Market rents

In the aftermath of the London fire, in some ways my heart isn’t in writing much about housing.  Disasters don’t often get to me, but this one has.

Nonetheless, the Dominion-Post led with housing this morning, and when I saw that the first word in the entire article was “greedy”  (followed by that other emotive term “landlords”) it wasn’t promising.    Just because people scoff when Fox News talks of being “fair and balanced” doesn’t mean the rest of media should abandon the aspiration.

Faced with rising demand for rental accommodation –  in a city where central and local government have again combined to make housing supply not very responsive to changes in demands –  owners (or their agents) of residential rental services businesses have faced excess demand for the limited stock available.  The typical response you might expect would be for rents to rise.

There are different sorts of pricing structures used for different goods and services.  Typical dry goods in a supermarket will have a fixed price, and occasionally the supermarket runs out of stock –  which can be mildly annoying to you or me, but is presumably easier to manage for them.  The value of New Zealand dollar (the exchange rate) is constantly changing, typically by quite small amounts, as pressures from potential buyers and sellers ebb and flow.   Even at a retail level, petrol prices now change very frequently.   There are whole literatures on the reasons why different structures are adopted in different markets (and I’m certainly not expert in that field).

Housing is typically nearer the variable pricing end of the spectrum.  In the market for actual house purchases, fixed price adverts, “buyer enquiry over”, tenders, and auctions all co-exist.   In the last two, the seller can reconcile supply (one house) to demand, simply by using the amounts bid.  In a fixed price advert, if there is more than one interested party, the seller might have to use some other decision criterion (although I imagine that typically even then one bidder will offer more).

It is, as I understand it –  not owning rental property, and not having rented one in this country for many decades –  customary to advertise rental properties with a fixed rental price.  Holiday home websites operate that way too –  and, in effect, they just operate on a “first come, first served” basis.    In a normal market, it probably often works quite well –  if there are plenty of people offering rentals, and plenty of potential tenants, even if one misses out on one property, there is another not far away.  If the property owners sets his or her price too high, they find there is little or no interest in renting their property, and eventually have to re-evaluate and revise the fixed asking price.

But the current situation seems to be one where lots of people are enquiring eagerly about almost any rental property on offer.  Fixed asking prices are, in that sense, too low to clear the market.   Over time you’d expect that those fixed asking prices would rise –  and thus take care of that particular element of the problem –  but that doesn’t deal with the property owner’s issue on the day: when 20 people want one rental.

Wellington Central MP Grant Robertson knew of two cases of renting tenders in Wellington – both from around the start of the year when students were returning to the capital.
“I think it is barely legal,” he said.
At one, would-be renters turned up to view a flat with an advertised price. “When they got to the property they were asked, ‘how much are you prepared to pay?'”

At the other there was no advertised price and would-be renters were simply asked how much they were prepared to pay.
“I think it is abhorrent. It is exploiting the fact we have a real shortage of rental homes in Wellington at the moment – exploiting people in vulnerable positions.”

So how is the property owner or agent supposed to respond?  Just ignore the excess demand and draw straws to determine who should get the flat at the –  evidently –  too low advertised price?  It is a market, and the property owners aren’t running charities for the homeless, but private businesses.

As is noted in the Dom-Post article, auctions aren’t always an ideal mechanism –  as an owner you are likely to care about the quality of the tenant as well.   But simply drawing straws doesn’t seem to have any particular merit –  moral or practical  – in this climate.

Don’t get me wrong.  The housing market in New Zealand is, in many, respects a scandal, and the problems flow largely from the choices of successive waves of central and local governments.  Since we are talking about right now, in this case it means the National-led central government, and the Labour-dominanted Wellington City Council.   But attacking a symptom –  rising rents, and alternative techniques to reconcile supply and demand –  isn’t a particularly meaningful response.   Owners of rental properties are, in many respects, the last people who should be being blamed here.

But I also learned something new from the article.    The journalists approached, and got some comment from one of their officials

Ministry of Business, Innovation and Employment national manager tenancy compliance and investigation Steve Watson said the practice was allowable under the Residential Tenancies Act.

“Any party who feels that they are being asked to pay rent that exceeds ‘market rent’ has the ability to apply to the Tenancy Tribunal who can review and determine the appropriate amount of rent for a residential property,” Watson said.

Really?   I know there has been centuries of philsophical and theological debate around concepts of “just prices”, but have we (or rather our Parliament) really legislated to provide for cases where some arbitrarily determined “market price” differs from a price being paid in….well…the market.  It seems that our politicians had done just that.

