the other hand, the cost of insurance, maintenance, etc. for the landlord will continue to increase at the market rate, so the landlord's profit on rent will continually shrink and may become negative. That's obviously going to make developing new rental properties less attractive.

spoonie 10y ago
Why are the landlord's costs going up "at the market rate" (which we will assume is higher than inflation)? Because the plumber lives in a market rent apartment and has to charge twice as much as a few years ago? Why would their insurance costs go up that fast? It's not like their property taxes are going up that fast. ;) I believe the arguments that rent control is distortionary and poorly targeted (maybe they should make it means-tested rent control! I'm sure that won't have any effect on poorer people trying to rent! :P). But I don't see how market-rate rent increases, that happen fast enough for people to reach for rent control, are because the landlords are maintaining the same margins and seeing their costs increase. I do get the opportunity costs and reduced resale value costs though.