Second-Round Effects of Rent Control Laws: The Argentine Case

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Introduction

In colonial India, a city had an issue with its cobra population, which was a problem clearly in need of a quick solution given the sorts of things that they bring, like death. To reduce their number, the local government started to pay for each dead cobra brought to City Hall. People felt attracted to that bounty and took up cobra hunting. It seemed the perfect solution, and it worked indeed: the cobra population decreased.

However, things later started to get interesting. As the snakes’ population fell, and it became harder to find them in the wild, people became rather entrepreneurial. They started raising the snakes in their homes, which they would then kill to collect the bounty. Authorities eventually realized that there were virtually no cobras in the city, but the budget for the plan was growing bigger and bigger. Consequently, they cancelled the bounty. In response, the people raising cobras released them into the streets. After all, who wants a house full of cobras? In the end, the local government had a bigger problem than before: more cobras and less money.

The unintended consequence of the cobra eradication plan is a good way of demonstrating how certain attempts by governments to solve an issue ends up exacerbating the very problem they intended to fix. This happens quite often, and rent control laws are a good example.

Rent control laws exist throughout the world, even though it is one of the few policies that economists unanimously condemn. It seems, however, that most lawmakers are not economists, but my dear colleagues, lawyers.

Rent control in Argentina

Argentine lawmakers, amidst a world pandemic and trying to defy the forces of the market, recently enacted a rent control regime, applicable indiscriminately to all Argentine territory (the “Rent Control Law”).

In short, the Rent Control Law:

-Sets a three-year minimum term for leases, which is public order and cannot be contractually modified by the parties.

-Mandates that the rental fee shall be a fixed and unique amount for the whole term of the lease, set at the time of execution of the agreement.

-Establishes that rent increases shall be made automatically, yearly, in accordance with an index created by the government, which will be obtained by averaging the consumer price index and the average wage index variations. 

The aforementioned creates three main problems for landlords:

-The three-year minimum term and the impossibility to modify it entails quite a considerable time commitment. As not every lessor is a real estate mogul, many landlords cannot confidently determine that they will not need their property for such a long period.

-Determining future cash-flows or return-on-investment becomes impossible, as there is no certainty or parameter of what the rent will be for years two and three of the leases. 

-Losing against real inflation becomes quite a possible outcome. Argentina is a country with a tendency to have high inflation levels, and local governments have a strong tendency to fix public indexes so as to underrepresent real inflation, for political reasons. Now, such indexes will determine landlords’ profits.

Immediate effects

Those problems create a natural tendency to decrease the number of properties offered for lease, as landlords are less willing to enter into a market in such unfavourable conditions. What happens then? It is a basic economic principle that when the supply decreases and demand remain stable, prices ultimately tend to increase. Due to the Rent Control Law, these increases cannot legally occur once a contract is in full force and effect, but as this law does not regulate the initial rent, landlords have been placing considerable premiums into it, due to the inefficiencies created by the Rent Control Law. 

We can see, then, that the immediate effect of the Rent Control Law was to create high entry-level costs for prospective tenants. 

Long-Term effects

The gap between market and regulated rents also has an effect on the long-term operation of the rental housing supply. A rent control statute is a form of price control, and like all price controls, it results in a systematic gap between the large quantity of goods demanded (because the price is low) and the small quantity of goods supplied (for the same reason). Without regulation, the price would rise, the demand would ease, and the supply would increase until the market was back in equilibrium. This does not happen when rent control laws that reduce the future total return of investments are in place, basically because investors have no incentives to enter into such a business. 

Then, in the long run, rent control statutes only exacerbate the housing shortages they are said to alleviate.

Inefficiency

In the usual private market, both landlord and tenant have made specific investments in a contractual relationship that is subject to the risk of strategic behaviour at renewal. The tenant must incur the costs of finding new premises if the landlord raises the rent above-market, while the landlord faces the costs of finding a new tenant if the present tenant will not agree to the proposed increase. Yet in the private market, both landlord and tenant are reluctant to exploit the vulnerability of the other for fear of retaliation, and a quick and easy agreement on renewal spares both parties the risk and cost of conflict. 

The situation is far more complex with the Rent Control Law in effect because instead of having competitive markets make the decision, the law introduced a political formula for allowable increases within the term of the contract. If the increases mandated by such formula have been below-market levels, landlords will probably end up trying to compensate for their losses when renewing the term of such agreement, considerably increasing the rent at that time, or even taking the property out of the market. In the end, the money transferred by tenants to landlords may be the same amount, but in a much more inefficient way.

Fairness

Finally, merely fixing the price of something at less than the market value does not guarantee that the people who most deserve it will get it. The Rent Control Law did not target specific low-income leases and sought to benefit all tenants, but that does not seem so fair. Do we want, as a society, to benefit a millionaire renting a mansion at the expense of a retiree that leases a flat to compensate for his minimum-wage retirement?

It then becomes relevant to highlight that (i) not all tenants are in the lowest-income groups and hence not all are entitled (by a scheme of distributive ethics) to the gains the Rent control law seeks to give them and (ii) not all landlords are in the upper-income groups and hence not all are able to bear the burden of costs imposed upon them (mostly considering high local property taxes).

Conclusion

Sometimes we hear an idea and can intuitively feel it is a good thing, as a law to help tenants. Having a roof above our head is a basic human need, and seeking fair and adequate access to housing is a noble public goal, but rent control laws such as the Rent Control Law are not the appropriate measure to tackle the matter.

That does not mean there is no place for legislation. What it does mean is that lawmakers should be keenly aware that every action has both intended and unintended consequences and regulation ever more so.

By enacting the Rent Control Law, lawmakers chose to create winners and losers. The winners will be tenants with below-market rents (for a short time), while the losers will be everybody else in the long run.

The unintended consequence of the Rent Control Law is an increase in entry costs for prospective tenants and a reduction in the availability of rental housing in the long term, ultimately leaving both tenants and landlords worse-off than before. This is exactly the reverse effect of what was intended. Sound familiar? The Cobra Effect.

The lesson is that simplistic policies can come back to bite you. The next time we hear a politician proclaiming a simple fix to a complex problem, we better check for cobras lurking in the bushes.


Laureano Genin is a corporate lawyer based in Argentina.

Laureano Genin is a corporate lawyer based in Argentina, where he advises local and foreign companies on cross-border transactions for the acquisition and sale of Argentine and Latin American entities.

He is also a Teaching Assistant in Public International Law at Universidad de Buenos Aires.


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2 COMMENTS

  1. Great article Mr. Genin. I am a proud citizen of Argentina, but we cannot live with the State always in our lives and the worst economy.

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