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What predictions does economics make about the likely result of this policy in Berlin of capping rent prices.

Berlin is freezing the rents of 1.5 million apartments for the next five years starting this Sunday in a controversial move to control the exploding costs that have forced many to move outside Germany's capital city.

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Rent control will over time decrease the supply of housing while increasing demand causing a housing shortage. Moreover, there are also studies that show that under rent control there are not just shortages of houses but also misallocation, that is the houses are no longer allocated to people who have highest utility/consumer surplus from having them (Glaeser and Luttmer, 2003).

A recent literature review on rent control concluded (Jerkins, 2009):

I find that the preponderance of the literature points toward the conclusion that rent control introduces inefficiencies in housing markets. Moreover, the literature on the whole does not sustain any plausible redemption in terms of redistribution.

Furthermore, the IGM forum, a platform that surveys the top policy economists, shows that virtually all of them think that rent control (at least as applied in US) had a negative effect on availability and quality of housing (see here).

However, note an important caveat is that as any policy also rent control is not always homogeneously applied. I saw some studies showing net positive redistributional effects of rent control but it’s only small minority of all studies and usually the positive results come from rent controls that were applied only to special subsection of housing market for example government owned social housing. Those studies to my best knowledge do not really apply to the Berlin case, which is going more or less the similar route as San Francisco or New York where the effects are shown to be significantly negative.

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    $\begingroup$ Non-rent controls on the renter are much stricter in Berlin than the USA, and there are good reasons why USA lessons are not transferable. Furthermore, there are externalities in play, so a superficial analysis may miss important pieces of the puzzle. $\endgroup$ – 410 gone Feb 28 at 7:36
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    $\begingroup$ @EnergyNumbers: What externalities are in play? And what are the reasons USA lessons are not transferable? Please consider expanding your comment in an answer. $\endgroup$ – FreeMarketUnicorn Feb 28 at 7:46
  • $\begingroup$ Comments are not for extended discussion; this conversation has been moved to chat. $\endgroup$ – EconJohn Mar 8 at 0:22
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This answer is based on Mowzer's comments.

Property development companies will not invest in existing apartments in Berlin, because they can achieve a higher return in other cities.

Property development companies will not invest in new apartments in Berlin, because they think the city government will apply rent control to new apartments - something they explicitly decided not to do - and if that happens they will be able to achieve a higher return in other cities.

This will lower the price of land substantially, which will increase the return which property development companies can achieve, until a new equilibrium is reached where the return for property development is similar to other cities, but with lower absolute prices.

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    $\begingroup$ "something they explicitly decided not to do" yet $\endgroup$ – towe Feb 28 at 14:57
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    $\begingroup$ @towe Were there indications that they plan to do it? Of course new apartments become old apartments eventually, but in the reasonably near future? $\endgroup$ – user253751 Feb 28 at 15:09
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    $\begingroup$ @GuntramBlohmsupportsMonica I guess we shall see whether Berlin needs development companies more than development companies need Berlin. Capital strikes are a thing ("we won't invest here unless you are a good place to invest"). Is this a reverse capital strike? ("we won't let you invest here unless you are a responsible investor") Remembering that a new development company could be started at any time, for example by annoyed residents of Berlin who now have no competition. $\endgroup$ – user253751 Feb 28 at 16:59
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    $\begingroup$ Also, land is not a resource that can easily be generated, more and more people are moving from rural parts of Germany to cities (which affects most bigger cities, not just Berlin, but doesn't help in reducing land cost), land is just one part of building new housing, and other cost factors, like energy efficiency, are sharply rising. So, no, no matter what happens, building new housing won't ever be cheaper in Berlin than it is now. $\endgroup$ – Guntram Blohm supports Monica Feb 28 at 17:00
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    $\begingroup$ Where I came from, there was a discussion about whether the public library, in the middle of a low-density housing area, should be demolished and replaced by an apartment block. Uh, no it shouldn't. Demolish one of the low density houses to make way for an apartment block. Only an idiot, or the free market, would consider the public library to be less valuable than the least valuable detached house in the area. The only reason to use the public library site would be that the council already owns the land. That's an entirely artificial barrier. $\endgroup$ – user253751 Feb 28 at 17:03
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As someone asked in a comment why would this lead fewer new houses being built; the logic of the developers is rather simple, e.g.:

Deutsche Wohnen CFO Philip Grosse said in an interview with Bloomberg that the firm is holding off on construction in Berlin, and instead will look to other cities to make new investments. The company said earlier this month that limits on raising rents and potential mandated rent cuts put cash flow at risk. The damage done to its bottom line, the landlord calculated, could be to the tune of 330 million euros ($363 million) over five years.

Basically, why invest in Berlin if their local government has given indication they are [now more] likely to "screw you" (as property developer) in the future? The problem, like always in such matters (of capital flight), is one of signalling.

Yes, the local government could pick up the shovel/tab and build more social housing compensating for the likely lower private investment. The question is: will they (raise enough taxes etc. to do it)? Also, a local government has basically zero powers to impose capital controls.


