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Should UK landlords be afraid of rent control?

Guest Post By Stephan Gasteyger, Co-Founder, Wonego.com

When, in 1915, thousands of workers flocked to Glasgow for jobs in munition factories and shipyards, landlords took advantage of the high demand for housing to raise rents. They were not expecting tenants to resist and to mount a historic rent strike which later led to the introduction of rent control.

Rent control was later abandoned in the 1980s by Margaret Thatcher’s government. Since then, the private rental sector has grown significantly, and so has the population. But the supply of housing has not kept up with demand.

With rents in the UK – excluding London - up 5% year over year in the last three months of 2015,  and up 8% in London (Homelet), the cost of housing represents a growing burden for a large part of the 10 million tenants in the country. Close to 50% of their income is now spent on rent, a figure which even reaches 72% in London (English Housing Survey).

Soaring rents put society at risk – rising household or student debt, inability to afford the right home, to study or to grow a family. Only a lucky few – mostly wealthy international students, expats and foreign investors – are able to benefit from the growing supply of high- end, expensive accommodation. The others face an uphill battle.

Is it time to reintroduce rent control in the UK?

There are two types of rent control measures:  first generation and second generation rent control.

First generation rent control (FGRC) generally refers to rent ceilings (e.g. a maximum level of rent determined for a certain home in a certain area). The landlord will not legally be allowed to charge more. First generation rent controls are outdated, as they generally don’t even take inflation or maintenance costs into consideration. They also distort the market, as the price of housing is capped and no longer acts as a clearing mechanism – hence some privileged ones may find a home at an affordable price but at the expense of most others, who will be left out.

Second generation rent control (SGRC) is, on the other hand, a more modern and dynamic way of controlling rent. It is often referred to as rent stabilisation or tenancy rent controls. SGRC does not only regulate rent levels; it also regulates the tenant’s right to stay in the same home once the lease has expired, and limits the landlord’s ability to evict the tenant for anything else than a catalogue of valid reasons.

SGRC measures are common in numerous countries and major cities. For instance, New York City has moved predominantly to second generation rent control, with c. 40% of homes being “rent stabilized”.  Paris saw the introduction of a new legislation last year, with rents having to be in a certain range for a specific area. Last but not least, we see Germany – and, more precisely, Berlin – as a particularly interesting example combining rent stabilisation, tenancy control and some rent ceiling features. We will explore the Berlin example in more depth below.

Berlin rent controls: a case study

Close to 90% of Berlin housing is rented. Every area has its own rental index (Mietspiegel), which reflects the average rent paid per square meter in an average flat. Rent levels vary depending on when the house was built, its location as well as the equipment and specification of the building and the flat.

The advantages of the Mietspiegel are twofold: first, the transparency as an indicator for rent levels; second, the fact that rent increases on existing tenancies will have to follow the local Mietspiegel and cannot exceed it.

Until last year, the Mietspiegel would not apply to new tenancies, however this changed with the introduction of the so-called Mietpreisbremse (“rent brake”). This new measure, which can be resorted to by the local government in an area facing a housing shortage, limits the rent increase to 10% above the average Mietspiegel. It does, however, exclude new developments.

Overall, the Mietspiegel, combined with tenant friendly, long-term rental contracts, have kept Berlin rents relatively low and affordable. But there are also quite some drawbacks to Berlin’s rent regulation, leading to some typical unintended consequences which rent control measures can bring with them.

Whilst the Mietspiegel worked relatively well when there was significant excess supply of housing in the early 2000s, Berlin’s popularity over the last decade led to the housing market evolving from a situation of glut to one of shortage. This is when some elements of Berlin’s controlled rent regulations started backfiring.

Lack of incentives to build – apart from luxury homes

A combination of poor planning as well as a lack of incentives to build (high land prices but low yields on new buildings due to regulated rents and relatively low house prices) means that building activity has not kept up with the growth in housing demand. The only way for private developers to make new buildings profitable is to focus on high-end apartments. This, in turn, does not help address the housing shortage, as luxury developments are more likely to get bought by wealthy investors, with rent levels being unaffordable for most tenants. As a result, those moving to Berlin (mostly young creatives, students, professionals) increasingly struggle to find an affordable home.

Holiday rentals are just more profitable

During and after the financial crisis, low interest rates as well as a flight to safety led to a rise in house prices in Berlin. However, regulated tenancies and rents were not compelling enough to some investors. Instead, new landlords were attracted by the much higher yields they could achieve with their buy-to-let as a holiday home as opposed to a long-term rental. Tourists responded positively to the growth in Berlin vacation rentals (mostly listed on Airbnb), which often offered an alternative and more intimate way to experience the city than a hotel – beside the fact that hotel room supply had not kept up with the rapid growth in Berlin tourism either. Whilst a bonanza for landlords and tourists, Airbnb did, to some extent, exacerbate the housing shortage further.

As a consequence, the local government has (almost) outlawed holiday rentals from mid 2016, which may return about 15,000 apartments to the market – a measure popular with some locals, although totally ineffective when it comes to addressing the real problem: indeed, 50,000 new homes are needed every year to rectify the housing shortage in Berlin.