Here are the relevant bits of section 25 of the Residential Tenancies Act

25 Market rent

(1)  On an application made to it at any time by the tenant, the Tribunal may, in accordance with the succeeding provisions of this section, on being satisfied that the rent payable or to become payable for the tenancy exceeds the market rent by a substantial amount, make an order reducing the rent to an amount, to be specified in the order, that is in line with the market rent.

(2) Notwithstanding anything in subsection (1), no application may be made under that subsection in respect of the rent payable under a fixed-term tenancy later than 3 months after—

(a)  the date of the commencement of the tenancy or (in the case of a tenancy that was subsisting immediately before commencement of this Act) the date of the commencement of this Act; or

(b)  the date of the last review of rent,—

whichever is the later.

(2A) …..

 (3)  For the purposes of this Act, the market rent for any tenancy shall be the rent that, without regard to the personal circumstances of the landlord or the tenant, a willing landlord might reasonably expect to receive and a willing tenant might reasonably expect to pay for the tenancy, taking into consideration the general level of rents (other than income-related rents within the meaning of section 2(1) of the Housing Restructuring and Tenancy Matters Act 1992) for comparable tenancies of comparable premises in the locality or in similar localities and such other matters as the Tribunal considers relevant.

Initially I wondered if this might be some historical provision to deal with, say, a situation in the Great Depression where there was a long-term fixed rent, and the general price (and wage) level fell sharply.  But that can’t be –  at least for fixed term tenancies these provisions can only be used within three momths of the tenant taking up the tenancy, or of the most recent rent review.

It just looks like an extraordinary piece of “feel good” law.     The standard (in 25(3)) is the rent that “without regard to the personal circumstances of the landlord or tenant, a willing landlord might reasonably expect to receive and a willing tenant might reasonably expect to pay, for the tenancy, having regard to the general level of rents”.

It isn’t clear at all why the “personal circumstances” should be irrelevant.  If someone desperately wants to live on a particular street, because they want to be close to aged parents (say) why shouldn’t that be something that can reflected in the price they pay for a rental tenancy?    One bag of flour might be much the same as the next one.  But except perhaps in high-rise blocks, almost every rental property is different from the others, even if only by location –  and location preferences are often quite idiosyncratic and personal.

I have no idea how often this provision is used –  perhaps more often now  having been highlighted on the front page of a major daily paper.  Various readers have a lot of exposure to running rental businesses, and I’d be interested in any perspectives they can offer.     But you also have to wonder why the MBIE official felt it appropriate to add in this information when he commented.  After all, the one common element, agreed (it would seem) by all parties in the story, is that the rental market in Wellington is very tight.  The general level of rents is presumably rising.        (And if, perchance, someone does agree to pay a level of rent “above the market rent”, it was a contract voluntarily –  even if grudgingly –  entered into: not great perhaps, but better –  for the renter –  in their own assessment, than the alternative.)

I was interested to see Grant Robertson stating that Labour will soon be announcing a package to “strengthen renters’ right”.  There may well be merit in some of that.   But the best way to protect the position of renters, and all others coming into the accommodation market (whether as renters or buyer) is surely to fix up the land use and housing supply markets.  Abundant responsive supply in the face of  changes in demand is the best assurance of genuinely affordable and secure accommodation.

(On which note, a reader sent me a link the other day to a stimulating piece on housing and land markets from a UK academic. I don’t agree with everything in it, but for those interested in the debate –  and in recognising the similar issues in other countries –  it is worth reading.)

 

 

24 thoughts on “Market rents

  1. Michael,
    While we are about it perhaps we could have a discussion on rent taxation.
    I have been a fan of a ‘notional’ rent rather than the actual, a bit like the FIF tax
    Starting at 6% would be good with usual allowance for costs.
    A landlord could collect their rent and ignore the tax except they would pay as if the capital value had earned 6%. Put it on all property including bare land, empty property not occupied principally by the owner, held for redevelopment etc.
    We could see a lot of landlords offer their holdings up to the owner-occupier market especially in Auckland.
    Some owners would win in a town where the general return is well over 6%.

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    • Not everyone wants to buy or can buy immediately. There are people that want to rent or have to rent while they save for a deposit. Decimating the rental stock seems rather foolish when it is clear there is not enough rental stock anyway.

      You also presume that property prices always go up which it does not. There can be capital losses for people that buy at the top of a property cycle.

