Rent controls: will they be softened?

Gulf News

Property analysts have cautiously welcomed proposals for a new rent cap scheme that would allow landlords to appeal for rents to be adjusted in line with market rates.

An official at the Real Estate Regulatory Agency (Rera) yesterday told Gulf News that landlords who feel the cap is keeping rents below market rates should be given the opportunity to hike prices above the restriction in line with a benchmark recommended by Rera.
...
Cases have emerged in new shopping malls and commercial complexes where a developer will offer discounted rents during the first year of operation as an incentive to attract tenants to the development, she said. "Landlords who signed such tenancies cannot currently apply for any increase in rents to bring them in line with market rates," she said.

According to Rera, an index of rental prices will be formed to help the rental committee decide the outcome of rental disputes.

On the same date the Gulf News editors write

The logic behind the rent cap seems exemplary. Landlords in Dubai in many cases had been able to exploit conditions in which rapid demand was overwhelming supply, to the point where delaying the release of units promised even more money in the bank.

Naturally, those desperate for affordable accommodation were delighted by the cap's introduction, since we've all been hit in the pocket, whether it's for school fees, food or transport. The cost of living has become a source of considerable angst for households, and a factor also for businesses considering whether to locate here.

But controls are an imperfect approach, which is why reviewing the issue is timely. If units are not reaching the market because landlords are withholding them on grounds of inadequate return, then the situation is only aggravated by artificial intervention. That's the law of unintended consequences in action.

There's a contradiction in logic in the editorial - how can removing the rent control lead to an expansion in the number of units available if you've said in the first paragraph that the "exemplary" logic of the rent controls is that units were being withheld absent the controls?

What we know is that, prior to rent control, demand for housing grew very rapidly relative to supply and rents jumped up considerably as a result. And the trend of rapidly growing rents is likely to continue as it takes time for supply of housing to catch up to ongoing growth in housing demand. This is entirely consistent with a competitive (non-monopoly) market - which is one where no one supplier has an incentive to withhold product to drive up the market price for all.

Rather than rent control RERA should be asking whether there are elements of monopoly in the market, and attacking those directly. We have some evidence, though, that the market is relatively competitive because economic theory tells us that rent control will exacerbate shortages, and this appears to be exactly what has happened.

In short, rent control has had the opposite of the intended effect: fewer units are available, not more. The closer the controlled price is to the market, the faster rents will return to pre-existing levels because suppliers will be in a greater rush to bring units on line. (Footnote: Underlying land values are another matter. If they are increasing (and they may well be given the value of living in Dubai) this will be reflected in increased rents.)

If at first you don't succeed...

... try, try again.

It's an ongoing game in Abu Dhabi between the rent control authority and the building owners. Here's another episode in the saga from Gulf News

"Changing the business from residential building into hotel apartments is not a legal ground to evict tenants," said Mohammad Rashid Al Hameli, chairman of the Abu Dhabi Rental Disputes Resolution Committee.

Al Hameli said under the law, landlords cannot ask tenants to vacate unless in specific cases, including approved demolishing, for personal use, tenant's failure to pay the rent, subletting the property without the approval of the landlord or violating public norms.
...
Al Hameli said tenants should not obey any eviction order issued by landlords or any authority unless the order is approved by the Rental Disputes Resolution Committee.

The take away message to investors: If you build anything new call it a hotel, not a residence.

A rental market opportunity

The Gulf News today has a nice description of the way landlords will try to get around rent controls. In RAK the government has gone so far as to make it difficult to tear down your apartment building -- one device landlords use to evict tenants who were renting at controlled below-market rates.

The latest scheme is to buy out the tenants. This doesn't produce a gain for the landlord if the tenants would simply turn around and rent the same apartment for at the market price (the buyout to the tenant is the same as the change in the rent in this case). It does work if at the market rate the tenant would move to a lower quality apartment.

Here's a bit of the GN report

This new tempting tactic has recently spread in RAK where tenants are being promised money to evacuate houses and shops they had taken on rent long time ago.
...
Officials said some of the tenants in the key areas in the emirate have been recently moving to remote areas including Shaam, Al Jeer, Al Rams and Ghaleelah where they find cheaper houses and at the same time benefit from the money they get from the landlords to evacuate.
Officials said the landlords do pay the expenses their tenants take to move their furniture and in other cases, the tenants sell their old furniture in excellent deals to their landlords who later dump such furniture in the garbage.

Surge of demolitions in Abu Dhabi

A commenter (Macthompson) wondered, "Do you have a mathematical model to share with your readers which can explain the business model behind decisions to knock down thirty year old buildings housing rent-capped tenants?"

Here's the story he's referring to: New law triggers demolition surge. Key extract:

[A] source at the municipality explained that many of these buildings do not need maintenance. "The problem is that since the rent cap law was issued, we receive many claims for general maintenance work, a permit that entitles the landlord to evacuate the building, hence avoiding the three-year term for leases... and offering the property without the seven per cent cap restriction," he said.

"The average number of monthly demolition applications was 5 to 10 [buildings] before, but in recent months it surged to 15, especially after the introduction of the new law," the source added. With an extreme shortage of affordable housing in the short-term, increasing the number of demolitions adds to an already compromising situation for residents. However, contractors insist the mechanism is based on a free market approach.

"Any landlord can put in a request ... if he has no financial commitment to the Shaikh Khalifa [rent control] Committee and given that he successfully evacuates the building from existing tenants," explained Mohammad Hussain, deputy general manager of Al Mansouri Contracting Company.

There's the answer to the question: if you own a rent controlled apartment you are allowed to demolish the building and replace it with a building that is not rent controlled. The difference in rents may be sufficient to induce owners to choose demolition and replacement. Based on the numbers above, it appears that this has increased the rate of demolition by about 100 percent over the rate prior to rent control. (It's not clear from the article, but it appears that "demolitions" includes knocking down buildings and substantial renovations short on knockdown.)

Why has government not controlled the rent on new apartments? Because it realizes that no new construction will be occur unless rents rise to a level adequate to yield a market rate of return on investment. And we know new construction is desirable because we know the demand for housing has grown.

Why has the government allowed knockdown-and-replacement? Perhaps because it realizes that one alternative to knockdown is for the owner is to stop maintaining his building.

(The story reveals that another way around the rent control is permitted: obtain a permit for general maintenance, and evict the tenants.)

A note to end on:

Rent control appears to be the most efficient technique presently known to destroy a city--except for bombing.

-Swedish economist Assar Lindbeck