Randall Pozdena

English

Research Papers in Economics

June 13, 1980 
Tenants' Complaints 
"Nobody shoulders a rifle in defense of  a 
boarding house. "-Bret Harte 
Bret Harte's quip about the political vulner-
ability of  landlords has taken on a new mean-
ing in recent years-witness California's re-
jection lastweekofa landlord-sponsored ini-
tiative to curb local rent-control ordinances. 
Indeed, decisions about rental housing are 
increasingly made in the voting booth or City 
Council chambers rather than in the market-
place. Rent control, once a phenomenon of 
New York City alone, has now spread to 
other parts of  the country, including such 
West Coast communities as Los Angeles, 
Berkeley, San Francisco and Seattle. Some 
local communities also have instituted 
ordinances to restrict the conversion of  rental 
property to condominiums. 
These measu res reflect a widespread desi re to 
address a perceived national crisis: rising 
rental costs and a diminished supply of rental 
housing. Behind the good intentions, how-
ever, are some serious misunderstandings 
about the way housing markets work. Existing 
controls might actually increase the cost and 
reduce  the  effective  supply  of  housing-
presumably the opposite of  their intended 
effects. Moreover, they could divert attention 
from truly effective housing policies. 
The market 
The key point to remember is that rental 
housing "competes" with the other form of 
housing tenure-owner-occupancy. In 
choosing between the two, a household 
compares the market rent of housing of a 
particulartype with the costs that it would 
expect to incur over a given period of  time as 
owner-occupants of similar housing. These 
homeownership costs include the foregone 
earnings on equity in the house, plus 
mai  ntenance costs and mortgage costs, net of 
any expected capital gains-all on an 
after-tax basis. 
Lifestyles and economic circumstances will 
dictate that some households become home-
owners and that others become renters. 
Indeed, for some families, homeownership is 
simply not feasible. This does not mean, 
however, that there is no effective 
competition between renting and owning. 
There are always families on the margin of 
this choice, and a severe imbalance between 
rental and homeownership costs at this 
margin cannot persist; if such an imbalance 
develops, the actions of  these "marginal" 
households will tend to bring costs back into 
line. If, for example, some event causes 
homeownership to be perceived as cheaper 
than renting, the marginal households will 
become owner-occupants, thereby reducing 
the demand for rental housing and causing 
rents  to  fall  relative  to the  costs  of owner-
occupancy. The market will then reach a new 
equilibrium at a lower proportion of renters 
(and rental housing) than before. 
The market in the 1970's 
Apparently this is what occurred during the 
1970's. As the decade progressed and infla-
tion unexpectedly worsened, many house-
holds  correctly  perceived  that  owner-
occupancy was a cheaper alternative than 
renting; when expected capital gains (and 
their special tax treatment) were taken into 
account, the purchase of a home made 
economic sense, even at high prevailing 
mortgage rates. Of  course, this new 
enthusiasm for owner-occupied housing 
caused housing prices to be bid up, and 
therefore was partly self-defeating. However, 
builders responded with new supply, and 
even with gigantic price rises, home owner-
ship for many households still seemed 
relatively inexpensive. 
Consequently, rents were bid down relative 
to other prices, as rental housing tried to com-
pete with the inflation and tax advantages of 
homeownership, and as the proportion of 
rental households shrank with the growing 0pinion(; expressed in  this newsietter do nol 
n e  ~-'  ~~  ~\~;~;  ~~i(li:~ r  a  IRe  s  (:  ~,~::  ~:~:  ~r~/l~  ~.~  .~  ~~~  ~  1;-~~1i~  (~t~:~~~  ~: III 
i/O( or the  l~of1rd of  of the Federal 
F;:e~:;erVe 
._--_. __ ._---.-.......... __ ... --_  .. _----------_  .. _---_  .. -----_  .. _.-.. _  .•. _--------------------
switch to owner-occupancy. The data clearly 
show that this chain of events actually occur-
red. Rents fell relative to other prices over the 
decade by approximately 8 percent (see 
chart). And the proportion of households 
renting shrank from 37 to 35 percent, nearly 
double the percentage decrease of  the pre-
vious decade. 
The condominium-conversion phenomenon 
of the 70's also reflected this process. 
Because of the tax treatment of rental 
property, according to a recent Commerce 
Department study, inflation does not make it 
cheaper for the landlord to own housing. 
