In a previous post I referred to a report on rental housing (released by RBC’s economics department) which claimed that vacancies need to be increased if rents are to stabilize or increase at a slower rate. In my comments I said that even in a high vacancy rental housing market there are reasons why landlords would increase rents by significant amounts on turnover, in defiance of traditional ‘supply and demand’ theory which says that when supply increases or demand drops (such as in a high vacancy market) prices will drop or level off. I said that in Ontario, in which older rental buildings are subject to rent controls, it’s not possible to raise rents by more than a small percentage per year with sitting tenants, which means landlords know they need to push rents upwards by a significant amount on turnover, the only time they’re able to do so, because if they don’t then they risk ‘locking in’ the existing, pre-increase rents with the new tenant (and the unit becomes subject again to the annual allowed increase). I said that it can actually make sense, if your building falls under rent controls, to let units sit vacant for a while and hold out for much higher rents instead of renting units immediately at the same rents or with minor rent increases. Even in a high-vacancy market, this means landlords have an incentive to raise rents by significant amounts on turnover, since the long-term benefits outweigh short-term uncertainties about higher vacancies.
How does this work? The table below compares monthly rents achieved by a hypothetical rental unit depending on several different pricing and vacancy scenarios. The scenarios are based on a hypothetical purpose-built rental unit which is currently occupied by a tenant paying $1,500 per month. The current tenant has given the landlord notice and will be leaving soon. The unit is rent controlled which means the landlord can raise the rent by any amount before leasing the unit to a new tenant but while occupied the allowed increase is assumed to be 2% annually.
Do my assumptions and my scenarios make sense? I think they do since they’re basically the choice that many landlords in Toronto face when their older, rent controlled units become vacant. The monthly rent of $1,500 is about normal for a 1 bed in the core which has been occupied for several years and has not seen rent increases beyond the allowed annual increase. My 2% allowed annual increase is a reasonable ballpark number for what’s been allowed under Ontario’s rent controls. Raising rents by $500 is not outlandish—many units which have not turned over have fallen behind market rents—while raising rents by $100 or $50 are routine amounts. The only questionable assumption is the turnover every five years, since under rent controls tenants have no incentive to move out and most are going to stay longer, but it’s impossible to know how long.
What can we make of these different scenarios? It’s clear that the best thing the landlord should do is to raise the asking rent by a large amount, in this case $500, and let the unit sit vacant for a year if necessary to get that rent. If the landlord is going to increase the rent by the same amount on future turnover then letting the unit sit vacant for two years is also an option. Even if the new tenant doesn’t ever move and the rent goes up by only the annual 2% allowed by rent controls, the landlord will still be ahead of other scenarios, especially those in which the unit was leased immediately after becoming vacant but the asking rent was raised by only a small amount.
What this means is that even in a high vacancy market in which large rent increases mean unit sitting vacant, it still makes sense for landlords to wait until the rent increases are achieved instead of rushing to lease them quickly and accepting much lower rent increases.