Friday, June 20, 2014

Rent regulation, Krugman, Yglesias and reality

A couple of years ago, when the city rent regulations were up for renewal, I wrote an analysis for Met Council to rebut Paul Krugman's standard but flawed complaint against rent regulations. In it I supressed a key force in the development market largely because it seemed at the time too pessimistic. But this morning it occured to me that there's much more to be said about it, and it's worth saying, especially now when there's no rent battle.

First to recap: Krugman's column was focused on San Francisco without recognizing -- or perhaps not knowing -- legal and market distinctions between that city and ours crucial to a clear understanding of the market and regulations here.

On his classic liberal economic view of rent regulations, it is assumed that regulations dampen development, suppressing supply so raising rents. It is also assumed that deregulation will push out current residents, increasing the supply of rentals, so lowering market rents. Rent regulations, on this familiar view that Krugman followed, are the cause of the city's housing crunch and the consequent excessively high market rates.

In the Met Council piece, I showed that both of these assumptions are false in New York City. Because they do not apply to new construction, NYC rent regulations do not dampen development. On the contrary, they are one of the very few incentives to develop in this city, rather than just price up existing apartments, a much cheaper option than construction. Deregulation prices up existing rents, so it de-incentivizes construction. So the first assumption is plainly false.

The second assumption is a bit less plain. When tenants are evicted by a rent hike, the tenants typically don't leave the local rental pool. Employment, family or cultural preferences tie them to the locality (for us, the larger metropolitan area). Instead, many move to cheaper neighborhoods, where, especially in a city where the supply is limited, they increase the demand for housing in those neighborhoods, raising rents there and in turn displacing the prior tenants.

The overall effect is one of musical chairs, not surplus. When everyone has found a seat and settled in, the rents should be exactly as high as before. And as long as newcomers arrive, the rents will continue to rise. with no relief to existing tenants.

The economic difference will be an increase in the aggregate funds available for rent as the formerly regulated tenants devote more of their income to rent and those who can afford more rent move up into those deregulated apartments. The increase goes to landlords.

If deregulated tenants have less disposable income as a result, they may contribute less to the consumer economy or contribute more to the workforce. Both are undesireable: the former dampens the economy, the latter, if it's significant, lowers wages in the workforce, which can also dampen the economy and increase inequality.

Both Krugman and Yglesias agree that construction would ease the market. That is certainly true, as far as it goes (and that is as far as I went in the Met Council piece). But this is liberal market utopianism: deregulate and the invisible hand of the market will provide through the balancing of the individual interests of both developers and residents. There is a diminishing return on construction. Once the supply exceeds the demand, construction will end and developers will seek greener pastures. Developers are mobile, so the construction market in NYC depends on the construction market elsewhere. The tight market everywhere serves the rentier.

Worse, NYC, unlike most places in the world, has a well of demand with no visible bottom. Build it and the wealthy will come. Upzoning, Yglesias' solution, brings newly constructed units to NYC but does not ease market rates, it merely upscales the city. Since apartments respond to cultural fetishes, the more new units constructred, the more old neighborhoods become attractive. A city, like any cultural artifact, defines itself by a value structure of differences as well as of uses suited to distinct motivations. The Lower East Side, once a ghetto (explicitly named as such in maps in the 1920's) for industrial labor and a place to avoid as a utilitarian necessity, now attracts urban youth who would find a penthouse in a glass building culturally sterile.

If, in NYC, new luxury rents were set at market rate and then regulated thenceforward, the incentive to construct might not be too much curtailed. But this will yield more luxury constuction, not more affordable housing, nor easing of the rental market.

When New Yorkers complain that the rents are too high, they forget that landlords charge the highest possible rate that tenants are willing (or, at the bottom, can) pay. Rents are "high" because renters (those above the bottom) want to pay (the bottom have to pay). They are at a negotiating disadvantage, since landlords hold multiple options including warehousing, while renters are mere individuals, unorganized.

If Krugman and Yglesias are wrong -- that is, are deregulation of rents or zonings ineffectual -- is there any way to lower rents? Regulating profit margin might work. It has an interesting precedent in city government. (Thanks to Bill Cashman who pointed this case out to me). Abu Dhabi, the owners of the Chrysler Building, pay its land owner, Cooper Union, the assessed real estate tax on the land. As a non profit, Cooper Union pays no tax. So the rent on the land is in effect determined by the city and state. The Rent Stabilization Board also regulates landlord profit, but it doesn't do this individually, and landlords' books are not open.

A simpler answer would be to place all land and buildings into public hands. If the city could extract a reasonable rent from the 1%, they'd easily be able to manage effectively the current NYCHA properties and even build more affordable housing. If renters were allowed to strike, landlords would eventually abandon their buildings and the city would inherit them. Too bad it'll never happen. It's the only sane solution to "the rent is too damn high!"

6 comments:

Anonymous said...

Uh, yeah. Cuz you know more than Paul Krugman.

rob said...

If you pay attention, you'll see that Krugman was talking about San Francisco, without observing the differences between it and NYC. There's no reason to expect any expert in economics to know every local law that impacts economic policy. So, yes, I know some things Krugman doesn't know. There are some things you know more about than Krugman. "Appeal to authority" is a classic logical fallacy.

boweryboy said...

