Santa Monica: Surf, Sand, Rent Control, and Whitey Bulger

Posted on July 1st, 2011 (1 Comments)

Here in Boston, the buzz has been non-stop about the recent capture of Whitey Bulger, the former head of the so-called Irish Mob and long-time member of the FBI’s Most Wanted List. I hope his arrest will provide justice and closure to the families of victims of his crimes.

An interesting tidbit of Mr. Bulger’s 16 years on the lam is that he lived in a rent controlled apartment complex - The Princess Eugenia - in Santa Monica, California. The jailed gangster paid $1,145 a month for a two bedroom apartment which could have been rented on the open market for $2,600. Like me, you are probably wondering, “Why does rent control exist?”

Imposing rent control is typically viewed as an anti-gouging policy to prevent landlords from unfairly increasing rents to existing tenants. In Santa Monica, for instance, a rent control law was passed in 1979 to “alleviate the hardship of the housing shortage and to ensure that owners received no more than a fair return.”

Under rent control, an apartment is rented at market rate and generally, as long as the tenant occupies the unit, annual increases are regulated by a local government agency. Approved rent increases for 2009 and 2010 in Santa Monica were 1% and 2% respectively. In San Francisco, annual rent increases are limited to 60% of the Consumer Price Index (CPI). Once an apartment is vacated, this market rate/CPI-related increase cycle starts over. New construction is usually exempt from rent control.

I, along with most of the economics profession, believe that rent control makes little sense.

First off, why are tenants being singled out to be protected from the vagaries of the housing market? With the recent burst of the housing bubble, the median value of houses in the U.S. has dropped by 27% from its peak in mid-2006. Housing owners have to experience the ups and downs of the housing market, why shouldn’t those who rent?

An odd side effect of rent control is that current market rental rates actually increase. Many incorrectly assume that when an apartment is vacated, landlords set high rates to compensate for their previous “losses.” This is neither true nor possible – the market dictates the rental rate. Suppose you are looking for an apartment and are quoted a price that is $500 more than comparable available units. Explaining this premium, the landlord mentions the last tenant stayed for 20 years and s/he now needs to “make up” for years of low rent. Are you going to pay the premium? Of course not. Rent control restricts the supply available to satisfy demand. This scarcity leads to higher market rates.

Consider Santa Monica, which due to its proximity to the ocean and eclectic local shops, is one of the most desirable Los Angeles neighborhoods to live in. If most of the apartment supply is occupied by people paying less than 50% of the going rate (as Mr. Bulger was), the limited supply of apartments that becomes available will be snapped up by people at the top of the demand current curve – those who are willing to pay the highest prices.

Rent control also results in cross-subsidization by owners of non-rental local dwellings. Since revenues are limited by rent control restrictions, the values of apartment complexes are below what they could be. To fund local budgets, the only alternative is to raise property taxes for everyone.

Finally, rent control laws curb investments into existing properties. Suppose you own an apartment complex subject to rent control and have $100,000 to invest. Would you invest into your apartments knowing that your upside is limited to CPI-related adjustments or find an alternative non-regulated opportunity?

To be clear, rent control is not intended to be a social policy to subsidize low income tenants. Instead, its unabashed goal is to “protect” renters by limiting future price increases to costs (CPI) and not take into account any market changes.

So what do you think about rent control? Are you pro or con?

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