The Oregon State legislature is considering House Bill 2001,
sponsored by the Speaker of House Tina Kotek, which would override the state’s
prohibition on local rent control ordinances. HB 2001 has three provisions: (1)
limit rent increases statewide to 5% for 2017-18, (2) permit any local
jurisdiction in the state to enact rent control, and (3) modify the inclusionary
zoning legislation that was passed in 2016. The challenge in analyzing this
legislation is that no details are provided regarding the nature of the rent
control legislation that the local jurisdiction may implement. No limits have
been placed on local governments’ rent control power, except that a “fair
return” to landlords must be provided. Discussing the efficiency of rent
control legislation that hasn’t been enacted is rather like commenting on
whether a baby is beautiful while the mother is still pregnant.
The Speaker’s Office has circulated an argument that the
rent control that will be implemented after this legislation is passed will be
“second generation” rent control, as defined by Canadian economist Dr. Richard
Arnott. According to Dr. Arnott, second generation rent control is typified by
limits on rent increases (rather than a rent freeze), prohibition of rent
control on new construction, allowances for larger increases with
rehabilitation and major improvement, and allowances of decontrol between
tenancies, none of which is included in HB 2001. I believe the differences
between first-generation and second-generation rent control are largely
semantic, and if there is a difference, it’s really a degree of the harm that
the legislation will generate.
Unlike most countries, the United States has a very limited
experience with rent control. Only three states – New York, California, and New
Jersey – plus the District of Columbia, have rent control. New York has some
form of rent control on a statewide basis, but regulation in California and New
Jersey operate at a municipal level. Of the 10 largest metropolitan areas in
the United States, New York, Los Angeles, the San Francisco Bay Area,
Washington, DC, and by including its New Jersey suburbs, the Philadelophia
metropolitan area have rent control. These states and metro areas have some of
the highest real estate prices and the highest percentages of tenant
households, which explains why those places have rent control. The Boston
metropolitan area had rent control until the legislature ended it in 1997.
The lack of rent regulation in the United States is a
positive development. Compared to most industrialized counties, the United
States has much lower barriers to development than other countries, and a much
lower ratio of housing costs to household incomes.
Effects of Rent
Control
The main negative effect of rent control is to limit supply,
deterring the development of new rental housing and deterring maintenance in
rental housing. Multi-family housing developers produce business plans that
project net income using assumptions about future rents and expenses, and the
persuasiveness of those business plans determines if developers can attract
investment capital and bank financing. Legislation that restricts those future
increases in rents will reduce the attractiveness of those business plans and
will force developers to set higher initial rents to account for the slower
increases likely to occur in the future. By raising the price point required
for new investment, rent control limits housing supply and raises rents.
A second way that rent control reduces supply is to limit
apartment rehabilitation. Mutli-family housing investors will often buy
apartment buildings that have deteriorated, and improve those properties over a
period of years. The strategy is to offer a higher level of amenities for a
higher rent. These investors usually use the normal turnover of tenants to
rehabilitate individual units, as the typical tenant in the United States lives
in an apartment for 12-18 months. Improving an apartment from a “C” property to
a “B” property or a “B” property to an “A” property will often result in
substantial increases in rents. Blanket curbs on rent increases (or forcing the
developer to apply for permission to achieve higher rents) will deter this sort
of investment activity.
The Speaker’s Office argues that new construction will be
exempted under “second-generation” rent control, reducing these impacts on
housing supply. However, nothing in HB 2001 guarantees this. Moreover, the
history of rent control in other jurisdictions suggests that promises to
protect new construction from rent control are often not kept. For decades, New
York City maintained a distinction between “pre-war” apartments, built before
1947 and governed by rent control, and “post-war” apartments which were not
regulated. However, the supply of post-war apartment units and and the
political constituency of post-war tenants grew sufficiently large that the New
York City Council, under the leadership of then Councilman Ed Koch, enacted
rent stabilization in 1969 to cover units built between 1947 and 1969,
promising not to regulate construction after 1969. Later in 1974, the New York
State Legislature enacted the Emergency Tenant Protection Act to extend rent
stabilization to units built between 1969 and 1974, promising not to regulate
units built after that date. The legislature later amended the Emergency Tenant
Protection Act in 1983 to regulate units built up to that date.