      Liked by 1 person

  2. As the owner of a property management company I have never heard of the market rent test being applied. I doubt that it could succeed in the tenancy tribunal other than when rent was increased markedly during the course of a tenancy. I suspect the rule was designed to stop landlords using a huge rent increase to force a tenant out early. A rent increase has a 2 month notice period which is shorter than the standard 3 month notice.

    Liked by 1 person

    • I use Goodwin Property Management and that market rent test issue has been brought up whenever my annual rent review comes up for tenants. I like to stay behind market rents to ensure consistency and longevity in my rentals. I am pretty sure that test has been used in tenancy tribunal before for it to be a standard test for Goodwin Property Management in their rent review process.

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  3. Maybe the ‘market rent test’ rule was designed for to protect renters post disasters -such as Christchurch earthquakes? If it was it doesn’t seem to have been applied. In the 3-4 years after the earthquakes, Christchurch rents increased on average by over $100 a week or $5000 a year (before dropping back a bit in the last 2 years). This forced many renters out of their homes as landlords wanted higher paying rebuild tenants.

    Thus for landlords with houses that were still habitable after the earthquakes they made economic gains while tenants lost -this seems arbitrary and unfair. It is hard to see how tenants could protect themselves from this economic setback. Homeowners of course can get insurance (which may be another set of inadequacies…) -but even fixed term tenancies can be broken -landlords can demand that they or their relatives need to move in for instance.

    There is a power imbalance between landlords and tenants -that I don’t think is healthy. Actually for both parties (some tenants response is a childish level of irresponsibility).

    I find it hypocritical and to be frank immoral that the government affirmed that the market had to hold sway for renters -despite the burden that put on existing rental households, yet urban property owners were protected by no changes to restrictive planning rules to make housing supply more competitive/affordable.

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  4. Michael recently you have queried Labour’s commitment to housing supply reforms. In particular querying what Andrew Little meant by wanting stability in house prices.

    Here is what Labour’s housing spokesperson -Phil Twyford had to say -in an interview for http://www.interest.co.nz/opinion/88222/differences-between-national-and-labour-housing-starting-show-through-adams-readies

    “What about house prices?

    It could be argued such plans might also have a big, big impact on prices. We put that to Twyford last week.

    “Governments don’t control the market,” he replied. “So, I’m not going to say that house prices won’t come down, but what we’re going to do is, make housing more affordable by building large, large numbers of affordable homes, and we’re going to squeeze the speculation out of the market.”

    “We don’t want to crash the market; we don’t think that that would be [helpful]. We want to stabilise the market and we want housing to be more affordable. And we think that by rolling out the measures that are in our reform agenda we will do that,” Twyford said.

    “The thing to make really clear is, that we don’t control house prices. We’re not going to promise that they come down, we’re not going to promise that they won’t come down.”

    Phil Twyford has been giving 1/2 hour plus talks on housing at various community meetings -where he doesn’t shy away from housing supply. It is hard to see how Labour can backtrack on this commitment.

    Here is a speech he did yesterday evening which was posted onto facebook.

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    • Labour will build houses on the fringe and not in central Auckland which will just result in more congestion on the roads and we will just end up with lots of houses that people really do not want to live in beacause it will just be too far away.

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      • Not necessarily. Assume an estate of say 5,000 cheap houses built vaguely near Kumeu. That would be roughly 10,000 workers. Given a population of about 40,000 there would be local shops, schools, etc employing some. The Westgate centre could employ some more – 10 mins bus/car and Albany maybe half say 20 minutes by bus/car with minimal congestion. OK some will work near the airport and some in the city and they will add to congestion but eventually that railway line will get used and of course a dedicated busway learning from the North Shore busway mistakes would take the rest. Just a little planning – you and I could organise between us so long as the council keeps their nose out of it.
        Of course if the council could grasp the concept that they don’t need to put everything in the CBD it would be even easier – lets move the law courts and Auckland Uni out west and everything falls into place.

        Liked by 1 person

      • Waikato Council put its head office in Ngaruawahia. Sure does not encourage more people to shift from Hamilton or from Auckland to go live there. As a head office you just struggle to find people to fill vacancies. Not exactly a great idea having a head office that can’t find staff.