The rental market becomes overly sticky – and a black market emerges

Regulation of the Berlin rental market has not helped the population as a whole – and only a selected few. Those lucky enough to have a regulated contract at a below market rent will certainly do everything to keep it and not move out – even if they have to. It has occurred that some of them will invest their savings in a buy-to-let property instead or move elsewhere – but keep their previous flat on the old rental contract – just to sublet it, in some cases via Airbnb. On the other hand, those just moving to Berlin will struggle to find a home, and may have to resort to the black market, where a landlord lets a house without tenancy contract or at a rate not respecting the Mietspiegel.

Does the UK need rent control again?  

With growing tension in the UK rental market, there is no doubt that rent regulation is likely to tighten further. Rent control has only recently been reintroduced in Scotland, where a Private Tenancies Bill includes SGRC measures protecting tenants against excessive rent increases and opens the door for rent controls in areas with rent pressure. However, the remainder of the UK remains untouched by rent control. After the introduction of landlord immigration checks as well as landlord licensing, it is very likely that some form of rent control will emerge in England as well.

And barely anybody seems opposed to it. A Survation poll found that only 7% of the public are “somewhat” or “strongly” against controls, whilst 59% of those polled said they somewhat or strongly supported state intervention. Unsurprisingly though, the measures are less popular with landlords than with the general public. A survey from the Cambridge Centre for Housing & Planning Research found that 25% of landlords would sell their entire portfolio were indefinite tenancies to be introduced in the UK; however, it would not change anything for 18% of them, whilst 24% would change the way they choose their tenants.

What is the most likely solution?

Looking at the Berlin example above, it becomes clear that rent control or stabilisation measures are unlikely to provide a real solution to an ever growing problem, which can only be solved by major infrastructure and building projects – and this will take years. In the meantime, better tax incentives for housesharing and taking on lodgers could alleviate the situation somewhat. And, at the same time, incentives for landlords will need to remain to invest and supply housing, as the introduction of rent control would, without doubt, be another blow to the buy-to-let market.

The most likely rent control measure – already discussed by the major political parties in England and Wales – is a SGRC policy aiming at extending tenancies and capping rent increases over the duration of the tenancy. A drawback of this would be that landlords may just increase the initial rent level.

The situation will certainly remain tense. It’s perhaps not surprising that, one century after the rent strikes in Glasgow, students at University College London (UCL) are, just now,  mounting a strike calling for a 40% rent cut. Would rent control solve this problem? Maybe temporarily. But Berlin regularly sees similar protests, in spite of its rigorous and well established rent regulations.

Stephan Gasteyger

Wonego.com

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The Property Voice Insight from Richard Brown

Should we fear rent control?

Rent controls are essentially a political issue in my opinion. Price controls by any other name, are often favoured by those centre and left to appease voters of that persuasion and opposed by those on the right, who favour a free economy.

In a free economy, the market sets the prices and the prices are determined by supply and demand. In a price controlled environment, prices are set artificially by a central body instead. Some price-setting mechanisms can actually lead to higher prices than a free market economy would produce, which seems at odds with the stated objective.

Here are some views of academics and economists on the subject of rent controls:

The Economist - This article suggested that rent controls could lead to reduced supply, reduced maintenance, lower incentives (i.e. returns), less turnover of properties & longer occupation from higher income residents in rent-controlled areas

An economist's view - This piece from Henry Hazlitt demonstrates why the application of rent controls is ultimately doomed. The problem is, as well illustrated by the article, that it all takes time for the house of cards to topple. It could be years, or even decades, before the real and negative effects of rent control are fully felt. This of course is countered by a short-term political / populist win...

London Assembly's Academic Research - As reported in The Guardian last year and drawing from the same report that Stephan also referenced from the Cambridge Centre suggests that rent stabilisation can be a finely balanced tool that could have unintended consequences as well as the perceived benefits sought.

If we look at places where rent controls are in place we sometimes see some strange or at least unexpected behaviour. In New York, we have people staying in rent controlled apartments for years or decades, therefore reducing the supply of rent-controlled accommodation. They often sub-let or simply stay to enjoy the low rent level despite sometimes being relatively well paid. In Paris, we have seen rent rises lifted to the maximum allowable, whether it is actually required or not and that can keep rents artificially high. In Germany, many cities where rent controls have been in place have also seen declines in population, so it could be argued have artificially held returns higher due to flat or declining housing demand.

Fundamentally, landlords are essentially motivated by a return on their capital investment. If the return side of the equation is insufficient, then they will usually look to reduce costs to improve returns or leave the market in order to seek better returns on their capital elsewhere.

Our biggest problem in the UK is a lack of housing supply - regardless of tenure. Even if we succeed in transferring housing from the private rented sector to home owners, we will still not have enough housing to accommodate everyone. This tells me that we would be applying the wrong solution to the wrong problem. What we need is to incentivise housebuilding for all tenures: home owner, private rented and social. In my opinion, the imposition of rent controls could lead to a reduced housing supply, particularly for private rented accommodation and social housing tenures. It is also possible that it will lead to a reduced quality of housing for those that remain, if margins or returns are squeezed too much, leading to costs being deferred or avoided to compensate.

In my view, basic rent controls are likely to be counter-productive in the long-term for the reasons stated. However, will they be introduced...quite possibly yes, depending on the political powers at the time.

That all said, if there is a fair system of managing rent levels, such as a link to RPI or wage inflation (given that CPI excludes housing costs), then is there anything to fear from them I wonder? Well, 'super-profits' would be eliminated, which should rid the market from the real exploiters, leaving 'normal profits' for those that remain and that sounds fair enough to me.