"Rent control is the second-best way to destroy a city, after bombing." —Lawrence H. Summers
Zohran Mamdani, the Democratic nominee for the mayor of New York City, clearly ran a good campaign. He used social media and short-form videos to find his audience and win with the message that the city has become unattainable to most.
But it is also clear that the stock market really does not like his message. Shares of firms with exposure to New York City's real estate market reacted immediately: Vornado Realty Trust, SL Green, Equity Residential, Empire State Realty Trust, LXP Industrial Trust, and others, were all down. At the same time, the wealthy vowed to leave New York for places like Florida, as they so often do these days.
One of reasons for this negative reaction was Mamdani's commitment to not just cap rent increases, but freeze rents in rent-stabilized units for the entire duration of his term. We've spoken a lot about rent control over the years (here, here, here, and other places) but, at a high level, the problem with rent controls is that they create a strong disincentive for landlords to invest and maintain their homes and for developers to build new homes. So what ultimately happens is that you get a more rapidly aging inventory of existing homes and a reduced amount of new supply.
A full-out rent freeze takes this even further. A rent freeze does not mean that utility costs will also be frozen, that insurance and taxes will be frozen, that interest rates will be capped, and that all other landlord operating expenses will be restricted from inflating. (If this were the case, we really wouldn't have market economy.) So what a rent freeze does is ensure that, in real dollars, a landlord is able to collect less money from tenants, while operating costs continue to increase under the line.
The same is true in condominiums and other ownership structures. Whenever somebody talks about frozen maintenance or common element fees, I immediately remind them that this is a bad thing, not a feature. It means the condominium corporation is on an unsustainable path and will eventually run out of money. Something is being sacrificed in order to keep up with rising operating and capital expenses. At the very least, you need to keep up with inflation.
I can appreciate that rents are too high. As a developer, I would love to be able to build to lower rents. It reduces absorption risk and it's better for the city. But rather than just freeze rents, a more productive and sustainable approach would be to attack the underlying root causes for the problem. A rent freeze is a short-term political fix that will have second and third-order consequences. Problems for a different day and for a different mayor, perhaps. But problems nonetheless.
Cover photo by Daryan Shamkhali on Unsplash
Last year, the city of Berlin agreed to a five year rent freeze for some 1.5 million flats constructed before 2014. The way it was initially approved is that it would freeze rents at mid-2019 levels and allow for only 1.3% inflationary increases. All of this is being challenged in the courts, but the Financial Times is suggesting that it could still come into force by March 2020. Here is an excerpt from a recent article. (Guy Chazan isn't holding back about the kind of people that he believes Berlin attracts.)
The legislation, which should come into force by March this year, is City Hall’s response to a lingering housing crisis that shows no sign of easing. Packed out with Brexit refugees, international party people and wannabe tech entrepreneurs, Berlin is in expansion mode, its population growing by 40,000 a year. Yet affordable housing remains scarce. Rents have doubled over the past decade, as new residential construction fails to keep up with soaring demand.
As I mentioned before on the blog, these policies are not intended to apply to new buildings. That would surely choke off new construction, which would only exacerbate the underlying supply issue that Berlin is facing. But not surprisingly, this move has also put a freeze on capital expenditures, according to the same FT article. Local trades are complaining that, "It's as if someone's just turned out the lights."
Berlin just approved a five year "rent freeze" on apartments in the German capital. The rent caps will be implemented on January 1, 2020, but will apply retroactively to all rental agreements from June 18, 2019 onward (which is when the decision was made). It is estimated that this new law will apply to some 1.5 million apartments.
The move is in response to rapidly rising apartment rents, which grew about 12% in 2017 alone. So I can appreciate where this is coming from.
From what I have read, it will not apply to new construction, which is the first thing I checked when I saw the decision. That would have almost certainly choked off any new apartment construction in the city. With a capped top line, it wouldn't take long for costs to increase and make new rental construction infeasible.
That said, a similar squeeze is liable to happen for existing buildings. It is one thing to cap rents (revenue), but what about utility, maintenance, labor, and other operating costs (expenses)? As costs rise and operating margins tighten, it can become exceedingly difficult to reinvest in, or even maintain, an apartment building.
For more on the announcement, here's an article from FT.