These repeated broken promises have led developers and
investors to be wary of investing in states that allow for rent control to be
enacted. As noted by economists Ed Glaeser of Harvard and Joseph Gyourko of the
University of Pennsylvania, New York, New Jersey, and California have some of
lowest housing production rates of any states in the United States. While that
lack of housing supply elasticity may have many causes, including excessive
zoning regulation and land controls, the threat of rent control is an important
factor in deterring new housing investment. And since the reputation (and
housing market) of an entire state can be harmed by a single jurisdiction
imposing rent control, it’s important for the legislature to maintain the
existing prohibition of rent control by local jurisdictions.
A second negative effect of rent control is the
politicization of landlord tenant relationships. In unregulated markets, an
apartment lease is a voluntary contract between two parties. Landlords are unable
to form monopolies or cartels so that competition for tenant demand is
vigorous. Apartment owners offering low quality units will earn lower rents.
Apartment owners offering improvements in quality (which is a form of housing
investment) will be rewarded with higher rents. Once rent levels become
statutory, all aspects of leasehold terms become a matter for legal
adjudication. If rents are held below market levels, a landlord will face many
potential tenants, and will lose the incentive to maintain established quality
levels. This might include reducing thermostat temperatures in winter, reducing
frequency of common area maintenance, reducing hours of security personnel, or
reducing the frequency of garbage collection. Arnott estimates that direct
government expenditures in Ontario for enforcing the housing laws are $5 per
year per person due to rent regulation. In the City of Portland would amount to
$3 million per year and a major expansion of our municipal court system. This
amount doesn’t include the legal cost to landlords or tenants.
A common reaction to the politicization of landlord-tenant
relationships is for the landlord to convert their building to condominium
ownership. If full value of the unit cannot be achieved in the rental market,
the landlord can sell their apartments in the ownership market. Under New York
City’s regulations, for example, rent stabilization applies to apartments of 12
units or more. Under the current legal interpretation, an apartment owned as a
condominium is treated as a single housing unit, even if the building has
hundreds of apartments. As a result, the housing stock in New York has changed
in the last 50 years from being 90% rental and 10% ownership to 70% rental and
30% ownership and about one-third of those rentals are unregulated, either
because they are in small buildings or units in condominium ownership. By
comparison, HB 2001 allows for regulation of all rental properties, unless it
is a duplex with one unit owner-occupied. My interpretation of the proposed
statute is that a rented condominium unit would be subject to regulation.
The politicization of the landlord-tenant relationship also
extends to the relationship between tenants and sub-let tenants. It’s fairly
common in New York for tenants to take on roommates to share the costs.
However, sublet tenants do not enjoy tenant protections, so one of the oddities
of New York’s regulation is that “primary” tenants (those tenants named on the
lease) can charge market rents to sublet tenants, even to point where the sublet
tenant is paying more than the statutory rent. My interpretation of the
proposed statue is that sub-let tenants will not be protected.
The Welfare Impact of
Rent Control
Rent control can be seen as a transfer
of income from landlords to tenants, which in the traditional cost-benefit
framework of economics is not a social cost. Social cost is measured by
economists as a burden on consumers or suppliers not counterbalanced by any
transfer. In my PhD dissertation, I estimated the lower bound of these social
costs for the housing market in New York City at between 0.9% and 1.4% of
income in the region. That may not seem like much, but that is approximately
one-third of the cost of the payroll of New York City government, including its
schools and City University system.
It’s also important to understand the distribution of those
benefits among landlords and tenants within the community. It’s natural to
think of landlords as wealthy and tenants as poor, so any transfer of income
from landlords to tenants would appear to make the income distribution more
equitable. However, only about one-third of households within the state are
tenants and not every tenant will enjoy the protection of rent control. The
likely outcome of HB 2001 will be the imposition of rent control within the
city of Portland and no regulation in its suburbs. It also seems likely that
the City of Portland will respond to demands by small landlords and allow
exemptions for small unit buildings, where gaining the votes of a few tenants
won’t be worth the cost of gaining the certain enmity of one landlord.
