There’s a recent article which has been making the rounds titled “How luxury apartment buildings help low-income renters.” I think it showed up first on a US website but it’s been republished in Canada. I’ve included a link to a US website below so you can read the article (I suspect that’s where the article was published first).
https://fullstackeconomics.com/how-luxury-apartment-buildings-help-low-income-renters/
The article’s basic argument is that if you want rental housing to be more affordable, or rather if you want more affordable rental housing to be available—we’re talking about attainable affordability, not subsidized affordability—then we need to build more, lots more, high-rent rental housing so that overall supply will grow and… something, something… more affordable rents. This argument is essentially a ‘trickle-down’ approach which relies exclusively on ‘upward mobility’ among renters to generate vacancies in rentals with affordable rents, something I’ve talked about before in a past post.
Here’s how the basic sequence, as I understand it, is supposed to work: (1) new luxury rentals are added to the supply, (2) renters in existing buildings move to new luxury rentals, (3) vacancies increase in existing rentals, (4) landlords slow or stop rent increases in existing rentals to eliminate vacancies, and (5) more low- and mid-rent rental units at lower rents are available for price-sensitive renters to rent.
Is this sequence—and expected outcome—realistic? I don’t think it is. Here are my reasons why not.
1. 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 rentals and probably at rents lower than the newly built rentals will charge. The thing is there is little difference between rentals built today and those built a decade ago. High income renters aren’t stupid and if they’ve got everything they need in their current rentals why would they pay more for a rental which isn’t much different except only a few years newer? Existing rentals are expected to provide affordable rental housing via renter ‘upward mobility,’ but if there’s no incentive for renters to move out of existing rentals to new, more expensive rentals, that means no movement of renters, no change in vacancies, and no pressure on rents.
2. Rent controls are active in several provinces in Canada and most of those regulatory regimes block significant rent increases except on turnover, although new buildings are usually exempt from rent controls. Even in regimes in which rent increases are not capped most landlords are not suicidal enough to raise rents by significant amounts on sitting tenants, even if they legally could. This has the obvious effect of discouraging renters from moving since they know that if they move they’ll almost certainly have to pay a much higher rent in their next rental, whereas if they stay it’s likely their rent won’t increase by too much even if it isn’t regulated.
3. Higher and higher asking rents in newly constructed rental buildings might result in sticker shock even among high-income renters. If too many new rentals are constructed, discouragingly high rents could cause slower lease-up times and larger amounts of lingering vacancies in new buildings. This could discourage developers from building large amounts of new rentals since a rapid absorption into the market at high rents is crucial for development success.
4. There’s no guarantee that new construction will increase vacancies in the rental supply no matter how many new rentals are added to the supply. Local market demand for housing may be so strong among renters and potential renters—demand may exceed supply by such a large amount—that any vacancies are filled immediately, no matter the asking rent (this is certainly the case in most major housing markets in Ontario). Ultimately, to depress rents or slow rent growth, we would need to add a huge amount of new rental housing, a sufficiently vast supply flood that would overwhelm demand and drive up vacancies far enough that landlords would have no choice but to react with lower or flat rents. Here in Ontario, we are decades and hundreds of thousands of new rental units away from such a scenario.
5. 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 explained in a past post, it can be advantageous for landlords to leave units vacant for months or even a year waiting for a renter who will pay a big rent increase instead of renting vacant units quickly at a lower rent increase, or even no rent increase at all. Common sense tells us that these types of market sensitivities and reactions to supply-and-demand shifts only work in a near-saturated rental housing market in which supply is only slightly lower than demand, making it possible for a small (say, one or two new luxury buildings) increase in supply to force landlords to adjust rents. By contrast, in rental housing markets in which demand greatly exceeds supply—which to be honest, is most markets in southern Ontario for the foreseeable future—there is no way that enough pressure can be put on landlords to adjust rents simply by adding a few new, high-rent rental buildings.
6. Higher and higher asking rents in newly constructed rental buildings show landlords of older rental buildings just how high rents could go. This encourages landlords to renovate their aging properties and increase rents to try to capture some of the rent upside which the new buildings have demonstrated that the market will bear.
So, to summarize…
The ‘trickle-down’ approach to creating affordable rental housing is entirely reliant on the upward mobility of renters. If renters in existing rentals don’t move into newly constructed rentals, thus freeing up units in existing rentals, and/or if the new rentals are absorbed by excess demand without affecting demand for existing rentals, then there will be no Microeconomics 101 classic supply-and-demand curve pressure put on landlords to moderate rents in existing rentals. In fact, we don’t even need to think of it in terms of supply-and-demand and rents and vacancies and new construction—common sense tells us that if you build new high-rent rentals and are counting on that to create affordable-rent rentals via renter mobility, then you have failed before you even start because you haven’t actually increased the number of affordable-rent rentals.
The solution to affordability challenges is to simply build more affordable-rent rentals. This is such a simple solution that it seems to be unthinkable. Of course, I understand and appreciate that the lower return on investment that affordable-rent rentals yield (thanks to lower rents) makes building mid-priced rentals less attractive or less feasible than building high-rent rentals, so in practice there really isn’t an easy solution to the affordability problem. In my opinion, relying completely on the private-sector and a ‘trickle-down’ approach is even less realistic, as I’ve described.
P.S.: The article cites two sources for data. I won’t comment on them in detail other than to say that data from Finland could be interesting but probably isn’t relevant for the US or Canada, and that the academic study by Evan Mast doesn’t conclude what the article claims it concludes.