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Rent control's bill comes years later
What rent control changes
Rent control lowers the return on owning residential real estate and makes that return less certain. Once some rent control exists, it is easier to extend it to other units or adjust its parameters. Because landlords no longer capture the upside of maintenance, it also invites later regulations that may not match what tenants were willing to pay for.
Discount rates and risk
A new apartment building gets built when the present value of its future rent beats the cost of construction, and that present value depends heavily on the discount rate. The discount rate reflects how much risk a buyer takes on and how much of it can be hedged. Owning five units instead of one provides some diversification, and under CAPM, risk that can be diversified away earns no extra pay.
Rent control adds a factor that moves every property in a city at once. Cash flows from all those buildings start to move in lockstep, so each added unit diversifies less, the market-clearing price of new units drops, and fewer potential projects clear the return hurdle needed to get built.
A chemical parallel
Environmental regulation has the same shape in the chemical industry: it adds a new core competency to master and makes results more correlated because they respond to changes in law, which adds up to a higher cost of capital and a lower supply of chemicals.
How did San Francisco's expansion affect supply?
In a study in the American Economic Review, economists Rebecca Diamond, Tim McQuade, and Franklin Qian examined a 1994 San Francisco ballot measure that extended rent control to small multifamily buildings built before 1980. Landlords of the newly covered buildings cut the supply of rental housing by 15 percent, by selling to owner-occupiers, converting to condominiums, and redeveloping. The authors estimated that the reduction pushed citywide rents up about 5 percent. Tenants who already lived in the covered units were 10 to 20 percent more likely to stay at their address.
Why does correlated risk raise required returns?
The capital asset pricing model, developed in the 1960s by William Sharpe and others, says investors earn extra return only for risk they cannot diversify away. When one policy hits every building in a city, the risk is shared across all of them, so holding more buildings spreads it less. Investors then demand a higher expected return before funding a new project. A higher required return shrinks the present value of the same stream of rents.
Why do many rent control laws exempt new buildings?
Lawmakers who want construction to continue often leave newer buildings out, so developers can count on market rents. New York's rent stabilization system, for example, has covered buildings put up before 1974. California's Costa-Hawkins Rental Housing Act of 1995 barred local rent control on units first occupied after February 1, 1995, and on single-family homes.
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