Regarding Simon's comment that Deutsche Wohnen is not actually a house builder: that is fair criticism of their statement, but not so much of my argument. Keep in mind that they've acquired over 100K apartments in Berlin presumably by offering higher prices than the competition to the former owners (most of which appear to have been large-scale realtors as well.) Ultimately a developer has to sell his product, unless he plans to rent it out himself.

To give you a parallel here: many [tech] startups don't make it big by going the IPO route but manage to recoup the investment by selling to a larger (and usually fairly monopolistic) firm/competitor. If the latter route did not exist at all, it would leave only one route to startup investors to make a profit. For housing, the exit of big buyers from a market basically leaves the developers with fewer routes to recovering their investment: sell to some small owner (who might need credit to buy in the first place) or become a rental company to some extent.

As an interesting, perhaps, aside here: Deutsche Wohnen appears to be largely owned by Deutsche Bank, so in some sense people are "renting the house form the bank", one way or another. (There is some difference as to whom carries the risk of default and who gets the long-term benefits [but also risks] of holding an asset in the [US-style] "ownership society" vs [German] "rental society".) But if we use this blurring analogy, Deutsche Wohnen exiting the [Berlin] market is roughly similar to a large bank exiting the mortgage market in a city, i.e. there's an implicit statement here that "it's not worth it", i.e. a form of lowering the "credit score" of the city as far housing development goes.

As one article notes

Less obvious advantages of [large] scale [residential portfolio companies] are comfortable loan conditions. According to Standard & Poor’s, Vonovia has a long-term corporate credit rating of BBB+, with a stable outlook. Unimaginable for a homeowner or private real estate investors, this allows for loans not secured by mortgages.

It's also interesting perhaps that an even bigger fish, Vonovia tried to buy out Deutsche Wohnen, but this [2016] bid was rebuffed. The history of bank mega-mergers seems to have parallel in Germany with the merger [attempts] of mega-residential-property companies.

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    $\begingroup$ By the way, a bit more searching on this found out that rent freeze was the political compromise. There were serious calls to outright expropriate Deutsche Wohnen taz.de/Berliner-Mietmarkt/!5583189 $\endgroup$ – Fizz Feb 28 at 13:01
  • $\begingroup$ Because everyone else is running away from it and therefore costs are lower and therefore returns are back to normal? That is generally how free market investment works. $\endgroup$ – user253751 Feb 28 at 13:17
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    $\begingroup$ @user253751: yes, compared to the rest of Germany. Very doubtful they are lower than in the Czech Republic or Hungary! $\endgroup$ – Fizz Feb 28 at 13:27
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    $\begingroup$ Developers could be "playing chicken" with the lawmakers. Rent control lowers their profit and therefore they want it removed. They could make these threats to leave the market, even if they could still operate profitably under the rules. $\endgroup$ – stannius Feb 28 at 22:52
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    $\begingroup$ "Deutsche Wohnen" has never built a house. Their threat to leave a market they have never entered is kind of hollow. $\endgroup$ – Simon Richter Feb 29 at 0:20
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West Berlin had a very restrictive rent control policy in effect until 1988. The result was an exceptionally low price level of rental apartments, while modernization was decades behind other cities. That benefited students, artists and musicians who created a unique cultural scene. In 2003, the city was still "poor but sexy", as mayor Wowereit famously said.

Rent control, like all market interventions, can play a net positive role when it is a counter measure against excessive market oscillations, for example real estate speculation. It dampens such oscillations.

The direct benefit is two-fold: It prevents speculative bubbles and prevents unreasonable and unsocial price hikes for the tenants.

There are currently signs for such a bubble; real estate prices are driven by the current extraordinarily low returns of other investments and therefore are only sustainable as long as the interest rate stays at the current extraordinarily low level. On the demand side, the quickly rising rents impose social hardships on tenants, which form a large part of the constituency in Berlin.

It is also not entirely true that rent control deters investors, not least because it is intentionally excluding new buildings. But even if that possibility is a concern regarding future policies: There is still a lot of money to be made. I have not heard of a dearth of investors — the issue is rather a shortage of suitable real estate and approval processes which are slow compared to the quickly rising demand, mostly through immigration. Last not least, if really no investor can be found — poor investors! — the city can build on its own. Berlin has a long tradition of city-owned housing companies, and as I said, it's not that no profits can be made at the current levels.

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With rent controls and the resulting excess of demand over supply, middle-class white people with stable jobs do very well, and other people find it impossible to find housing. Where landlords can’t use the amount of rent that potential tenants are willing to pay in order to choose between them, they are forced to use use other criteria. Some of those will be rational, such as who seems most likely to pay the rent on time with no problems, and some will be irrational, such as racism and other prejudices.

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Well one obvious prediction is that a smaller percentage of the Berlin population and economy will be involved in speculating on rent prices.

Less of the overall activity will be directly or indirectly related to purchase, development, redevelopment and sale of property.

Lending will be more available to other areas of the economy.

Industry will be more diverse in areas of activity. Because Berlin is a startup hub and focus of innovation, imponderables and rare moonshot triumphs will be made more frequent. For this reason alone classic economic supply/demand analysis hardly applies.

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