Trickle-Down Rentals

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Does everyone remember trickle-down economics? That ridiculous ‘theory’ from the 1980s and early 1990s which claimed that if government helps out rich corporations and rich individuals some of their wealth with naturally ‘trickle-down’ to everyone else, helping the economy generally and poorer people specifically.

It was always disingenuous, self-serving nonsense of course, because lavishing tax cuts, tax credits, tax loopholes, grants, government ‘investments’, preferential tariffs, and other economic goodies on big corporations and high-worth individuals didn’t do anything to encourage any of the wealth to flow down to the rest of us. The meme below (source unknown) illustrates perfectly how it actually works.

It occurs to me that the trickle-down theory could be applied to rental housing. Lots of people, especially developers, but also pundits and policy wonks, often claim that by constructing more luxury rentals high income renters will move to the new rentals, increasing vacancies in existing rentals, and, through basic ‘supply and demand’, force landlords of existing rentals to reduce rent increases or ‘stabilize’ rents as a way of dealing with increased vacancies. In other words, the claim is that by building more luxury rentals we improve affordability in the rest of the rental supply. This is basically the trickle-down theory applied to rental housing. Given that the trickle-down theory has questionable efficacy when applied to economic matters, I think it’s important that we approach its rental housing version with caution.

For this theory—the notion that by building more luxury rentals at market leading rents we will improve affordability among existing (older) rentals—to apply to rental housing, the following sequence would have to play out: (1) new luxury rentals are added to the supply, (2) luxury renters in existing buildings move to new luxury rentals, (3) vacancies increase in existing rentals, and (4) landlords slow or stop rent increases in existing rentals to eliminate these vacancies. Is this sequence realistic?

First, there’s no guarantee that high income renters will leave existing rentals when new luxury rentals hit the market, since they’re probably already renting luxury-grade rentals and probably at rents which are lower than the newly built luxury rentals are asking. High income renters aren’t stupid and if they’ve got everything they need in their current rentals, why pay more somewhere else just to get a rental which is a few years newer?

Second, there’s no guarantee that new supply will increase vacancies in the rental supply, or in particular that vacancies will be created in existing (older) rentals specifically. Local market demand for housing may be so strong among renters and potential renters that any vacancies are filled immediately (this is certainly the case in most major housing markets in Ontario). In fact, it’s more likely that newly built rentals will have higher vacancies than existing rentals and that owners of new rentals will have to offer discounts or other rent ‘concessions’ to fill units.

Third, there’s no guarantee that owners of existing rentals will stop or slow down rent increases if they experience a spike in vacancies. For reasons which I will explain in a future post, it can be advantageous for landlords to leave units vacant for months or even a year to get big rent increases instead of renting vacant units quickly at low rent increases, or even no rent increase at all.

Basically, there’s a thousand possible reasons why building more luxury rentals won’t necessarily improve affordability among existing rentals. Which leads me to think that if you want to improve affordability in existing rentals through the device of building more supply, then why not simply build more mid-priced rentals?