Soaring rents may expose flaws in longtime economic theory: Don Pittis

From the vantage point of Winnipeg, Wayne Simpson has seen two sides of the Canadian property market.

"My daughter was in Vancouver with a good job and fled to Calgary — she does her job, in Vancouver, out of Calgary," says the University of Manitoba economics professor.

Simpson's personal experience is quite different. He lives in Winnipeg, a city subject to a provincewide rent control system that officially limits increases to between one and three per cent.

Economic error?

In Toronto, reports of landlords suddenly demanding huge rent increases have renewed demands to expand rent control there. But the economic questions the increases raise affect people across country.

According to the theory of market rents, those staggering rent rises weren't supposed to happen. Ontario's former Conservative premier Mike Harris specifically changed the rules to end rent control on housing constructed after 1991 for the very purpose of letting market forces restrain rent increases.

So what went wrong? Is the economic theory false?

This week, an economist at one of the big banks, Benjamin Tal from CIBC, released a report restating what is treated as a given by many market economists — that rent controls create a rental property shortage.

The corollary of that argument is what advocates call a "free enterprise" system, where landlords can charge rents as high as the market can bear. In that case, says the argument, market signals will convince landlords to build more rental units, filling the gap in demand, and holding rents down.

The problem is that data from hot markets around the world shows that taking the lid off rents leads to a flood of income to speculators who have invested in rental properties, but shows little sign of keeping rents affordable.

Marc Vachon, chair of the geography department at the University of Winnipeg, who currently studies the impact of micro condominiums on Canadian life, lives in a rent-controlled building and recently fought an attempt to increase his rent by nine per cent. After appealing to the regulator, the increase was rolled back to 2.5 per cent.

"That's always been the argument, that rent control stops the development of new rental units," says Vachon. "This is not so true for Winnipeg."

The city has seen a glut of condo construction, and a downtown hotel recently converted itself to rental units.

Simpson also points to a building boom in the city that has continued despite the rent control system.

Rent control light

One reason may be that while long-term tenants have rent increases held to inflation, once they move on, landlords can do major renovations, allowing them to charge rates much closer to current market rates.

Also, says Simpson, building rental accommodation remains a good investment. Newly built properties provide a good safe stream of future income. Rents are set at the current rates when they are built and rise with inflation. The loss of any future windfall should prices suddenly rise is seen as a reasonable trade-off. (See details and exceptions for the actual Winnipeg system here.)

Evidence from the U.S. shows that in the past, moderate rent controls haven't had a strong effect on the construction of rental properties.

"Simply building more units to bring down overall prices might work in some settings," said a 2015 report in Pacific Standard, "But in tight housing markets that are already heavily developed, as most major Northeastern or West Coast cities are, it's unclear whether rents are primarily driven by supply."

As with other free market truisms, such as the idea that raising minimum wage causes unemployment, a simple economic analysis doesn't always work in the complex real world.

The same sort of simple economic argument says high rents and high property prices drive away the bright young people that make a modern economy thrive. Tell that to Hong Kong, Tokyo, London and New York.

Vancouver places 39th on the recent Economist list of expensive cities. Toronto comes in at a bargain basement 86th.

"Toronto and other big cities ... have advantages that don't go away just because it gets more and more expensive," says Simpson, who still tries to entice faculty and students with Winnipeg's lower cost of living.

Solving the wrong problem

There is another possible reason why freeing market rents does not lead to sufficient building. It may be that rent controls never were the real cause of the housing shortage, says University of Calgary economist Trevor Tombe.

"Real estate is one of those really complex markets where there's all sorts of overlapping policies and overlapping jurisdictions," he says. Zoning or transportation issues can mean new rental properties don't get built in the areas where demand is strongest, bidding up the most desirable properties.

Others have said that foreign investors or empty properties being held, unrented, for speculation are important causes.

Even if evidence from elsewhere shows that moderate rent controls pegged near to inflation don't destroy the rental market, Tombe's observation is one more reason why regulators must look beyond rent controls to solve property shortages.

• Why a housing bubble is good (but maybe bad for you)

Of course, it may be that in Toronto's Wild West property market, the economic theory on free market rent has been right all along. It's just that we'll only realize it once the property bubble finally bursts.

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More analysis by Don Pittis