Housing rent control, a false solution

To address the problem of housing scarcity and high housing prices in Western societies with political democracy and a more or less liberalized economy, the State's actions rely on four major lines of public policy. These are the public supply of housing, subsidies for purchase and rental, taxation on construction and transactions, and regulation, which ranges from urban planning regulations and licensing rules to administrative intervention in the market.

All of these issues encompass complex issues and deserve discussion, which I have sought to contribute to in these pages. Currently, given the worsening housing crisis, some are calling for the need for administrative regulation of rents to make them affordable for the majority of the population. This idea, which seems like a simple solution to the problem, is, in my view, one of the worst public policy options, with consequences I will seek to highlight later.

Let me just briefly note the first three lines of policy, which include many of the “impossible solutions” I previously discussed here and here .

The public housing supply would certainly be one of the keys to the problem. Even for those like me who defend a liberal perspective, it is undeniable that the State, as a major—if not the largest—real estate owner in the country, has not only responsibilities but also resources that, strategically mobilized, could positively influence the market. A significant supply of public housing—based on a model of partnerships with private entities—focused on renting, with controlled costs, and aimed at the middle class, would have a significant balancing effect on prices. Furthermore, there is the possibility of channeling community funds toward these operations.

The very low percentage of public housing in Portugal compared to other European countries is well known, with the existing housing being marked by a history of mismanagement and, essentially, targeted at highly dependent population segments.

In an impoverished society like ours and faced with market failures, subsidies – in purchasing and, above all, in renting – applied in a limited way, can be seen as effective and socially fair, when directed only to those who really need it, especially young families.

But subsidies carry risks. They became widespread in the 1980s, through interest rate subsidies, to encourage an entire generation of people who couldn't find housing in the nonexistent rental market to buy new homes. The long-term result was not only an unsustainable housing model but also a severe budget crisis. More recently, subsidies, along with lower interest rates on loans, have contributed to rising housing prices, fueling demand amid a very limited supply.

A less burdensome tax on real estate is now taking some tentative steps, after having been on the menu of incentives for urban renewal for some time. The results are not yet being felt in the supply side, with some—myself included—arguing that it should be taken much further, with a true fiscal shock impacting the entire housing production and transaction cycle.

Industry players point out that taxes will represent almost 40% of the final construction price, highlighting the potential scope and potential impacts. However, a tax-addicted state's reluctance to lose tax revenue has prevented bold action in this area.

Finally, regulation, which, unlike the previous ones, does not imply public investment or loss of tax revenue and has therefore been the preferred course of action of governments, both left and right. After all, legislating to address problems and creating burdens for individuals is one of our areas of expertise.

I recognize that a modicum of regulation is necessary for civilized societies to function. Undeniably, regulation in Portugal has significant room for simplification and increased effectiveness, particularly regarding technical rules governing construction, urban planning regulations, and the entire administrative process leading to building licensing.

But it is another aspect of regulation, the temptation to administratively condition the value of housing rents, that I want to focus on now.

After 1974, the housing rental market became less significant in Portugal compared to our geopolitical environment. This shortcoming is a central aspect of the current housing problem and should therefore be prioritized in public policies. I mention 1974 because the political, social, and economic upheaval of the PREC exposed and exacerbated existing dysfunctions in the rental market and almost completely drove private investment from this sector.

In fact, the problem stems from over a century of successive variations of the so-called "binding" urban leasing regime, which began in 1910. This regime is characterized by excessive protection of tenants' interests, conditional rents, and automatic lease extensions, thus penalizing landlords and severely restricting their autonomy. In other words, landlords have long and at their own expense played a role of generalized social support, subsidizing tenants—a role they were not supposed to play.

In the 50 years of democracy, several attempts have been made to untangle the knots of this regime, attempting to bring it closer to the market without causing major social upheaval. These liberalizing attempts came, under the political conditions available, from the center-right. On the left, the binding nature of leasing continues to be viewed favorably, attributing it social justice merits, as it fulfills an abstract right, promotes wealth redistribution, and protects local populations from expulsion. All of this is anchored in the left's historic hatred of property and the market.

