A Grand Coalition of Folly: The Rental Price Cap

The fact that politicians put forth populist and economically irrational proposals just prior to elections to garner a few extra votes is apparently an evil we must learn to live with. The most recent example of this phenomenon is the ‘rental price cap’, a proposal motivated by the rapid rise in rental prices that has been witnessed in urban centres over the past few years. In Berlin, for example, the cost of new rentals has risen by around 40 per cent since 2007. For individuals with low or moderate incomes, it is becoming more and more difficult to reside in desirable neighbourhoods. To counter this trend, the SPD wants to stop the rise in rental prices through new legislation, and the CDU has indicated its willingness to go along with such measures.

Currently  increases in rental prices in Germany are capped at 20 per cent over a three-year period, for new rental contracts prices arefreely negotiable. The SPD favours capping rent price increases at 15 per cent over a four-year period, but their proposal would also include limitations on price increases when tenants change. The CDU would exempt newly constructed buildings from the rental price ceilings so as to preserve incentives for construction investment. However, rental price increases for existing properties would be capped under the CDU proposal.

These measures would, in fact, curb the rise in rental prices. Those individuals fortunate enough to already be renting an apartment in a sought-after neighbourhood or able to find a new apartment despite the rental regulations would be relieved of the burdens of higher prices at the landlord’s expense. This outcome is deliberate, as renters apparently enjoy more public sympathy than landlords.

However, these proposed measures would have devastating side effects. Above all, they would aggravate the housing shortage problem, and this effect would be immediate, occurring even before any observable decrease in building activity. More rental properties will be converted into condominiums, or, alternatively, leased as commercial real estate. In addition, the new regulations would make it preferable to leave dwellings unoccupied in anticipation of an increase in their value. Anyone with a larger rented apartment who, in fact, no longer needed as much space, say, because their children had grown up and left home, would not want to move into a smaller apartment. The rental cost for the old apartment would be relatively low, and new apartments would be virtually unobtainable. The rate of owners using their rental properties as personal residences would also increase. In the medium term, the decreased availability of rental apartments would be further accelerated due to the lack of new investment. Refurbishing and modernisation measures would be cut back and fewer new apartments would be built. New construction would be affected even if new rental contacts were exempted from the rental price cap, because investors take into consideration that apartments will be leased multiple times.

The rental price cap would also alter the market for the few remaining rental apartments. Since with lower rental prices, demand would vastly exceed supply, arbitrary discrimination would become more widespread in the rental market and the pressure would increase on renters to circumvent the price cap through payments “under the table” to brokers or property owners. The consequences would be corruption and tax evasion. The disruption in price formation for rental apartments would have adverse effects throughout the real estate market. Since it would become more difficult to find a rental apartment, mobility would decrease, with negative secondary effects, such as greater unwillingness to take on a job in a new location.   

It would clearly be more effective to attack the root of the problem and develop new models for sustainably enlarging the supply of affordable housing. However, this would require a level of expenditure that government budgets are currently in no position to undertake. Imagining that this deficiency could be eliminated for once and for all for through price regulations is an illusion. The government has to focus on its core mission. In the housing market, this core mission is to assure that needy households can find suitable housing. To accomplish this, transfer payments such as housing allowances need to be adjusted as necessary to match changes in rental costs. By contrast, across-the-board rental price caps would only serve to undermine the functioning of markets and intensify the housing shortage.