Thursday, April 24, 2008

Rent controls demanded

There was a whinging letter in the SCMP this morning demanding that the government introduce rent controls to protect tenants against "greedy landlords".

Leaving aside the tone of snivelling, self interested hypocrisy in the correspondent's letter, history has shown that, like other forms of price controls, rent controls have been a bad thing for all concerned. The usual consequences of rent controls are:

1. poorly maintained properties due to the need to cut costs elsewhere and the absence of incentive to maintain or improve properties;

2. risk of default and foreclosure if interest rates rise above the controlled rent level (which in Hong Kong also results in tenants being evicted);

3. reduced supply of properties for rent as investors avoid the market and deploy their capital elsewhere and speculators revert to the practice of keeping their properties vacant to make them easier to sell and banks make finance for investment properties more difficult to obtain.

Landlords are already assuming significant economic risk when purchasing a property. They have to pay outgoings, maintain the property and meet their mortgage obligations (among other things). As investors in the US can testify, investing in property is not a risk free proposition. Even in HK, one only has to think back to the period from the beginning of the Asian crisis to the end of the SARS epidemic when residential property prices fell by about 60%. Landlords are entitled to a return on their investment to compensate them for the use of their capital and the risks they take by being property owners. Part of that return is rent.

It is tempting to suggest that landlords who suffered horrendous capital losses, declining rentals and high vacancy rates during the downturn are entitled to enjoy the benefits of the economic boom. They are, but that is irrelevant to the point that the free market is the best way of setting the price for all goods and services (other than those in a monopoly situation).

As to the level of return, a small flat in a building of average age in an average area would currently show a net yield of between 4-4.5% after outgoings but before mortgage payments. (More expensive properties will show a lower net yield.) This is less than the earnings yield on the Hang Seng index and, in a place where inflation is above 5%, is hardly exorbitant.

The blunt reality is that rent levels have lagged capital appreciation and are only slowly catching up in response to rising demand for accommodation.

Not only are rent controls economically bad, they are morally indefensible.

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