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  5. Good article. Spot on with what most property investors, landlords and perhaps most tenants would agree with. However whilst mentioning the hideous fire in London you did not link the two sides of the argument to the fire. Is not this fire the extreme example of what happens when the State / City provides public housing at income related rents. Suddenly a different standard unrelated to the achievable rent applies to the quality of the property and the management of the tenancies. Some social properties are clearly substandard and some well in excess of minimum standard required to house needy people. This is the core issue in New Zealand criticize private landlords and force them to provide facilities regardless of the economic merit of so doing but then have a different set of economic judgements on social housing. If economics did not come into the issue of providing social housing then clearly we would not have a shortage of social housing.

    Liked by 1 person

  6. Regard Toby Lloyd’s linked article. From what I have read he gets some things right and some things wrong.

    He is right to say that land has unique characteristics -I think this relates to city location and contiguity (the ability to assemble the desired shape/size parcel of land).

    I think it is wrong to say “Buy land. They are not making any more” as quoted by Mark Twain. For most of last century houses + land were not especially valuable -values went up in proportion to incomes.

    I think there is a widespread misreading of Riccardo and his theory of economic rent. Riccardo assumed a fixed quantity of farmland and one product -corn (grain) to base his economic analysis on.

    So Riccardo assumed inelastic supply. This is only true for urban environments if very restrictive planning rules apply -which they do in London/UK (since 1947) and NZ (since approx 1990).

    In more liberal land use cities the normal supply curve rules apply -for new housing, commercial premises etc. Supply can come from cities extending outwards or intensifying upwards.

    In my twitter feed I get tweets from LondonYIMBY -they seem to specialise in showing pictures of large, attractive buildings that were built for affordable housing 100+ years ago which would not be permissible to build currently -despite most of London being only being 2 stories high.

    Toby Lloyd had a throwaway line that only places with huge amount of land could do an affordable Texan city sprawl. But that ignores examples in Europe -German cities have stable property prices and Asia -Tokyo is much more affordable than London -where supply is more balanced -being both up and out.

    A really good read on these spatial economic theoretical issues is -“Economics, Real Estate & the Supply of Land”by Prof Alan W. Evans.

    P.S I am sceptical of Betterment taxes too for the same reasons -the assumption that land supply is inelastic is not necessarily true. So a tax on land use change is not without economic consequences. It is not a perfect tax with no deadweight loss.

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    • Thanks Brendon – i mostly agree.

      These were the comments I sent back to the person who sent me the link to the article.

      I guess what left me a little sceptical was the rather loaded line “endless urban sprawl may be acceptable in Texas and other land-rich places, but it has serioud environmental, social and political implications that render it untenable in the UK”.  If all he is saying is that it is politically impossible, then fine –  we know there is no jurisdiction that has ever successfully unwound the tight land use/planning restrictions –  but the rest seemed a bit unsubstantiated.  After all, London has a massive green belt around it.  one could, technically, make it all developable for houses –  and the train and arterial road links are already largely there. . Do so, and it is likely that land prices would plummet.  It isn’t as if the UK’s population is rising rapidly, and by rich country stds, London is already v dense, so it doesn’t make a great deal of sense to me to suggest that it would be some social or environmental disaster.  He doesn’t seem to recognise that what matters is not that lots more land is built on, but that lots more land could be built on –  expectations, opportunity cost etc

      All that said, I’d have no problem with a mandatory shift to land value rating, which would shift incentives on owners of undeveloped land.  It looks like a good policy for a party serious about reform –  if only we had one –  altho I’m a little wary of quite how much difference it would make

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      • A land tax on undeveloped land is unfair when the infrastructure to develop is just not there. In many cases the main trunk line for public drainage is too far away or the connection point might be on private land where access permission may not be granted.

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      • Do you mean rates on undeveloped land? Or do you mean charging rates mainly on the land portion of the CV? The latter would hit people like myself who have purchased an old low spec house on a rather large section. If my rates increased from say $3k to say $9k then we might have to move (with our rose garden) to somewhere outside of Auckland. All seems reminiscent of the window tax they had in the UK during the industrial revolution that led to large factories with very few windows.

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  7. In the UK in the 70’s the tenancy law was really strong. It was almost impossible to get a tenant out during a period of high inflation and strong rent tribunals that were totally on the tenants side which led to the following:
    Highest rate of empty residential property in Europe and thriving squatter settlements
    Foreign students given priority over UK citizens
    Peter Rachman became famous for his unsavoury ways of evicting tenants

    In New York during the 80’s the landlords had some input to the rental tribunals so there was some balance. Didn’t Trump senior make his fortune with residential property?

    In the 90’s in Australia I met someone who bought a very cheap house ($60k) to be a rental; his tenants were druggies and the police knocked holes in his walls searching for drugs. No compensation so he boarded it up.

