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Be careful what you wish for

Legislation limits the choices available to people in a market, so it better be for a good reason

Let's take a small detour before we get to the point of this article. The New Zealand (NZ) Government recently is introducing a raft of new legislation under the Residential Tenancies Agreement (RTA) to protect tenants. Among others, the changes include:

  • Security of rental tenure - landlords can no longer end a periodic tenancy without cause by providing 90 days' notice.

  • Ban on rental bidding - landlords can no longer list a property without a price and encourage bidding by prospective tenants.

  • Fixed 12-month rental terms - rent increases can only occur every 12 months rather than every six months.

Predictably, the Real Estate Institute of New Zealand (REINZ), a real estate professional body has expressed its views on the RTA. They warn that tenants without an excellent track record may struggle to find a property due to the RTA. REINZ also notes the potential for unintended consequences such as landlords selling their properties, reducing the supply of rental property. Queue landlords evicting tenants because of new rules.

NZ isn't the only country in the world with systems to protect tenants or control the rental property market. Rent controls existed in Ancient Rome to prevent price gouging. In France, a landlord must give at least three months' notice of eviction. In California, tenants on monthly rental agreements must get 30 or 60 days' notice of a rental increase. Various jurisdictions seem to favour the tenant or landlord more.

For the purposes of this article, it doesn't matter which example you pick. Despite initial appearances, this article is not about whether the new RTA legislation is right or wrong. Nor is it about tenancy rules or housing directly.

The recent legislation is just a neat example to illustrate an idea core to economics - that the introduction of rules often limits the number of choices available to agents in the market looking to transact, making it harder to reach a mutual agreement.

Fundamental to economics is the idea that rules limit the choices available to people in a market

Across industries, time, country, planets, and alternate universes, this dynamic of rules limiting choice plays out pretty predictably. In this case, tenants' and landlords' choices are limited by the introduction of legislation. For example, a tenant who wants to rent a house and is willing to accept less than 90-days notice for eviction can no longer do so under the RTA.

See the Venn Diagram below to illustrate the point. In a scenario with no government intervention, tenants and landlords have the set of choices to reach an agreement defined by the 'yellow' intersection. With government intervention, tenants' and landlords' choices are reduced by the 'red' area. They have a smaller set of available choices as the terms of their agreement must intersect with the government rules as well.

Set of choices with and without government rules

The result of this legislation is that there are fewer opportunities for parties to come to an agreement because the choice set is more limited. Again, not just talking about tenancy rules.

Your gut reaction to this is probably something like 'that may be so, but...!' - and that 'but' is fair enough. There are plenty of reasons to introduce legislation. The area in 'red' may represent outcomes unacceptable to a prosperous society e.g. people living in squalor. It could be that legislation is needed to protect the vulnerable or address market power imbalances. Those are just a few examples. Of course, governments need to be aware of the unintended consequences of rules to achieve these things, we will come back to that shortly.

What we see with legislation like the RTA is the government establishing a market boundary. Enacting the RTA suggests that it is vital we uphold tenants' rights in certain areas (e.g. rental security). We must have this minimum level of rights, regardless of some people being willing to settle for fewer rights. Frankly though, it's unlikely many governments think of it that way.

The answer to the question 'should we introduce this new piece of legislation?' is usually 'it depends' - which is as unsatisfying as it is true

Let's look at an example of how limiting choices could be counterproductive, despite the best of intentions.

A government decides it wants to improve housing affordability. They have many options to achieve this ranging from housing subsidies to building social houses directly. All of these should be considered. For argument's sake, let's say the government chooses to impose a rent threshold.

  • Tenants paying over the threshold would now pay less. The home is more affordable for them and the government has achieved its goal for these people. Big win for them.

  • Tenants under the threshold may see their rents go up if the landlord views the threshold as a target, or seeks a higher return to offset other properties that were over the threshold.

The immediate impacts could suggest that the policy works, particularly for those over the threshold.

Now let's come back to unintended consequences. Long-term there could be a reduction in the quality and quantity of rental housing. Landlords may not maintain the property if they are making less of a return. Those who own investment properties may see less reason to rent them out in the first place. Houses could become more cramped if there are fewer rentals on the market, which could mean diseases like the flu are spread more readily. Tenants and landlords may look for ways to bypass the new rules.

When people's choices are limited by legislation, they look for alternatives and optimise within the new 'set' of choices. So while housing affordability might have improved temporarily for some tenants due to rent controls, the higher goal of having more people in affordable houses could fail long-term due to the change in people's behaviour.

A 2019 study in San Francisco demonstrated that due to rent controls landlords removed rent-controlled units from the market, leading to a 15% reduction in rental units, and a 7% increase in rent, across the city. Rent control meant that San Francisco's housing became less affordable, despite the objective of improving affordability.

The road to hell is paved with good intentions.

Beware of third parties creating new rules that don't affect them

None of this discussion is to suggest that tenancy laws or rent legislation are a good or a bad idea. It's simply to illustrate the point that legislation can reduce choice, impede the ability of parties to reach an agreement and lead to unintended consequences that run counter to objectives.

Where we land is that if a government decides to introduce legislation they need to be aware of who they are limiting the choices for and the response of market agents. Unintended consequences have a habit of coming back to bite.

It often isn't governments that pay the price for bad decisions. Due to term limits, voting patterns and the time it takes for something to move from a 'good idea' to a 'bad idea', those who enacted bad legislation may never be held accountable. The cost of bad policy is ultimately felt by those who have to deal with the consequences.


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