With rents held below market, only a fraction of tenants
wanting those units will receive an apartment. Under every rent control statute
that I’m aware of, existing tenants in place are protected, in favor of new
applicants. Therefore, by its nature, rent control will protect older, white, more
established tenants over newly-formed households, young adults, and newly
arrived ethnic minorities and immigrants. When new vacancies occur, landlords
will find multiple applicants offering the same rent and be able to select
higher income and more stable households over applicants with more uncertain
prospects. This discrimination will inevitably shift demand to unregulated
markets, either among small, unregulated properties in the city and towards the
suburbs. As rents rise in the unregulated sector, tenants in those markets will
suffer. And even for the tenants lucky enough to find a rent regulated
apartment, they will likely pay search costs and side payments as a means to
find a below market apartment. It is customary in New York to make payments or
“key money” to building superintendents and managers who often have the first
knowledge of an apartment vacancy. It is customary for apartment seekers in New
York to hire and pay commissions to apartment brokers, who in other markets are
compensated by landlords looking to fill vacancies.
There is also an economic burden to the community from the
reduction in value of the existing housing stock. As rents are held below
market, apartment property values will fall and the burden of local property
taxation will shift towards single-family households. This problem may be
limited in Portland, where under Measure 5 and 50, assessed values of property are
typically 30% below real market values and assessed values grow by a
statutorily-determined rate of 3% per year. However, legislation to return
Oregon to full-market valuation has been introduced in the current legislature,
so the risk of a shifting of the property tax burden to single family
households is real.
Finally, HB 2001 is inconsistent with the policies enacted
by the 2016 legislature to respond to the housing crisis with inclusionary
zoning. Under the policy sanctioned by the state and enacted by the City of
Portland, developers of housing properties of 20 units or more will have to
insure that rents are kept below market for 20% of the units at a level that is
30% of the income of household at 80% of area median. This policy involves a
cross subsidy of below market units by market rate units. While this policy is
of dubious value, given that it will act as a development tax, imposing rent
control on the market rate units will only make these inclusionary zoning projects
less likely.
Housing Prices and
Rents in Portland
HB 2001 has been introduced as an emergency response to the
problem of rising rents in the Portland metropolitan area. Rising rents and
rising house prices in the metropolitan area is a function of high demand and
inelastic supply. To understand that problem, we need to understand the impact
of Oregon’s land use system.
When I moved to Oregon in 1991, my boss, Dr. Nohad Toulan,
Dean of the Portland State University College of Urban and Public Affairs
described to me the fundamental trade-off of Oregon’s land use planning system.
Developers were restricted to build in the rural areas of the state to protect
the agricultural and forestry economy of the state. Housing development was
largely constrained within urban growth boundaries, and farmland was restricted
in how it could be subdivided. However, within urban areas, developers were
promised a 20-year land supply and quick approval of development proposals that
met local zoning. Under the Metropolitan Housing Rule, suburban jurisdictions
were required to allocate land for all housing types, even apartment buildings
in the suburbs.
25 years later, that compact between environmental
protection in rural areas and housing development within urban growth
boundaries has broken down. Since the late 1970’s, the population of
metropolitan Portland has grown by 78%, while the urban growth boundary managed
by Metro and DLCD has grown by only 10%. It’s as if we were continuing to wear
the size M shirt that our mother gave us in junior high school. As population
has grown within a limited land supply, land prices have risen dramatically
inside the urban growth boundary to the point that land prices are 10-15 times
higher inside the UGB than outside.
This problem grew out of decisions in the 1990’s when our
Region 2040 Plan was developed. Citizens were given the choice of “growing up
or growing out”, which meant that we needed to densify the region if we wanted
to avoid suburban sprawl. The choice was presented as a matter of urban design,
with the subtext that “growing up” would be a mature decision and “growing out”
implied gluttony. What was not understood at the time was the trade off that
“growing up” would mean higher housing costs.
In a recent study that I completed for Holland Residential,
we studied the rents charged for new housing developments in the Portland metro
area built between 2010-15 and found a consistent relationship between density
and rent levels. For garden apartments that were two-stories, usually wood construction
with tuck-under parking or surface parking, apartment rents were $1.00 to $1.20
per square foot. For five story apartments that were built as four stories of
wood construction over a concrete podium, rents were typically $1.70 to $1.90
per square foot. With few exceptions, these buildings were constructed in
Portland west of 39th Street (Caesar Chavez Boulevard) and south of
Killingsworth Street. Finally, true high-rise apartments bigger than 5 stories
that were built with concrete and steel construction all came in at rents of
$2.70 to $3.00 per square foot. And all of those properties were built in the
Portland central city, including the Pearl District, South Waterfront, and the
Lloyd District. As we shift to a “growing up” strategy, we require more
production of higher cost units.
