Defining Ideas

The Rent Is Too Damn Low

Monday, June 17, 2019
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New York Governor Andrew Cuomo signed the grandly titled “The Housing Stability and Tenant Protection Act of 2019” into law last week. Its extensive amendments to the earlier law passed with lopsided majorities in both the state Senate and Assembly after progressive lobbyists stormed the legislative beaches in Albany. They pitched their campaign as a fight between good and evil—between rich landlords and strapped tenants. They emphasized the precarious position of some tenants facing eviction, but ignored the huge windfalls given to those fortunate tenants who occupy stabilized units that rent for only a fraction of their market value.

The implicit economic assumption behind the reforms was that the protection of tenants under the Act would result in a simple wealth transfer from rich (or undeserving) landlords to poor (or deserving) tenants, with no collateral consequences to the quality of housing stock or the rate of new investment in rent-stabilized units.

After the passage of the legislation, the Democratic Senate Leader Andrea Stewart-Cousins and the Democratic Assembly Speaker Karl Heastie could scarcely contain their elation: “These reforms give New Yorkers the strongest tenant protections in history. For too long, power has been tilted in favor of landlords and these measures finally restore equity and extend protections to tenants across the state.” Why earlier caps on rents favored landlords was never explained.

The Republican opposition sounded a more pessimistic note, claiming that the legislation would degrade the state’s aging housing supply. Senator Ken LaValle predicted that it “would have a deleterious effect on providing affordable housing, which is must need for our citizens.” Joseph Strasburg, who represents about 25,000 property owners as head of the Rent Stabilization Association (“RSA”), noted that members of the RSA had already cut back on improvement projects because of their inability to recover costs, resulting in lost job opportunities. It is the classic struggle between Democrats who talk redistribution and Republicans who talk about adverse effects on incentives and growth.

So, who’s right?

This question is quickly answered by looking at some of the legislation’s key provisions. Notably, New York’s Rent Stabilization Act (“NYRSA”) is now made perpetual, thereby avoiding a series of contentious triennial struggles over its renewal. But that means that new restrictions cut more deeply into the income stream of landlords with no offsets to help them maintain services.

First, the law bars landlords from raising the rent of so-called preferential renters who currently live in units that rent for less than the stabilized level. About 1.2 million units fall into this category. The correct inference from looking at this segment of the market is that regulation is not necessary to keep rents in control—competition accomplishes that task without government assistance. But now the only allowable increases are those that are consistent with the commands of the New York City Rent Guidelines Board, which determines annual increases. And so, another 1.2 million units are brought within the system, and for no reason.

Second, the law prohibits landlords from taking a 20 percent increase in rent whenever a unit turns over. This provision is critical because allowable cost-increases under stabilization tend to lag behind actual costs. The 20 percent increase, while short of market rates, helps to narrow the gap.

Third, the system of “vacancy decontrol” has ended. Under vacancy decontrol, apartments are taken out of the stabilization acts once two conditions are satisfied.  First, the rental must exceed a certain fixed rate, currently $2,775 per month. Second the unit must be vacated. The original idea was that over time the system of rent control would phase out. That never happened because the decontrol rate was frequently raised to reduce the overall conversion levels. Even with that limitation the system did allow for close to 300,000 apartments to transition out of rent stabilization over several decades. Progressives regard that program as a net loss, wholly forgetting that if the supply expands in the unregulated market, rents there will go down.

This point really matters because rent-stabilized units can remain in a family long after children have grown and the original tenants have died. It is common for elderly couples and widowed men and women to retain their rent-controlled apartments. If each rent-controlled apartment (of which there are close to one million in the state) could become home for just one more person, New York could accommodate another million people without the additional expenditure of a single dollar. That process is now brought to a halt.

Fourth, the new stabilization law limits the amount of rent increases made to landlords who make major capital improvements to 2 percent per year, down from 6 percent. It also limits Individual Apartment Improvements to $15,000 every fifteen years. The cost of these projects cannot be recovered by such low increases, so mutually beneficial arrangements are likely to be stopped in their tracks.

One question that the New York legislature did not confront is whether tightening the noose around landlords may amount to confiscatory regulation that runs afoul of constitutional protections under both the Due Process and Takings Clauses of the U.S. Constitution. It is accepted by all sides that some landlord protection is required. Otherwise the state could now decree that no landlord is entitled to recover any rent ever from his tenants. So, to supply the new protection, stabilization laws treat landlords as though they were public utilities who are entitled to a reasonable rate of return on their invested capital.

It works as follows. As costs increase, a landlord’s rent prices have to keep pace. For example, if the cost of providing services for a unit during year one is $100, the landlord is entitled to a rent that covers that amount and provides for a reasonable rate of return on investment, say, 10 percent, for a total rent of $110. If the cost of providing services for the unit went up by ten percent, then the new rental would have to be $110, plus the 10 percent return of $121. The key point here is that the $121 remains the top figure a landlord can charge even if the market value of the rental unit increases to $150.  The tenant gets that embedded premium, which is why he or she will not leave. The landlord, of course, continues to bear the risk that the value of the unit might decrease.

The hard question is whether the 2019 Act allows for the appropriate rates of return under the public utility model. This is hard to know in the abstract without knowing the cost of providing services. But it is well known that rent stabilization guidelines have been on the chary side. Official figures from October 1, 2018 to September 20, 2019 list the cost at 1.5 percent for a one-year lease and 2.5 percent for a two-year lease. But there is no differentiation based on individual circumstances. The restrictions could easily result in revenue losses for landlords in the face of cost increases. No public utility would have to sustain those costs. Why should it be different for New York’s many landlords, both large and small?

The deeper question here is why use the public utility model at all? The traditional system of rate regulation was properly regarded as an offset to the monopoly power that gas and electric companies, for example, could exercise over customers who had no other place to turn. The system had multiple permutations, but the constant theme was that the rates had to be high enough to avoid charges of confiscation but low enough to limit the abuse of monopoly power. That second risk does not exist in highly competitive markets, like housing, where rates are already at competitive levels.

The simple claim is that rent control constitutes an illegal taking of real estate because the government does the following: It decides to take a unit that rents for, hypothetically, $150, and then requires the landlord to rent it at $100 to a tenant who is solely responsible for the rent; that transaction transfers the physical occupation of the unit on expiration of the initial lease to the tenant at a discount. Making the bold assumption that the mass transfer of private apartments to tenants satisfy the public use requirement of the Takings Clause, the correct response is to put that extra $50 per month on the government, so that the political branches can then decide whether they wish to fund those extra costs out of public revenues, as suggested by the late Justice Antonin Scalia in his 1988 opinion in Pennel v. City of San Jose. This question answers itself. It is far easier to offload the costs onto landlords rather than to put them on the government’s general revenues.

The first rent control statute that was adopted in Washington D.C. in the aftermath of World War I was meant to impose a two-year emergency moratorium on rent increases. Justice Oliver Wendell Holmes sustained this action as a legitimate emergency police power measure in the 1921 five-to-four decision of Block v. Hirsh. The NYRSA has expanded the definition of an emergency to apply whenever the vacancy rate is below five percent, because there is always a housing shortage induced by the low rents imposed by the rent control ordinance.

The correct analysis rests on the assumption that rent regulation is never allowed to reduce rates below the competitive level. Just think of the administrative nightmares and political struggles that could have been avoided if Justice Holmes had realized that short-term emergencies quickly disappear if new entry is allowed. New York has yet to learn the same lesson, and the consequences will be deleterious to landlords and tenants alike.


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