Therefore, downward pressure on real  rental 
income has not been offset by lower landlord 
costs, in real terms. In the final analysis, the 
conversion of rental property to condo-
miniums occurred because it became 
cheaper for households to own (and live in) 
apartments than it was for landlords to own 
the units and rent them out (after adjustment 
for the effects of taxes and inflation expecta-
tions). To put it bluntly, each converted unit 
was worth more to the household than it was 
to the landlord, reflecting the fact that the 
landlord had a strong incentive to sell rather 
than rent. 
Seeds of discontent 
The forces creati ng these changes are beyond 
landlords' control. The shift out of rental 
housing has occurred because of  the desires 
of  households, propelled by the effects of 
inflation and homeowners' special tax treat-
ment. Indeed, in real terms, rents have 
actually fallen -virtually  'continuously-for 
over a decade. This situation doesn't seem to 
jibe with the image of landlords as merciless 
"gougers" of their unfortunate tenants. 
Several factors may have contributed to this 
misconception of landlord behavior. First, 
despite the decline in real rents (i.e., rents 
relative to other prices), nominal rents have 
indeed risen. It is natural for all of  us to blame 
sellers of goods and services rather than gov-
ernment policy for rising prices. Landlords 
may have been singled out simply because 
2 
they are highly visible and politically vulner-
able sellers. 
Second, the composition of rental house-
holds has  changed because of the working-
out of inflationary processes. Only  those with 
relatively high tax rates (and hence, high 
incomes) have sufficient incentive to move 
from rented housing to owner-occupancy as 
inflation expectations rise. As a result, rental 
housing becomes increasingly occupied by 
poorer households. (Renters earned 64 per-
cent of the national median income in 1970, 
but only 55 percent in 1977.) The burden of 
today's rents.may seem very high to such a 
group, despite the relative decline in real 
rents nationwide. 
Finally, in some localities real rents inay have 
actually risen, because of local-government 
restrictions on housing supply coupled, per-
haps, with heavy in-migration. (However, real 
rents have not risen in San Francisco, Los 
Angeles and certain other areas where renter 
discontentappears to  be very high.) And clear-
ly,landlordscould hardlybeblamedforrising 
rents where such factors were in evidence. 
Attempts at control 
Whatever the genesis of  renter discontent, the 
simple fact remains that tenants outnumber 
landlords-so that rent control perennially 
remains an attractive legislative issue. The 
typical rent-control ordinance permits rents 
to rise only by the costs of maintenance and 
other variable costs, and forces landlords to 
document these costs in hearings before 
special boards. 
Proponents of rent control see such regula-
tion as a "fair" means of rewarding the land-
lord with "justified" increases while pro-
tecting the tenant from being "gouged." But 
this argument incorporates some rather 
questionable economics. The market rent, to 
repeat, is determined in competition with the 
owner-occupied alternative; if rents are "too 
high" relative to the true costs of owning 
housing, tenants will switch to ownership 
status until rents are brought into line. In con-1972=100 
108 
106 
104 
102 
100 
98 
96 
94 
92 
Real  Rental  Costs" 
90~~~~~~~--------d-d-~ 
1966  1970  1974 
trast, if rents are held below their equilibrium 
value (below cost) through rent controls, 
capital will simply flow out of rental housing 
until costs and rents are once again in line. 
This process of disinvestment generally 
occurs slowly (through under-maintenance 
and slowed construction) but it can, in ex-
treme cases, occur quickly through condo-
minium conversions, abandonment or 
demolition. However it occurs, the available 
supply of rental housing will decline, in 
quantity or in quality. (As far as the tenant is 
concerned, a decrease in the quality of 
housing at a fixed rent is the same as an 
increase in rents in well-maintained 
housing.) Thus the very goals of the policy-
controlling costs and supply-appear 
doomed to fail. 
Attempts to preserve the supply of rental 
housing by banning condominium conver-
sions similarly seem doomed to failure. By 
definition, a landlord is induced to sell rental 
units as condominiums when the capital in 
the rental housing is more valuable in an 
alternative use (owner-occupied housing) 
than it is in the rental market. If capital is not 
permitted to flow out of rental housing in this 
manner, it will flow out through undermain-