    More recently we became accidental landlords a decade ago. It is worth paying 8.26% of your rental income to have a manager find and manage your tenants. There are risks to investing in property but everyone boasts about their property successes and nobody mentions their failures.

    Rents over a few years break even with the costs but of course the unanticipated bonus has been the giant increase in property prices ~ seriously who fifteen years ago would have bet on the Auckland council and the government conspiring to be so incompetent for so long?

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    • For those property investors that have invested in multiple properties would have noticed that supply issue with Auckland 15 years ago. It is mainly to do with the geography, Nimby and heritage rather than anything that the government or council can easily resolve.

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      • Well I did notice but I rather thought they would do something about it. Wasn’t it obvious that the railways needed upgrading to be roughly commuter standard (that would only solve south and west) and that the city had to be a robust network rather than a star shape with all road leading to CBD (develop Albany, Manakau, etc). And didn’t the government ever consider immigration should be pegged to say the international average which I’m guessing is 10,000 – or about half a million fewer Aucklanders in the last 15 years.

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      • The modern trains have a different track requirement from the older tracks that have been laid. The existing infrastructure is too old and therefore it is not as easy as just to buy a new train set and off we go. All the existing tracks basically have to be relaid. The cost is in the $30 to $40 billion and therefore not going to happen too quickly as the Christchurch and Kaikoura disasters are still on going and will require the government to borrow $30 billion or more. That’s why the pace of rebuild is so slow.

        The Reserve Bank should have recognised that and under emergency issued a mini QE for $50 billlion whe the US was doing its own QE.

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  8. THE OECD GIVES US ADVICE
    The OECD has warned New Zealand on the vulnerabilities from Auckland house prices. It calls for housing densification and suggests a raft of measures to improve NZ’s dire labour productivity. They want the RBNZ to have the DTI tool.

    http://www.interest.co.nz/news/88317/review-things-you-need-know-you-go-home-thursday-gdp-underwhelms-oecd-gives-us-advice

    Now the problem I have with this is that the oecd has been handing out advice to NZ forever. That advice generally is slavishly acted upon by to stupid to think properly Govt.’s and here we are today.

    New Zealand’s GDP result for the March 2017 quarter disappoint markets today. Most analysts were expecting a +0.7% quarterly gain, but it came in at +0.5%. The RBNZ had forecast a +0.9% rise. On an annual basis, the result was +2.5% rather than the expected +2.7%. Growth from the dairy sector manufacturing (but not exports) covered for a surprising fall in construction activity. Growth per capita was +1.8% pa.
    henm will we start doign things for the benefit of NZ and not some under employed pratt from some other place with little of no interest in our welfare.
    I hope we don’t spend money or pay for the advice they give. Let them go broke ASAP.

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    • In fairness to the OECD (and I will be writing quite critically about aspects of the report, and especially of their chief economist’s) it is a long time – think 20+ years – since governments were doing much new, in economic policy reform, that the OECD actively advised.

      Mostly that is probably to the good, since the OECD does not have a good “model” to explain the extent of NZ’s continuing underperformance, so it isn’t clear why their recommendations would carry much weight in trying to remedy things now. (Of course, there is always a mix of sensible specific recs, and more questionable ones, in any of their reports.

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  9. So if there is once house available for rent and 10 tenants applying, however you cut the mustard only one is going to be successful and nine are going to miss out.
    So how do you chose?
    – the speediest (the first to apply)
    – the best looking (Shortland Street here we come)
    – the most needy (rewarding the most fecund)
    – the highest bidder (rewards to the wealthy)

    Whichever way you go, you are going to get nine disgruntled non-tenants.

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  10. Toby Lloyd’s comments about supply and demand seem correct to me. Particularly that development will stop if prices go down. Particularly if we are talking about, say, a <1% population increase, or <1% of a cities land being developed. Wait a while and it will re-balance.

    As you say, and I agree, the only way I can see to resolve that is to make a lot more land buildable, so that land owners believe that in the long term the value of their land will be less than currently, and that they should therefore sell/develop their land asap.

    The first step is of course to get the planning rules right.

    Perhaps the next step is to incentivise land owners to develop their land rather than hold it. A land value rating/tax system may have some effect. But I think it only applies a value to the land based on what is already built. A step further would be one based on the "residual land value" he mentions ie. a system based on what could be built on a piece of land. I can imagine all sorts of difficulties, but I think the incentives would be strong if everyone's rates/taxes were done that way.

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