Rent control varies from city to city and country to country, sometimes with a highly negative impact on investors. Here is a look at different kinds of rent control regimes and their pros and cons from Global Property Guide:
Rent control, seen by many economists as old-fashioned, has recently made a surprising comeback in one group of high-growth, dynamic economies—the Gulf.
In December 2007 Dubai’s government toughened up its 2005 Rent Law and reduced the maximum 2008 rent increase to only 5 percent. Abu Dhabi has likewise capped 2008 rent hikes at only 5 percent.
In neighboring Qatar, a rent freeze has been implemented while the government is determining the new rent increase cap. For the past two years to February 2008 rent increases were limited to 10 percent annually
In adopting rent control the Gulf has moved in the opposite direction to the rest of the world. Elsewhere, rent control regimes have generally been dismantled or softened since the mid-1990s. R ent control has been removed in most of Eastern and Central Europe. Asia has also followed the trend: China, Japan, Malaysia and Singapore have lifted rent controls since the early 2000s.
The Gulf measures have dismayed landlords, and alarmed property investors.
Below, the pros and cons of rent control regimes, which now exist in about 40 countries are reviewed by the Global Property Guide.
The Global Property Guide believes that rent control is generally harmful, but it can be benign, if:
- It is implemented so that its market-restraining effects are modest
- It helps to defuse public protest about high rents, and
- It assists citizens by providing an agreed framework for contracts.
Different forms of rent control
Rent control in Sweden is an interesting example.Rents are set far below reasonable returns-on-investment. A European University Institute (EUI) study calculates that:
- To make a 5 percent return on investment, a Swedish developer would need to set rents 70 percent higher than allowed by the Rent Tribunal.
- Rents in all dwellings must match rents for alternative, comparable dwellings, based on size and ‘attractiveness’, primarily rents in low-rent municipal houses.
- Rents are little influenced by location, so that metropolitan units are specially underpriced.
The system lacks transparency and predictability, so that few new private sector apartments are now being built in Sweden. Of the approximately 30,000 dwellings completed in 2006, only 36 percent were intended for rental. In comparison, from 1990 to 1996 more than 50 percent of new dwellings completed were intended for rental.
Types of rent control
1. Tenancy rent control
The most common form of rent control is where rents are initially freely negotiable but there is a limit on the amount of rent increase (‘tenancy rent control’ or ‘second-generation rent control’).
The maximum allowable increase is either:
- A fixed percentage (e.g. Dubai, Philippines, Pakistan, Tunisia),
- Or a fraction of the construction cost index (e.g. France) or consumer price index or CPI (e.g. certain cities in the US, Italy, Netherlands, Spain, Switzerland, Colombia, Uruguay)
- Or a combination of the two (e.g. Canada).
Tenancy rent control is typically accompanied by vacancy decontrol—i.e., when the unit is vacant, rents can be increased by any amount. Newly constructed buildings are usually exempt from rent control.
2. Maximum rent systems
Sometimes the authorities determine the maximum rent, and apply it equally to new and old tenancies. Often, the maximum allowable rent is a certain percentage of the property value (enforced in India, Taiwan, Luxembourg, Jamaica, Dominican Republic, Syria, and Costa Rica). The property valuation is typically based on historical cost and not on the current property value, so that real rental returns fall over time.
3. Rent freeze systems (“absolute” rent control or “first generation” rent control)
Sometimes rents are kept at a pre-determined level, typically that of the year when the law was introduced (such is the case in Qatar). For newly constructed units, no rent increases are allowed after the unit is rented out.
Such laws were implemented mainly after World War II to avoid rapid increases in rent due to increased demand from refugees or from returning soldiers. This type of rent control has mostly been abolished, relaxed or is largely un enforced (e.g. US Virgin Islands).
4. Split systems
Here only a certain portion of the housing market is under rent control ; typically, rental units for poor households or de-nationalized buildings (e.g. US, Philippines, Cyprus, Czech Rep., Dominica, Aruba, Bahamas, Bermuda, Trinidad and Tobago, and Honduras).
5. Ineffective systems
While most rent control laws are biased towards tenants, some are actually benign due to the way in which they are implemented—or not implemented, as the case may be. Non-implementation is a surprisingly widespread phenomenon.
In some countries, there is a prescribed amount of rent increase—but the parties are free to accept it or not. If one of the parties feels that the increase is too much or too little, they can ask for the rental authority to adjust the rent (enforced in the province of Quebec, Canada).
In others, the landlord can apply for a rent increase higher than the prescribed amount, if he would otherwise experience hardship, or for capital recovery or renovation.
Inflation is also significant. In the Philippines average inflation is around 4 percent to 5 percent, but the annual rent increase cap is 10 percent. This is largely benign, and gives landlords plenty of room for capital recovery.