tenance -usually  with serious consequences 
for the neighborhood as a whole. 
For these reasons, rent controls must be 
deemed a failure world-wide. Most of 
Western Europe-France, West Germany, 
Holland-is now dismantling the wartime 
legacy of rent controls. Europe's experience 
with rent controls has been devastating: there 
is virtually no private construction of rental 
housing except at the luxury level, and gov-
ernment housing agencies have been unable 
to provide substitute public housing. Poor 
maintenance of rent-controlled housing has 
created many substandard dwellings, despite 
laws designed to punish landlords who fail to 
maintain their property. France in 1971 set up 
a special agency-the National Agency for 
Improvement of Housing-to deal with the 
*Rental component of 
the CPI deflated by the 
personal consumption 
expenditures price 
index. 
3 
increasing deterioration of  the rental housing 
stock. 
The United States has encountered similar 
problems with rent controls. In New York 
City, where controls have been in force since 
World War II, the result has been a virtually 
continuous decline in both the absolute 
numbers of rental units and their share in the 
total housing stock. Approximately 10 per-
cent of the housing units standing in New 
York in 1970 have been lost since then to 
deterioration and abandonment. Most of  the 
units were rental units. New construction, 
while partially offsetting the overall loss of 
housing,  primarily  has  represented  owner-
occupant housing. 
The solution 
Ultimately, we can provide economical 
housing only by encouraging additions to 
supply-that is, encouraging new construc-
tion. Only then will there be sufficient alter-
natives for households so that active competi-
tion will restrain housing costs and market 
rents. New construction need not be tai lored 
to the rental market to provide benefits for the 
renter population; competition at the margin 
between renting and owning ensures that 
rents and homeownership costs will move 
together. 
Curiously, many communities which impose 
rent controls also attempt to restrain new 
development  -Berkeley is one such 
community-usually with the aim of 
"preserving" the character of existing neigh-
borhoods. This combination of policies prac-
tically guarantees that neither wi  II be success-
ful. The undermaintenance that.occurs in 
such situations gradually raises implicit rents 
by lowering the quality of housing services 
and, at the same time, destroys the quality of 
the neighborhood itself. 
Randall Pozdena 'J!le::>  iOJSpU~J:J Ul?S 
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RANKING DATA-TWELfTH FEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and Liabilities 
large Commercial Banks 
Loans (gross, adjusted) and investments* 
Loans (gross, adjusted) - total# 
Commercial and industrial 
Real estate 
Loans to individuals 
Securities loans 
U.s. Treasury securities* 
Other securities* 
Demand deposits - total # 
Demand deposits - adjusted 
Savings deposits - total 
Time deposits - total# 
Individuals, part. & corp. 
(Large negotiable CD's) 
Weekly Averages 
of Daily Figures 
Member Rank Reserve Position 
Excess Reserves (+ )/Deficiency (-) 
Borrowings 
Net free reserves (  + )/Net borrowed (  - ) 
* Excludes trading account securities. 
#  Includes items not shown separately. 
Amount 
Outstanding 
5/28/80 
136,599 
115,092 
33,048 
46,356 
23,873 
1,032 
6,207 
15,300 
41,954 
29,311 
26,594 
64,539 
55,099 
22,822 
Weekended 
5/28/80 
336 
44 
292 
Change 
from 
5/21/80 
- 146 
- 13 
209 
34 
- 29 
- 103 
- 145 
12 
788 
- 392 
196 
354 
- 235 
31 
-
-
-
-
Weekended 
5/21/80 
199 
2 
197 
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!!PMPH  ..  P!UJOj!IPJ  ..  puozpV  ..  P>jsPIV 
(D)~~y~\\JJ~JJ~ \ill~~ 
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@£\\JJ@~@(QI TI~JJ@~@~ 
~  \ill~m~J1~<dI~crn \S{[~JJ~~;§~CQ[ 
Change from 
year ago 
Dollar  Percent 
9,942  7.8 
11,441  11.0 
2,232  7.2 
8,738  23.2 
1,835  8.3 
576  - 35.8 
1,521  - 19.7 
22  0.1 
381  - 0.9 
556  - 1.9 
3,250  10.9 
14,362  28.6 
14,283  35.0 
5,973  35.5 
Comparable 
year-ago period 
13 
202 
- 189 
Editorial comments may he addressed to the editor (William Burke) or to the author, , , , Free copies of this 
and other Federal Reserve publications can be obtained by calling or writing the Public Infonnation Section, 
Federal Reserve Bank of San Francisco, P,O, Box 7702, San Francisco 94120, Phone (415) 544-2184. 

Tenants' complaints

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Tenants' complaints

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Research Papers in Economics