Why Rent Controls are Such a Problem for Toronto

Why Rent Controls are Such a Problem for Toronto

Rent control is one of those thorny problems that seems like a great idea but inevitably fails to deliver. Today, we’re going to cover why rent controls have been implemented, and why they pose unique long-term consequences for Toronto.

What are rent controls?

First, let’s clarify what rent control actually means, and then how it’s been implemented in Toronto.

Rent control is a system implemented by a government to restrict how much and how often a landlord can increase rent. In Toronto, how much a property’s rent can be increased is decided annually by the Ontario Government based on the consumer price index, or CPI. Essentially, rent-controlled properties cannot be increased more than inflation, cannot be increased by more than 2.5 per cent, and can only be increased every 12 months.

Traditionally, rent control has been in force in Toronto. But then in 1997, the conservative government under Mike Harris eradicated controls on new buildings. Anything built after November 1991 wasn’t subject to rent control guidelines.

However, they basically grandfathered in any building built before November 1991, leading to what’s usually called ‘the loophole’.  If it was constructed before 1991, then rent controls were in effect. After 1991? It was not in effect.

Well, it worked—with rent control removed on new buildings, dozens of condo towers and housing highrises started going up, and rental and housing supply increased significantly.

Fast-forward to 2016/2017 and again, Toronto is in a housing crisis. There’s simply not enough rental property for everyone who wants it, and prices reflect this scarcity. We’ll get into the economics in a minute but what was driving this crisis wasn’t arbitrarily high prices, but rather a tremendous influx of new people to the city.

With pressure mounting for change, the provincial government reversed the 1997 decision. Now, rent controls were back on for everyone.

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The case for rent control—what they tell you

Rent control seems like a good idea because of inelastic demand. People need a place to live and so they’re usually willing to pay extraordinary prices to keep their homes. For example, imagine that your favourite brand of liquid laundry soap suddenly increased their prices by 1500 per cent. You’d probably just stop buying that brand. Even if every liquid laundry soap increased their prices by 1500 per cent, you could always buy powdered laundry soap or even a natural alternative.

In short, your buying behaviour is heavily influenced by price, that is, it’s elastic.

With rental property though, this is far less accurate. People are generally willing to give up many other things before they move out of their homes, even as rental prices increase. They are very insensitive to price, and thus, the demand is fairly inelastic. No matter what, they want their home.

Obviously, just like a drug dealer can jack up the price of cocaine and not see a significant drop-off in sales, so too can landlords potentially increase the price of rental property without significant risk of losing tenants.

So rent control is positioned a bulwark against the inherent greed of landlords (or so the story goes). By limiting the rental increase amount, rent is stabilized, and people can live in their homes. By keeping up with inflation and having provisions in place so that landlords can increase rent both between tenants and if they make significant improvements, they continue to make a tidy profit without devastating tenants.

So goes the argument for rent control.

But that’s not the whole story.

Everyone wants to live in Toronto.. and who could blame them??
Everyone wants to live in Toronto.. and who could blame them??

The supply side of rent control

So far we’ve looked at demand. But the second important thing to consider is supply—who is building new buildings for tenants, and how does rent control affect them?

When rent controls are in place, developers and investors are significantly less likely to drop the serious wads of cash needed to break ground on a new building.

Why?

Two reasons. If the developer is planning on managing a property and continuing to hold it on their books, their potential return on investment is far lower. What’s more, developers might end up in a position where other costs increase but they’re unable to increase their revenue, resulting in losses.

According to Jim Burtnick, SVP of sales at Sotheby's International Realty Canada, landlords already experiencing this problem with rising property taxes, water, and hydro bills eroding their ROI.

Second, if a developer is planning on selling the building as condo units, it’s a much harder sell to those looking to use them as investment properties. Since that’s a major market in urban centres, it makes the building more difficult to sell which in turn makes them more difficult to build. Jim Burtnick tells us:

If we didn’t have these foreign investors buying condos pre-construction, first of all these buildings wouldn’t be going up as quick as they are because they need to typically get to a 70-75 per cent threshold of being preconstruction sold for a developer to get financing.

Without investors purchasing condos pre-construction, Toronto would have far less housing stock than it does and be in a far worse off position then it currently is.

By making them more difficult for developers to sell pre-construction by limiting the potential ROI, rent control negatively impacts the total units available in the short- and long-term. And therefore, harms renters.

Toronto by Lisa De Jong
Toronto by Lisa De Jong

(unintended) consequences

Now we all know that a supply/demand graph is a great place to start, but often doesn’t tell the whole story of any property market conundrum. Human nature, government policy, and international factors all play a role.

And rent control is no exception.

When rent control is implemented, there are two significant unintended consequences. First, because rents can only be raised in line with government policy annually, BUT can be raised as much as landlords want between tenants, renters are extremely reluctant to move.

For example, the Financial Post reported an anecdote about how Norah Ephron (net worth: $15 million) lived in a rent-controlled apartment in New York City for years, paying a mere $1,500 p/month in rent rather than a market estimate of $12,000.

According to Jim:

Tenants have no incentive to leave... because they know their rent [increases] are capped at 2.5 per cent.

The point is that rent control discourages people from moving around different properties, thereby reducing the flexibility of the market and reducing vacancy rates.

To sum up:

  • Rent control is used to lower the cost of rent for renters over time and provide a stable, shock-proof rental environment.
  • The idea is to separate the rental market from the property market to better serve renters who are at the mercy of landlords (in theory).
  • In reality, rent controls disincentivise investment and thus limit supply of new rental accommodation
  • Rent control also stops people moving around, further reducing vacancy rates.

The result? Rent control actually harms the rental market.

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A better way

Rent control is the tool of choice for politicians because it’s a surefire way to capture votes. That’s why it’s so often the chosen solution for housing challenges in cities like Toronto.

The problem is it doesn’t work. So is there a better way?

According to Jim, the solution is really all about the basic economic equation – increasing supply faster than demand increases. With 100,000+ new immigrants every year to Toronto and long-term projected GTA growth of 42 per cent by 2041, demand isn’t going anywhere.

We need to foster an environment that attracts new investment and facilitate developers doing what they do best – breaking ground on new buildings.

In short, the best way we can serve the expanding rental market in the long term is a significant increase in how many houses there are in Toronto.

And the best way to do that is to make it easier for developers to do what they do best—the government just needs to get out of the way.

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