In other cases, the rent control law is largely unimplemented (US Virgin Islands, Taiwan). In the Bahamas, for instance, rents for houses worth B$25,000 and below are government-determined, according to a 1975 law, but no house in the Bahamas is now worth so little.
In defense of rent control
A common (and much abused) justification for rent control is the right to housing, which is sometimes protected by the constitution.
Another justification is to correct market inefficiencies such as information asymmetry and high transaction costs. Because of the high cost of moving, tenants can arguably be pressured by landlords to accept rent increases. Tenants may also be unaware of the real condition of units until they move in. If the tenant complains, the landlord may threaten to increase the rent.
Standard contracts perform a service to both landlords and tenants. In many cases in modern society, the state intervenes in contractual relations between individuals in order to provide simplicity, clarity, and order. Both landlord and tenant are helped if standard provisions exist, for instance, which determine what should be agreed on - the initial rent, rent adjustments, date of payment, penalty for delays, conditions for eviction and such. These can provide both flexibility and security.
The problem with rent control
The principal argument against rent control is that it tends to distort economic incentives, leading to inefficient distribution of resources.
- Rent control reduces the incentive of landlords to supply rental units. Rental units tend to be in scarce supply under rent control. Ironically this leads to an escalation of complaints against the landlord class. Vacancy levels tend to be relatively low and a vailable units tend to be rented only under strict conditions, again aggravating relations between landlords and tenants.
- Rent control discourages landlords from maintaining and repairing units till the end of a tenancy.
- There is also an incentive for landlords to discriminate against tenants likely to stay for a long time, like retirees or couples with children.
- In some countries, landlords collect key money to offset the losses occasioned by rent control.
- Rent control tends to lead to bullying and illegal behaviour by landlords. If rent increases are allowed between vacancies, landlords will try to evict tenants in any way possible. This will likely translate into demands for government protection for tenants, i.e., into a further layer of bureaucracy and policing.
- Tenants in tenancy rent controlled units are less willing to move to other places, despite the possibility of earning higher wages.
According to a study by Basu and Emerson (2000), “t he removal of rent control can not only increase efficiency in the rental market, but can also lead to a general lowering of rents, making all tenants better off.”
Lessons for rent control
When might rent control be desirable? Where it will help provide all parties with contractual certainty.
Global Property Guide believes that rent control can be harmless or even (in some cases) mildly beneficent, where it occurs in the context of standardization of contract structures, designed to increase market certainly and to provide guidance for citizens.
However as noted before, rent control should be minimalist.
- The rent control scheme should be simple.
It should be easy to determine if the unit is covered by rent control or not. It is generally easier to determine if the unit is covered by rent control if the basis is the actual rent, and not property value or construction cost. Using furnished vs. unfurnished for rent control delineation can also lead to confusion.
- The basis should be transparent.
Using the CPI or inflation as the basis for rent increases is generally desirable, because it is transparent. Most central banks and statistical agencies regularly report inflation.
Using a formula that only the rent tribunal can understand and configure creates abuse and corruption.
- The rent control system should allow capital recovery.
The rent increase structure must allow landlords to recover their investments and certain costs. Without this basic precondition, private housing investment will grind to a halt, with all the attendant evils mentioned earlier.
- The scheme should be predictable.
If the allowable rent increase is changed annually, then the government must announce it early to allow landlords and tenants to negotiate and evaluate their options.
- The rent control scheme should be easy to implement and enforce.
Decisions must be easy to execute and implement. Given the cyclical nature of the rental market, prolonged litigation and eviction proceedings can lead to substantial losses for the landlord and/or immense distress to the tenant.
- Special courts can help
The legal system is an important variable. In most countries in Europe, and countries with English common law systems, a rent tribunal or rent board hears complaints regarding rent adjustments. The decision can only be appealed to the tribunal itself. The process is usually swift and efficient.
In many other countries, on the other hand, cases related to rent adjustments are handled by generalized courts and can be appealed to the highest courts—which usually means a cumbersome and expensive process.
Canada, for instance, has a reasonable system. Although the laws appear to be pro-tenant, the system is not entirely disadvantageous to landlords. Allowable rent increases are based on each province’s CPI, allowing regional disparity.
A landlord can usually petition for a rent increase above the "rent increase guidelines" set for the province. Landlords doing so have to apply to that province's rent authority. Landlord-tenant disputes are resolved by the provincial (small claims) court system, or through a tribunal/arbitration system. The system is very efficient.
This article has been reposted from Global Property Guide. You can view the article with accompanying charts, including a comprehensive listing of rent control regimes from around the world on Global Property Guide's international residential real estate website.