The Rights and Wrongs of Regulation
The City of Berlin recently opted to uphold a summertime proposal from the municipal Government to cap rent increases in the most visible sign of new rent controls in Europe. The reaction is understandable, with average rents in Berlin up 107% since 2009. With 14% home ownership this proposal is also a strong play to the electorate, showing that politicians are prepared to act against unaffordable homes in Europe’s cities under population pressure.
But, with all biases declared, this is bad policy.
There is a long history of political tinkering with housing markets. Housing costs are also a truly unifying issue, with cities across the developing and developed world trying to manage unmanageable house price and rent rises. Urbanisation is ubiquitous, but so too is the intractable challenge of a meaningful housing supply response to keep costs in check. Where solutions are in action, they take a long time and even more political capital against often voracious anti-development opposition.
So, local politicians see regulation as the easy out. In so doing, they contribute to even greater problems.
Landlords, faced with no room to grow revenue, respond by slashing costs. Property management suffers, capital expenditure is pared back, and voila - a literal second class tenure emerges. As conditions deteriorate the pressures for renters to buy can incentivise landlords to sell up all together, exacerbating problems of availability in rental stock.
At the same time, investors are now less likely to buy or build new stock, so improvements to housing quality are biased towards owner-occupation. Even in Berlin, where properties built after 2013 are exempt, the fear of ’mission creep’ is enough to put investors off. There is a weight of empirical and academic research that shows these impacts are the inevitable market response. It’s a lose/ lose outcome.
Municipalities need to understand that the market is broadly rational and is able to re-weight capital towards more favourable locations or sectors. Residential investment is not a closed loop anymore - roughly 30% of investment in 2018 was cross-border. Unless the state is inclined to bring all rental housing on balance sheet, it will go elsewhere. Working alongside private landlords is a far more productive use of policy.
As Andrew Allen, Global Head of Investment Research (Real Estate) for Aberdeen Standard Investments notes, rent controls per se aren’t the problem. As a manager of in excess of £7bn of direct residential investments, the ASI perspective is that any control has to be set fairly for both resident and investor, with long term stability at its core. Controls that are ultimately unstable or uneconomic will simply push long term capital sources away from residential investments. There is much evidence and interest from huge flows of capital prepared to develop and modernise the badly needed stock of European housing. It could be an extraordinary own goal - for which nobody benefits - to undermine this opportunity to help solve Europe’s housing crisis with the investment ambitions from long-term institutional investors.
With Berlin, we are at an inflection point. It is perhaps more socialist than most European cities, with the new regulations borne out of a former East German party. But, it may also be a harbinger of wider change; Paris, Madrid, Amsterdam and London have all made softer moves or noises to legislate rental markets.
The message to policy makers is clear - don’t be fooled by the easy option. At least, don’t make these policy changes without a clear understanding of the local market response. For investors, the message is more nuanced. Residential investment remains highly attractive, but current pricing may not fully reflect policy risk. Take note.