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Removing California's Costa-Hawkins Act and the Future of Rent Control

In an attempt to combat prohibitively high housing costs in California, some look to repeal the 1995 state law that limits the power of local rent control ordinances. However, removing those restrictions would likely exaggerate current problems.
Reuben Duarte | @reubenduarte | April 5, 2017, 12pm PDT
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In 1995, California passed the Costa-Hawkins Rental Housing Act (Costa-Hawkins), which placed a limitations on local rent-control ordinances. Costa-Hawkins has been derided by liberal housing advocates who argue that Costa-Hawkins is partly responsible for the inability of cities with high housing costs to provide affordable housing. California State Senator Richard Bloom (D-Santa Monica) has co-sponsored Assembly Bill ("AB") 1506, which seeks in plain language to repeal Costa-Hawkins.

Earlier in March, a segment on the local NPR affiliate featured two advocates, Dean Preston, executive director of Tenants Together, a renters rights organization based in San Francisco; and Fred Sutton, director of Government Affairs at the Apartment Association of Greater Los Angeles. The segment is about 24 minutes in length and worth the listen. Preston takes a largely municipal rights position, arguing that cities are best able to determine how to define rent control and argues that repealing Costa-Hawkins would have little impact on construction activities. Sutton takes a largely economic standpoint: that rent control is a type of price control that leads to price distortions and would definitely have an impact on construction of new housing. Given the prominence the housing cost debate has taken in California's largest cities, particularly in cities that would more likely enact stricter rent control activities should the option present itself. Thus, it seems appropriate to briefly explore this question: What would happen if Costa-Hawkins really was repealed?

Costa-Hawkins and rent control

There is no statewide rent control law in California. Rent control is at the discretion of local municipalities. In fact, only 15 cities in California have some type of rent control ordinance, including Los Angeles and San Francisco. Costa-Hawkins places limits on these local ordinances, including prohibiting the rent control of buildings constructed in 1995 or later, established "vacancy de-control"— the ability of a landlord to set new market-rate rents after a tenant moves out of a rent-controlled unit, as well as exempted single-family homes from any rent controls. Costa-Hawkins makes other changes, but the three listed are arguably the largest impacts and their removal would represent a big shift in housing policy in California.

Does rent control work?

It’s worth briefly discussing rent control itself. The most common reasoning behind implementing rent control is that housing costs are high, so capping rents is a way to ensure that costs can remain affordable. However, there is littleevidence that rent control actually makes overall housing costs affordable. In fact, the majority of economists and existing literature conclude that rent control leads to housing cost increases. One of the early studies on rent control, and one of the most cited, was in 1988 by economist Anthony Downs of the Brookings Institution.

Downs explores rent control in depth, identifying two types of rent control designs: "Stringent" and "Temperate." Downs explains that the long-term effects of rent control on the cost of housing is negative at best, but the design of the ordinance can moderate or exaggerate these negative effect. Variables include the types of housing units covered under rent control, the inclusion of vacancy de-control, whether rent is capped or tied to a formula permitting adequate increases to cover operations and maintenance, the length of time the ordinance is intended to be in effect, and the overall market conditions that exist.

Downs also points out the basic economic supply and demand argument: rent control often appears to be most appealing at a time of high-inflation, or a rapid increase in housing costs. However, at that time, the appropriate response to low supply and high demand is to increase supply to place downward pressure on prices. Rent control, particularly stringent rent control, offers little incentive to developers of all stripes to construct new units because they would be financially unfeasible, particularly those needed high-density developments that are often beholden to investors, such as large institutional banks.

Additional studies worth exploring include the 1995 paper by Richard Arnott (pro-rent control advocates used his work to justify rent control to such a point that Arnott actually wrote a supplemental paper refuting those claims, citing misunderstanding of his research) and the 2012 study for the National Bureau of Economic Research that explored the effects after Cambridge, Massachusetts abolished its rent control in 1995. I welcome additional, peer-reviewed, studies, advocating either side, added to the comment section of this post.

No rush to new rent control

In a post-Costa-Hawkins world, there would likely be little immediate change. Cities would need to engage in long discussions and contentious votes on whether to expand existing rent control ordinances. This will pit the usual interest groups against each other and action would not happen overnight.

Additionally, only 15 cities in California have some type of local rent control as shown below. There are hundreds of cities in California, and 88 in Los Angeles County alone.

California Cities with Rent Control

Berkeley

Oakland

Beverly Hills

Palm Springs

Campbell

San Francisco

East Palo Alto

San Jose

Fremont

Santa Monica

Hayward

Thousand Oaks

Los Angeles

West Hollywood

Los Gatos

Further, though high housing costs in the coastal areas of the state make the news, housing prices (sale and rent) inland and in the central part of the state are still relatively affordable (by California standards, maybe). Thus, even with a repeal of Costa-Hawkins, it's unlikely that there would be a rush for additional cities to pass ordinances where none previously existed.

Nevertheless, removal of Costa-Hawkins frees up cities to impose more strict—stringent—rent control ordinances. In theory, cities with existing ordinances could pass universal rent control covering all units, new and existing.  Despite what would be a slow start, if we assume cities like Los Angeles moved forward with more stringent rent control, we would likely see some long-term effects.

Post-Costa-Hawkins Los Angeles

At the time Downs wrote his paper, he described Los Angeles as a temperate rent control city. That characterization was in part due to the fact that rent control in Los Angeles exempts new construction—units built after 1978—from price controls. Thus, units with certificates of occupancy dated October 1, 1978 or later may be rented at market rate. Repeal of Costa-Hawkins would permit L.A. to shift from existing temperate rent control policies to stringent policies, resulting in a number of effects in the housing and development markets.

