Prop 10: Does Rent Control Make Sense for California?

In June, the California Secretary of State confirmed Proposition 10 as a ballot initiative that, if passed, will allow cities in California to implement rent control.  With the housing shortage in California, San Diego in particular, renters have seen dramatic increases in rent that quite simply have not kept up with the cost of living. As a result, San Diego is seeing gentrification in areas not normally associated with the displacement of middle- class renters, like La Mesa and the surrounding suburbs of downtown.  This displacement is what is most likely bringing Proposition 10 to the ballots this November.

Historically, middle–class workers in California were able to afford homes, which granted them stability in terms of their cost-of-living.  However, with skyrocketing housing prices, even those with good jobs have found themselves struggling to get into their first home. This confluence of unaffordable housing and the gentrification of the middle- class has brought the issue of rent controls back into the public purview.

Currently, rent controls are largely prevented under the 1995 Costa Hawkins Rental Housing Act.

The Costa Hawkins Act contains three major provisions:

• It protects a landlord’s right to raise the rent to market rate on a unit once a tenant moves out.
• It prevents cities from establishing rent control—or capping rent—on units constructed after February 1995.
• It exempts single-family homes and condos from rent control restrictions.

Rents in San Diego have increased substantially over the last 3 years and vacancy rates remain low.  The average rent in March of 2018 in San Diego was $1,887, which represented a 20% increase since 2015.  At the same time, vacancy rates remain low, approximately 3.2%, which is below the historical average.

San Diego, unlike Los Angeles and San Francisco, has not implemented any rent controls.  Across California, there are only 15 municipalities that have implemented rent controls prior to the acceptance of Costa Hawkins.  Most rent control ordinances limit the permissible rent increase the landlord can charge if the tenant chooses to stay in the unit year over year.  Rent control ordinances typically also prevent a landlord from evicting a tenant unless the landlord is planning on removing the property from the market.  Finally, in some areas, even if the landlord is courting a new tenant, the landlord would be limited in the amount that he could charge the new tenant. 

The implementation of rent controls will dramatically shift rights from property owners in rent controlled areas to renters who are fortunate enough to obtain housing in those areas.

The Economics:

In San Diego, the primary cause of higher rental costs is the result of the shortage of available rental units.  With vacancies approaching 3%, most economists agree that San Diego’s high rental prices are a direct product of a fundamental lack of supply.  Under this line of reasoning, which is the prevailing wisdom, the implementation of rent controls would simply lower the value of housing and therefore discourage investment in new housing.  As the argument goes, while a select few who are in rent controlled districts would benefit, the decrease in new housing investments would cause higher rents for the remainder of San Diego’s renters.

Another line of reasoning focuses on the demand side of the equation.  California’s homeownership rate is currently around 10 percentage points below the national homeownership rate, 54.6% versus 64.2%.   That differential has always been true in California.  Not surprisingly and directly proportionate, the rate of renters in California is about 10% higher than the rate of renters for the rest of the country, 46% compared with 36% respectively.  Theoretically, by increasing homeownership rates, you would automatically decrease the number of renters in the market.  Proponents of a demand side argument theorize that implementation of rent controls may decrease the value of homes for investors, but the value of homes would remain constant for primary residence holders.  By shifting the value away from investors, homeownership rates will increase naturally through the conversion of rental properties to primary residence holders.

The rationale surrounding the demand side analysis is tortured on a number of levels.  Most obviously, increasing homeownership rates by converting rental properties into primary residences simply decreases the number of available rental units on the rental market.  While it does address the issue of gentrification for those that are able to buy homes, it does little to actually address the fact that there are more renters than houses available for them.

The argument does, however, touch on a fundamental issue that is unique to California:  With such a large percentage of California’s population being renters, 10% more than anywhere else in the country, does California have an obligation to provide some stability to middle- class workers who are lifelong renters?

The Politics

The real rationale for Proposition 10 and the repeal of Costa Hawkins is grounded in politics, not economics.  First, Proposition 10 itself does not implement rent controls; it simply would allow municipalities to implement rent controls at the local level.  Proponents of Proposition 10 argue that areas such as San Francisco, Silicon Valley and National City all have different housing needs that should be addressed at the local level.  Proposition 10 simply gives local municipalities the flexibility they need in order to meet the needs of their community and develop flexibility in community planning.

Proponents of Proposition 10 argue secondarily that housing stability should be a right as opposed to a privilege.  The median household income in San Diego County in 2017 was $66,500.  According to BankRate.Com, assuming 20% down and only $1,000 a month in non-housing related expense, the maximum recommended housing price is about $240,000. Meanwhile, the median home prices in San Diego rose 8.6% in April, 2018 to reach its highest level ever at $570,000.

Based on these numbers, the average middle- class worker cannot reasonably expect to ever buy a home in San Diego or in most metropolitan areas in California.  Since that is our current reality, then shouldn’t local municipalities be given the option of protecting middle- class families from being displaced from their communities?  Shouldn’t local government be given the tools to promote a stable and diverse community?   If we value economic and racial diversity, shouldn’t a community be given the flexibility to plan for low income families through rent controls?

I struggle with these issues personally.  We moved seven times in 11 years before we bought our home in 2018.  Most of that was by choice, but I do know that rents went up precipitously over the same period.  The one time where our landlord was selling the home we were renting, it was frustrating.  As our kids are getting older, we are definitely accumulating more stuff, making the prospect of moving more daunting.  Having a home now, I value homeownership, the stability it brings, and the investment in the community it allows.  It would be devastating to know that I could never buy a home and I think that under those circumstances, I would want some stability in terms of my rental situation.

On the other hand, I firmly believe that the housing shortage and gentrification are supply side problems.  The only practical means of bringing more housing on the market is to streamline the process of development and to increase investment into the housing market.  Ultimately, the California housing market must be relied on to do what the California housing market has always done:  Correct itself and bring housing back in line with what people can afford.

On balance, I take the position that Costa Hawkins should not be repealed.  There are a myriad of reasons that lead to unaffordable housing in California.  While each of these reasons can be separately analyzed and are topics worthy of their own articles, we have to start by looking at Proposition 13 and the relatively low effective property tax rates in California.  From there, we quickly move to the development life cycle and costs of litigation.  Finally, we have to look at the wealth effect and role that real estate plays in California’s economy.

Ultimately, what I am confident that we will find is that investors are competing with the middle-class for homes and driving the middle-class out of the owner occupied market and pushing them into an already flooded rental market.  Further, I’m confident that the driving force behind the low owner-occupied housing rates can be traced to tax incentives that favor the investment buyer over the owner-occupied buyer.

As a result, the path to addressing middle-class gentrification is through policies that encourage higher owner-occupancy rates.  While rent control may cause a small and unintended increase in owner-occupied housing rates, it really does little to help renters.  Trying to address gentrification through rent control measures as allowed under Proposition 10 is just the wrong tool for the job, even if done at the local level.  Instead, we must look long and hard at policies that have caused California to have the second lowest owner-occupancy rate in the country.