I'm surprised that you did not bring in how nyc's real estate market is the new hedge fund. Supply and Demand cannot find their invisible hand when the rich around the world see purchasing nyc real estate as a better bet than the stock market. Real estate in nyc has less and less to do with residential living -- tons of rich people don't want to live here, they just want a piece that will appreciate, and right now, a luxury pad has a higher roi than most stocks.

Cody said...

The idea that additional construction doesn't lower rents is just silly.

You posit an unsupported claim of bottomless demand, and a dogmatic lack of belief in the ability of the market to meet this supposed infinite demand. Even while the city of New York itself demonstrates the absurdity of this claim. Victorian capitalism managed to construct millions of units to meet demand, when bricks were carted to the site by horse and wagon

Land use and building regulations decrease supply by two main mechanisms. They increase the time and cost to bring units to market, with fees, risk, higher labor costs, etc. They also decrease the number of eligible sites for a particular use by restricting what can be done on each site. Therefore there are fewer potential outlets for supply to be brought to meet demand, and when a site that can meet a type of demand is available it is extremely valuable.

For example, suppose there is a site that could be used for luxury housing or workforce housing. Rising rents for both occupancy types indicate that there are shortages of both. Years of rising rents indicate severe shortages. Inferior locations have very high rents as rich people cannot live in the buildings they'd prefer to live in but which are never built. Middle income people then live in buildings that would otherwise be affordable, and so on.

Imagine we could say that the city is missing 20,000 units for the very wealthy, and 300,000 units for the working class.

Our site is in a Class B location. The rich will drive the price up here because the better locations have no available supply.

If the city had built 20,000 units of housing for the very rich, then this location would be better used for middle or working class housing, and the price of the land would be lower in response.

And housing would be built, given low enough labor costs. The break point is in land price, labor cost, and holding costs vs rent. All three of the cost drivers are increased by housing shortages. There is less labor available because there is insufficient workforce housing to house them and the rents are too high, setting a floor on area wages. Holding costs are higher due to higher land costs and due to excessive zoning and building regulations.

And land costs themselves, obviously, reflect years of pent up demand due to limited building activity/month on limited legally buildable sites. The cost to develop is also due in part to the enormous expertise required from entrepreneurs and companies trying to navigate the regulations to build.

You are right that housing is first built for the ultra-wealthy. You are right that at first this pushes more people away from the center. Development has ALWAYS been built for the wealthiest first. But you fail to see the next steps. A substantive satisfaction of the pent up demand, a lowering of land values, the allocation of formerly too-expensive sites for the building of housing for the middle classes.

Market function leads to development that is more evenly distributed throughout the city, at varying price points. But in each location development is likely to be specialized to its highest use. The city organizes itself in to nodes of wealth, but the wealth is far closer to the middle and lower classes than today because land value variance is far more finely grained.

With pent up demand the highest use is always the same - the ultra rich whose rents the land values are based on. But when this demand is satisfied and land values can no longer be valued against it, highest and best use patterns become far more nuanced throughout the city.

Cody said...

We can see a pattern in our older cities from the time before zoning. Instead of a mass of wealth and masses of poverty, we see nodes of wealth throughout the city, each surrounded by less intense uses for the middle and lower classes.

People imagine that without zoning every building would be a high-rise. But in reality the nodes of density are in varying locations each rather concentrated. High-rent demand is small in comparison to the demand for more modest dwellings.

Pre-war Chicago followed this pattern.

We should also have no fear of Karachi-like patterns. This is a function of a populace that is far more impoverished than Americans, with lesser expectations from their living arrangements. Tehran or Karachi is what happens when there is very high demand for housing for the poor, but nobody is wealthy. Endless tenements.

rob said...

Cody: Your analysis is exactly what I wrote for Tenant/Inquilino so many years ago in the context of rent regulations: they are an incentive to develop and development is the only way to ease rents in a tight market. But there are several confounds, among them:

Developers develop first at the top. As soon as supply exceeds demand at the top, development halts in an attractive city where expectations are high. So the downscale market is never eased.

Empirical: overdevelopment recently has softened the market only for the upscale; nowhere in the Bronx, e.g., has rent declined.

So current rent regulations have failed to prevent overcrowding of families downscale, and it's just a matter of time before upscale rents will increase. And deregulation would make it even worse for the bottom although it might ease the top, as I explained in the Tenant/Inquilino piece and elsewhere on this blog.

Development is finance-intensive, so the low interest rates available since the financial collapse are an incentive for developers to build now while the rates are low. So I think the soft market is actually a supply-demand anomaly induced by the Fed's attempt to stimulate the economy. If you've read the series on the history of the tenement on this blog, you'll see this appears to have happened a couple times in the past, once when tenements were first built around 1820, resulting in one seven-story tenement overdevelopment, and then just before the 1901 New Law, resulting in a handful of seven story Old Law single-lot tenements.

If you respond, please avoid disparaging judgments like "silly" or "dogmatic belief." It makes it more difficult for me to respond appropriately. Re dogmatic: my account was against the dogma. On the other hand, there's Say's Law. In economics, there seems to be a dogma for any taste (-;

Thanks for your comments.