The meager results and inconsistent reviews of the urban rental system continue to push families toward purchasing, as the financial burden of purchasing is typically cheaper than paying rent. This, in turn, further reduces the rental sector.

Thus, the main reason for rising rents—and, of course, also rising sales prices, but that's not my point here—is the shortage of supply. There's a mismatch between the pressure of housing demand and the availability of rental properties in the market. This, in addition to leading to a natural rise in market prices, also has more perverse effects, such as speculation and parasitic trading on available properties.

But a closer look leads us to identify segments in which this mismatch is very severe (houses accessible to the lower and middle classes) and others in which the market, although booming, operates more dynamically and efficiently (houses intended for the affluent classes, including foreigners).

This stems from developers' lack of interest in the low- and middle-end segments of the market, primarily for two easily identifiable reasons: the impossibility of achieving attractive returns, given the costs associated with construction (land, materials, labor, regulatory compliance, administrative processes, and taxes), and the greater risk of tenant default, a risk exacerbated by the slow functioning of the justice system. We could also add to these two reasons the uncertainty of the political environment and the legislative framework, although this uncertainty is widespread across the market.

Of course, there are other reasons for rising rents, especially in major cities. The area's notoriety, the economic activity present there, the arrival of new, more affluent residents, the perception of value, real estate as a safe haven asset, among others, are all virtuous factors that drive demand and also help explain the price increase.

Given this, is administrative rent conditioning a solution to putting more homes on the rental market? It seems clear to me that it isn't. But I'm interested in highlighting the observable economic, social, and urban consequences of this form of regulation.

The Portuguese experience clearly demonstrates how rent control is a mechanism for destroying value, illustrating Lindbeck's famous expression, "Rent control appears to be the most efficient technique presently known to destroy a city, except for bombing."

In a free society, conditioning compromises the rental market and discourages investment by limiting agents' actions and expectations of profitability. Administrative pricing below market value itself promotes scarcity, leading to increased demand for a reduced supply of available housing.

The natural reluctance to put houses on the market at prices considered low and that do not adequately remunerate the investment in real estate production also leads to the retention of homes and informality, with the parallel market and other expedients that exploit the scarcity of supply.

Price conditioning devalues and degrades the building stock, decapitalizes owners, and depreciates housing values, reducing the quality of construction and maintenance. By reducing incentives for maintenance, or making it unaffordable due to a lack of resources, buildings deteriorate to extreme conditions and are condemned to a marginal market, leading to the so-called "insolvency spiral."

Socially, conditioning promotes injustice, as it equates poor and rich tenants. If subsidizing the poor is necessary, given the reservations I expressed earlier about this line of public policy, the entire community (i.e., the state) should bear the burden, not a few landlords. Similarly, the spatial distribution of scarcity leads to another type of injustice: while some tenants benefit from lower rents in convenient locations, others will have to relocate or even find it impossible to find housing.

Population mobility is the freedom to make life choices, and it is affected by the lack of rental housing and the scarcity of vacant homes. Restricting mobility affects employment, exacerbates commuting, and ties people to the low-rent housing they've managed to obtain or pushes them to buy, which also affects their future. Elderly people will remain in large houses they no longer need to benefit from low rents, or they will informally sublet to generate income, without their landlords' knowledge.

In terms of urban dynamics, these issues transcend the housing crisis. The dysfunctionality of the rental market is the root cause of depopulation and functional desertification in the central areas of our cities. This created a vast void that compromised the resilience of the urban system and led to overwhelming occupation by exogenous factors.

Naturally, the negative aspects highlighted are perverse effects, not intended by the well-intentioned institution of housing rent control. But, as Milton Friedman aptly said, public policies are judged by their results, not their intentions.