5% Cap on Apartment Rents – Washington's Latest Economic Folly

...apartment rent increases over the last several years were almost exclusively driven by the effects of state interference.

Last week, the Biden administration introduced plans to limit increases in apartment rents to 5% annually. Far from a straightforward cap, this plan contains various nuances, which I will explain below. Nevertheless, the basic fraud on display here is twofold.

First, the state continues to ignore private property rights while manipulating markets with price controls – an attempt to commandeer the market’s fundamental role of price discovery and place it in the hands of bureaucrats.

Second, and more to the point, the current regime is trying a desperate political maneuver in an election year – one that will ultimately harm the target audience, but sound the right progressive notes in the meantime.

Brief Background

One of the primary benefits of owning rental property is its relative tax efficiency. Mainly because of depreciation – booking the declining value of property, generally at the same rate over a 27.5-year period, as an expense – owners often see little or no taxable income associated with their rental property. There are also various methods of accelerated depreciation that allow owners to book depreciation expense at an even faster rate than the traditional 27.5 years, thus reducing their taxable income further.

The administration’s proposal is to disallow the use of these accelerated depreciation methods for landlords that own more than 50 total apartment units if they implement rent increases greater than 5% annually on non-renovated units. This is a simple quid pro quo, with government using the accelerated depreciation benefit as the carrot and the 5% cap as the stick.

What Price Controls Actually Do

In a free market, landlords are motivated – like any other businessman or entrepreneur – to maximize profits, earning the highest possible return on their capital. To the extent a government-enforced price control is introduced that interferes with that ability, they will seek other ways to compensate. Maintenance expenses will be deferred, lower-quality services will be provided, personnel will be reduced, and so on. The net effect is a lower quality of life for the tenants residing in a particular community or apartment building.

Also, rent controls will naturally dampen incoming supply. New apartment units will cease to be built, or at least they will be built at a lower level of quality and cost, to balance the lower future operating returns promised by rent control.

A rent-controlled apartment industry will therefore ultimately suffer from low supply, low quality, and relatively high rents. Business-minded operators, seeing little ability to make sufficient profits, will exit the industry. Politically minded operators with less business expertise, maybe those with connections that allow them to bypass the price controls in some way, will fill the gap. Crammed with rent seekers and lacking innovators, the industry itself will become fundamentally corrupt, delivering a product to the consumer that is expensive and woefully lacking in quality.

The True Causes of Higher Rents

The ostensible case made for rent caps – that landlords will simply raise rents while ignoring property conditions, thus doubly stiffing tenants – is economically illiterate. In a free market, there is no tradeoff between maximizing profits over the long term and providing tenants with a quality living experience. Studiously attending to property maintenance, providing an aesthetically pleasing grounds and physical plant, and staffing capable personnel are all actions that enhance a property’s reputation and operations, thus lifting both current income and asset value. On the other hand, a landlord who cuts services, reduces maintenance, and generally lets operations suffer will be punished by the market immediately. Alternative options will prevail while lower occupancy and tenant quality will lead to reduced income and an impaired value at the subject property.

Further, apartment rent increases over the last several years were almost exclusively driven by the effects of state interference. In particular, the printing of trillions of dollars, most notably in 2020, and ramming that newly created money through the economy via wholesale lending caused massive speculation and malinvestment, leading to the most extreme pricing bubble apartment properties have ever seen. As a result of inflated acquisition prices, rents needed to rise to offer a return on capital.

Property taxes, now rising 50-100% annually in many cases, are climbing due to assessed value increases – a direct result of that government-directed inflationary bubble.

Property insurance premiums, also rising 50-100% annually, are tied to property replacement costs, which have increased dramatically for the same reason.

As consumer price inflation accelerated, so did the cost of parts and materials used in property maintenance, including appliances and basic supplies.

Even the psychology of tenants has been impacted by government policies. A recent rent/eviction moratorium combined with promiscuous issuance of government “stimulus” checks has created a class of tenants that believe rent is optional and, in any case, someone else will eventually pay for it. To combat higher delinquency and filter out non-paying tenants, rents generally increase.

Regulation Nation

The premise behind all state intervention in the economy is that the state knows better than individual, voluntary actors in the market. Government price controls in particular are immoral and wreak havoc on economies, negatively impacting the quality of life for those they profess to help.

Barely hidden behind the pretense is the reality of the situation. To wit, the current regime is desperate to earn political points in an election year. They offer a policy that they know will hurt the working class, whom they detest, but may nonetheless deliver additional votes and campaign contributions in the meantime.