Residential Magazine

Don’t Repeal the Law of Supply and Demand

Rent-control measures are likely to harm homeownership opportunities

By Dick Lepre

This past fall, California lawmakers passed a statewide rent-control bill. Backers of the measure argue that it’s technically a “rent cap,” but that’s likely semantics since “rent control” is an unpopular term. Broadly, this bill restricts rent-price growth for any place in the state that did not already have a local rent-control law.

The bill exempts buildings constructed in the past 15 years, which is a rolling date. That is to say, in 2020, any building built before 2005 will be subject to rent control. In 2021, any building built before 2006 will be subject to rent control, and so on each succeeding year.

Rent control is popular with politicians because tenants outnumber landlords and rents have increased substantially in some places. Under this bill, annual rent increases cannot exceed local inflation plus 5%. If inflation in a given city is 3%, the maximum annual rent increase the next year cannot exceed 8%.

How does this affect mortgage originators? One effect of rent control is to limit the supply of all housing, be it apartments, condominiums or single-family homes. Any locations that pass rent control will continue to see higher prices for homeownership, which will affect originators by creating fewer clients who are able to afford a home.

Alternatively, these measures will drive people to move from high-cost areas such as California. Already- low supply, coupled with laws discouraging new construction, likely will translate into fewer mortgage originations in places with rent control.

Rising rents

The underlying problem with rent control is that it attempts to remedy an effect without addressing its cause. There are four factors in play with any economic market, including housing: supply, demand, price and elasticity. Housing prices go up when demand exceeds supply.

When demand for some consumer products in- creases, supply is increased because doing so is profitable. Housing is different, however, because supply is massively constrained by land-use regulations, zoning and an often lengthy permit process.

In California, this new law amounts to an attempt to repeal the law of supply and demand. Local zoning and land-use regulations prevent supply from meeting increased demand. The rent-control law regulates the price of rents. And it poses a question — who is going to build rental housing if the profit motive is constrained by rent controls?

Potential owners of apartment buildings are squeezed on both ends. On the front end, apartments are expensive to build because the process is long, increasing the costs due to regulations. The National Association of Homebuilders estimates that regulations imposed by all levels of government account for an average of 32.1% of the development costs for multifamily homes and 24.3% of the costs for a single- family residence.

 On the back end, the return on investment is diminished by rent control. To make it worse, builders and owners face the risk of declining prices or rents if there is a recession and jobs leave the area. If rent control discourages multifamily construction, it might seem that builders would turn to single-family home construction. That is not likely. In a city such as San Francisco, there is essentially zero single-family home construction. New development consists of condos and rental apartments.

The developers that do multifamily construction are a different set than those who build single-family homes. In short, they will not decide to build houses in the suburbs. They likely will build multifamily housing in other states. The workers who build high-rise construction, whether that’s apartments or office buildings, are used to being moved about. They also have different skill sets than people who build single-family homes. Construction workers who build with steel and concrete may not possess carpentry skills.

Inelastic market

In an ideal market, both supply and demand should have what is termed elasticity, which measures how efficiently the law of supply and demand is operating in the real world. If demand increases, supply should increase. If prices increase, supply should increase.

Housing supply is extremely inelastic. Home prices rise because demand exceeds supply, but supply, limited by regulations, cannot rise to meet demand. Buyers want homes, builders want to build and carpenters, electricians and plumbers want to work, but nothing happens. Two groups that benefit are existing single-family homeowners who see property values increase and tenants occupying rent-controlled units.

Rent control creates another problem: It decreases mobility and thus stagnates the market. A person may be offered a better-paying job, which would necessitate giving up their below-market rent because they would have to move. Rent control makes the labor market less dynamic and negatively impacts salaries, consumer spending and gross domestic product.

Rent control most certainly benefits existing tenants. Tenants have the obvious financial benefit of not having their rent increased, and there also is the social benefit of not having to become separated from family and friends. Once someone moves, the rent on the now-vacated unit will be higher than it would have been absent rent control. The new tenants in rent-controlled apartments are essentially subsidizing the long-time tenants.

Better remedy

Rent control has negative externalities. If rent control in San Francisco causes rents on vacant units to be unaffordable, prospective renters will live elsewhere and drive up rents in surrounding communities.

Rent-controlled units are more likely to be converted into condos. This reduces the supply of rental units and creates a housing stock that caters to higher- income individuals. Other unintended consequences include a higher rate of homelessness, and a driving out of racial and ethnic minorities who cannot afford market rents on vacant units. Rent control has helped gentrify cities such as San Francisco.

Rent control also has administrative costs for governments. For example, in 1996, the rent-control board in Santa Monica, California, had a budget of more than $4 million a year to control rents on only 28,000 apartments.

If a city or state thinks that rent control is needed, it should stop and ask, “Why are rents so high?” The answer is always the same: Rents are high because the supply of rental housing is scarce relative to the demand. The solution is to relax zoning, land-use regulations and the permit process to enable supply to increase.

The same is true of prices for single-family homes. Prices are high when the supply of for-sale homes is scarce relative to the demand. Again, the solution is the same — relax zoning, land-use regulations and the permit process, enabling supply to increase. Government often creates problems through regulations and then decides the solution to the problem is to pass more regulations, rather than to undo the problem-causing regulations.

• • •

Everyone in the mortgage origination business should care about the availability of housing. Originators should advocate for the relaxation of laws that discourage new construction and oppose laws (such as rent control) that create less-affordable housing, whether that is single-family homes, condos or apartments. Building more homes of all types will help contain prices, making homeownership affordable to more people and generating more business.

Building more homes of all types will help contain prices, making homeownership affordable to more people and generating more business.

If people spend a smaller portion of their income on housing, they will have more disposable income, which will lead to economic growth and should create more potential homeowners. Although change must happen at the municipal level, originators should watch carefully for the fallout in housing supply due to legislation of the kind that was passed in California.


  • Dick Lepre

    Dick Lepre is a loan agent for CrossCountry Mortgage LLC. He has been in the mortgage business since 1992 and has been writing a weekly email newsletter on macroeconomics, mortgages and housing since 1995. Lepre (NMLS No. 302379) is from New York City, but he has lived in the San Francisco Bay Area since 1968. He has a degree in physics from Notre Dame. Follow him on Twitter @dicklepre. 

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