Density at Any Cost
The UGB’s restriction on land supply in the region is
reducing housing production in the region and forcing what is developed to be
much higher cost. Since the Great Recession, housing production in 2013-16 is
about 20% below the average level in 1990-2007, when apartment rents and
housing prices were much lower. When examined on a county by county basis,
production is up in Multnomah County but down in each of our three suburban
counties who rely upon the less expensive and more land intensive models of
garden apartments and single family construction. The irony is that apartment
construction has returned to pre-recession levels, giving Portland residents
the impression that we are in a housing boom. Yet the boom in apartment
construction doesn’t make up for the decline in the development of new
subdivisions in the suburbs. And without the suburban single family
construction, high income consumers have steered to traditional neighborhoods
in the city, leading to gentrification and displacement.
This problem has been compounded as Metro has adopted a more
unrealistic definition of a 20 year land supply that the planning system
requires. Metro has followed a state-mandated procedure to estimate future population
and employment growth. A buildable lands analysis determines if the existing
UGB can handle the growth. Over time, Metro has developed models of infill
development and redevelopment that supplies growing fractions of our housing
supply. Infill and redevelopment often require using less attractive parcels
that were left over from earlier waves of development, or the tearing down of
existing structures, both of which require higher costs and higher rents. Metro
also accepts at face value the zoning capacity that is presented by local
jurisdictions, even when that capacity is uneconomic. The City of Portland, for
example, has zoning in Gateway, Montevilla, Rockwood, and Lents that allows
five-story construction along major arterials. However, these districts are the
lowest rent areas within the Portland metropolitan area with rents of $1.00 to
$1.10, much lower than the $1.70 to $1.90 needed to support that type of
construction. For these districts to develop at five stories within 20 years,
rents would need to double (accounting for inflation), which would mean
astronomical rent levels in other parts of the region with more amenities.
In its 2015 decision to freeze the urban growth boundary,
Metro justified this decision through its Metro Scope computer model, which
constrained development within the existing UGB. Under this scenario, apartment
rents and housing prices were projected to more than double in 20 years,
reaching levels in Los Angeles and San Francisco. Now, before that scenario
would happen, of course, economic growth in the Portland region would come to a
grinding halt. However, the 2015 Urban Growth Report is a stark reminder that
“growing up” has its costs, and that we need to accept the tradeoff in our
liberal values of environmental protection and housing affordability. As a
region and a state, we cannot afford to subsidize the housing costs of a third
of our population. The challenge of housing is poor is compounded by our errors
in land use planning.
Moving to a More
Equitable Region
As advocates for low income households, we need to be
sensitive to the problem of housing supply. As a necessity, housing is a much
larger fraction of the income of low-income households than higher income
households. Barriers to housing development create a disproportionate impact on
the wellbeing of the poor than the middle income or the wealthy. We need to
urge state government to increase housing supply by expanding the land supply
in the region for human settlement. Allocating land in Washington County for
producing grass seed, strawberries and hazelnuts at 7% of its market potential
as land for housing is a misallocation of resources and a planning error.
We also need to recognize that we cannot and should not
provide subsidized housing for every low-income household. If you add all the
various housing subsidy programs (including low-income housing tax credits,
public housing, housing vouchers, inclusionary zoning units), that represents
less than half of all households in the United States below the poverty line. Most
low-income people rent at market levels. Building subsidized housing creates a
targeted benefit for a few households, but most low-income households find
housing themselves. Those low-income households need the community to build
large amounts of housing, which by its nature will be built for middle and
upper income households, which will free up older housing at prices they can
afford.
Finally, we need to avoid policies like inclusionary zoning
and rent control that essentially tax new development to help produce a few
below-market units. Subsidized housing units can be thought of as a public good
for the community to help people with particular needs, but that kind of
community resource should be paid by general taxation. Taxing new development
may seem politically expedient, but it only perpetuates and compounds the
problem.
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