Yukonomist: Time to stop digging

In Economics 100 textbooks, rent controls are commonly included as case studies of well-meaning but economically damaging policy, Halliday argues

keith halliday

They say that if you want to get out of a hole, the first thing to do is to stop digging.

The real estate version of this is that if you want to fix a shortage of rental housing, you should stop discouraging investment in rental housing.

In Economics 100 textbooks, rent controls are commonly included as case studies of well-meaning but economically damaging policy. If you cap the price of something at a level below its market equilibrium, the texts say, you’ll get reduced supply and increased demand.

That equals shortage.

Nobel-prize winning economist Paul Krugman, who also writes a left-of-centre column in the New York Times, wrote that “rent control is among the best-understood issues in all of economics, and — among economists, anyway — one of the least controversial.” The Brookings Institute summarized recent research as follows: “While rent control appears to help current tenants in the short run, in the long run it decreases affordability, fuels gentrification, and creates negative spillovers on the surrounding neighbourhood.”

Many media stories portray rent control as hurting landlords and benefiting tenants. Reality is more complicated. Landlords are affected, of course. But if you live in a city with surging house prices, like we do, they can easily sell their unit at a profit and invest their money in something else if rent controls bite too much into the bottom line. Existing renters enjoy capped rents. The people who really pay are future renters, who find it harder to find a place to live and more expensive when they do.

This means, as is so common, the cost is borne by young people and new arrivals. Rental shortages also hurt people with difficult life situations who need to move out unexpectedly.

Nonetheless, the run up in housing prices around the world has revived interest in rent control. Paris brought back rent controls. Berlin introduced a five-year rent cap for apartments built before 2014. Bernie Sanders campaigned for rent control in the U.S. presidential primaries. He called for rent increases to be capped at 3 percent or 1.5 times inflation, whichever was higher.

Indeed, the new Liberal-NDP rent control plan for the Yukon — a cap of one per cent on rent increases — is farther to the left than Sanders’ proposal.

The Economist reports that Berlin’s new rent control policy did indeed result in lower rents. But it also saw the supply fall. The number of ads for rentals fell by more than 50 per cent.

If your objective is to support a bigger supply of more affordable rental housing in the long run, you need to look at the whole business model. This means looking at it from the investor’s point of view. And remember that many of these investors are regular Yukoners (full disclosure: I own a rental unit, and raised the rent by the rate of inflation last year).

Consider this example. Suppose, back in 2019, a teacher with 10 years of experience and in the over-$97,000 tax bracket got a mortgage and bought a house for $400,000 to rent out. Now rent increases are capped at one per cent. But insurance and City of Whitehorse utilities are likely to go up faster. Lumber and contractor prices for repairs have been skyrocketing. If the rent includes utilities, then electricity costs have also gone up faster than inflation. Interest rates are down thanks to the pandemic, but if the teacher was conservative in 2019 and locked in for five years then that isn’t any help.

She also pays taxes on the rental profits at her highest marginal rate, 36.9 per cent in 2020. Note that capital gains and dividends from owning stocks are taxed at much lower rates.

Meanwhile, due to the general housing shortage, suppose the value of the house has gone up $50,000 or more.

Here we have a situation where our teacher-investor is still making money, but less than planned. Costs are going up faster than rent, meaning that she will likely make less money in each future year of rent control. She knows the new Liberal-NDP rent control policy is supposed to last until 2023, but doesn’t know if it will end then or perhaps be made permanent. Perhaps some future election will even see someone campaigning on rent freezes or rollbacks.

Keeping the rental property is one option, but selling it to a homeowner and moving the cash to the stock market may be more attractive. She wouldn’t pay tax at all if she moved her equity into a Tax Free Savings Account. Plus, share certificates don’t get frozen pipes or call for repairs on long weekends.

Investors with older properties needing more maintenance will be most likely to sell, especially if they have an aging roof or oil tank.

The key point is that it is not necessary for all investors to sell their houses for there to be a problem. With 780 applications for last January’s lottery of 250 lots, there is clearly plenty of demand for houses. If even a tenth of investors decide to sell their rental properties to new homeowners, that releases a wave of former tenants looking for rentals in a city where the supply has suddenly fallen.

In the long run, the best solution is to increase the supply of housing overall. For example, around 170 lots were released per year on average over the last three years. The current plan is to get up to 250 lots per year. Even that may not be enough. Yukon government population forecasts an estimated 750 people moving here per year through 2025.

A better strategy for the government would be to support low-income renters with direct subsidies, and to encourage rather than discourage investment in rental properties. The Liberal-NDP alliance is going a different direction, and one widely critiqued by generations of economics textbook authors. Hopefully I’m wrong about the long-term consequences. But if you have trouble finding a rental unit in the next two years, you might want to let your MLA know about it.

Keith Halliday is a Yukon economist and author of the MacBride Museum’s Aurore of the Yukon series of historical children’s adventure novels. He is a Ma Murray award-winner for best columnist and received the bronze for Outstanding Columnist in the 2019 Canadian Community Newspaper Awards.