Decline of new rental unit construction

Capping prices of rental units is largely the same as establishing inclusionary housing requirements. Except, where inclusionary housing requirements are often limited to a percentage of the units, usually around 10 percent to 35 percent, stringent rent control would cover 100 percent of units (absent specific language to the contrary).

Contrary to popular opinion, there are few developers in the industry who can self-finance a project. The vast majority of development projects require a number of investors, including institutional banks. Whether the universe agrees with the premise of profit for housing or not is really beside the point. We have to accept that, like any business, developers must show a return to these investors to even begin the project. By comparison, those who construct 100 percent below market units—affordable housing developers—receive a great deal of subsidy from the local, state, and federal government to make their projects financially feasible.

The difference between a true affordable housing developer and a developer required to cap rental rate of new units is that new projects providing normal units at below market prices as a result of a price cap would not qualify for the same level of subsidy. Thus, it is not realistic or reasonable to expect developers to construct new units when the proposition would result in a net loss for the developer and his or her investors. Such a reality would keep investors away from rental projects, and without adequate investment, these projects would ultimately go undeveloped.

With stringent rent control impacting both existing and new rental units, we would likely see a steady decline of new construction of rental units while a modest increase in the proportion of for-sale unit construction (think condos and single-family homes). This would be very noticeable in a city like Los Angeles, where the bulk of new multi-family housing has been rentals, in part because the cost to own and cost to buy have been relatively close, and the barriers to home buying have been onerous to first-time buyers. Nevertheless, if rental prices are forced to artificial lows while construction and regulatory costs remain high, and absent any direct subsidies to developers, there is little to no incentive to continue to construct rental units. Instead, developers will likely shift to for-sale units, such as condominiums and single-family homes out in the peripheral areas of the city.

Increase in overall housing costs

This is an interesting effect because a vast, stringent citywide rent control would essentially cap rents and, thus, housing costs. But this is only true for renters lucky enough to find an available unit. Rent control cannot cap the prices of for-sale units, nor will it cap the value of the land rental housing is on. The result will be a relatively stagnate rental housing supply, while the condominium market will pick up to meet the still-present housing demand. Of course, construction of new condo projects would take time and run into the same NIMBY and regulatory forces that slow all construction. Thus, supply will continue to sit below demand, resulting in an increase in price for for-sale units.

Increase in condo conversions

It's important to note that rent control hardly exists in a regulatory vacuum. Other regulations will amplify its impacts, such as the statewide Ellis Act, which supersedes any local land use ordinance. Whether the rent control is universally stringent or somewhat temperate, such permitting a nominal increase in rent annually, the revenue generated will likely fall dramatically below the likely rate of inflation. Meaning, the cost of operating a rental housing development will far exceed the income generated, and this gap will increase over time. Additionally, the cost of land will continue to rise due to high demand from both residents looking for a home and developers looking for a site. Combined, these create an ideal environment for property owners to convert rental units into condominium units commanding high market-rate prices. As condo-conversions increase, residential evictions will also increase, which could be measured by an increase in evictions under the Ellis Act. As evicted residents search for new units, it will add pressure to a shrinking rental housing market with no release valve. After all, just because you don't build it doesn't mean they won't come.

Increased inequality

This overall shift in the type of construction and costs will only exaggerate current levels of inequality in our already unbalanced economic ecosystem.  The same studies of rent control show that it typically results in lower degree of mobility/transiency of residents. That is, once people have rent controlled units, they rarely give them up (for understandable reasons). But with little to no new rental supply coming on line, this leaves turnover as the only means for new residents to obtain rental housing. Further, as the rental market shrinks from the likely increase in condo conversions, competition for the rare available rent controlled unit becomes fierce. The majority of seeking the unit will be denied and left with a handful of options. First, those that did failed to get the unit can chose to buy, but given the raison d'etre of rent control to begin with, these individuals will likely already be out-priced for for-sale units. In places like Los Angeles where many cities share the region, individuals out of the rent-controlled market of Los Angeles city will be pushed to peripheral cities that do not have rent control where prices are typically cheaper regardless. Alternatively, they may leave the area all together. The result is more homogeneous neighborhoods, cities, and even regions where cities lack economic diversity of residents. Instead, lower income individuals are pushed to the periphery, or out of state, while the wealthy solidify within highly desirable areas. We are seeing such effects play out today, but repeal of Costa-Hawkins is likely to exaggerate this phenomenon in the long run.

Solving the wrong problem

Rent control is often approved on an emotional basis. Rents rise, and the community demands action from their leaders. Elected officials then pass rent control ordinances, or expand existing ones, so that they appear to be "doing something," despite the documented shortcomings and drawbacks of rent control itself. And no doubt, rent control will benefit those already in qualifying units, but it will leave out those new residents looking to move with no outlet for the pressure. But if doing something means hurting the economic viability of the very communities they seek to protect in the long run, how prudent can that be?

While protecting the rights of existing residents is important and necessary, rent control is the wrong solution to the problem of an overarching environment of high housing costs. There is near climate change-like consensus among economists that rent control is a long-term negative for municipalities. The appropriate solution was apparent even back in 1988, and evidenced presently by plateauing housing prices, which is to push for policies that increase the number of units of all types be constructed, not giving developers a reason to halt new constructions or convert existing units. Continuing to push for policies that present an either/or option will continue to force the hand of self-interest, where we all lose.

Reuben Duarte's picture

Reuben Duarte

Reuben Duarte is a Land Use Planner at Sheppard Mullin in Los Angeles, California, where he assists real estate developers, property owners, and other business entities in guiding their projects through the entitlement process, including permitting, re

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