I would estimate that over half of all politicians fall into the naïve club that make claims based on assuming nothing will change in response to a new tax, a new regulation or new incentive. For example, they might take the value of all commercial real estate in a metro, state or province and assume that if commercial property were fully taxed and not subject to artificial limits, we would collect billions or so more in property taxes.
But such proposals always ignore the reaction to new taxes and market regulations. The property tax rule in California has resulted in many market distortions, such as less inventory on the market, and the possibility that one neighbour with an identical home as another pays 1/10th the amount of property taxes for the same services.
Regional economies are like inflated balloons; press one place and you expand the air into other areas – action and reaction. If you show me some market segment benefitting from government action, I will show you another area of the market that is losing and vice versa. Sometimes the reactions of the market are such that the negatives more than outweigh the positives or negate the intended benefits. This is what we call Perverse Economics. Here are a few golden oldie examples:
Rent control: The challenges of providing affordable housing are most pronounced in large coastal cities, where healthy economies have pushed housing from the demand side. Proponents of rent control argue that tenants can be exploited if building owners are allowed to raise rents to market levels, risking homelessness. Rent controls vary by market, but in most markets, rents can be increased only when a tenant moves out, while in others only new or rehabilitated units can have rent increases. New York City is a classic case of such rent controls and a great laboratory to show what happens with long term rent controls; housing affordability does not improve.
The intention behind rent control is understandable, but impact on the overall market is negative. Opponents to rent control find such regulation not only inefficient, but also inequitable in serving a city’s residents with various levels of windfall gains extracted from landlords. Abuses are sometimes difficult to detect with rent[1]controlled units. During COVID when landlords were not allowed to evict tenants who could not pay rent, most landlords found that their tenants who could pay continued to do so, but some tenants stopped paying rent despite their means. This became a government-enforced form of welfare transfer, increasing the risk of owning real estate and lowering values. It is somewhat ironic that average values ended up moving up because of massive government stimulus payments that resulted in even stronger rental demand for a while.
Price control: President Nixon imposed sweeping wage and price controls in August 1971 in an attempt to contain inflation. Oil and gas were among the many commodities impacted by price ceilings. Although most controls ended after about three years, wage-and-price controls on oil, gasoline and petroleum products were kept in place throughout the Ford and Carter years. Rather than containing inflation, the “controlled” prices led to a shortage. Oil exploration and domestic oil production slowed, and the artificially low price did nothing to reduce the amount of gas demanded by drivers. Recall that prices are the equilibrating mechanism that balance demand and supply, and when this pricing is constrained, the market will not be in stable equilibrium.
Making matters worse, OPEC placed an oil embargo on the United States in 1973 due to the U.S. support of Israel during the Yom Kippur war. Consumer behaviours in reaction to the rationing were not surprising. Many drivers bought locking gas caps to avoid gas theft and instead of missing work to spend hours in line some people hired “car sitters” who would do it for them.
Policies introduced in response included odd-even rationing and limiting the number of gallons each customer could buy to shorten wait times. Predictably, both served to create further problems, including an increase to wait times, going to the pump more often, and making the shortage worse.
Cheap Student Loans: Student loans are priced without regard to major or the probability of being able to pay back loans. The result of easy access to student debt has seen a plethora of faux educational programs promising high paying careers and offering cheap degrees.
Easy credit, just as it did in the housing market, has resulted in many students naively going into debt without any prospects of paying it off. The result of this easy debt has seen a significant portion of students being pursued to go into quicker, easier, but unproductive areas by unscrupulous “schools”. Another impact has been to make home ownership less affordable as students try and pay off these debts. A market-based program would charge higher rates when the risks of default are higher, but if the government will provide the debt, then such market based rationing systems are not in place. The unpriced debt access may have also led to higher tuition rates than otherwise.
When markets are not allowed to work freely, distortions in consumption will arise. Sometimes good intentioned politicians initiate a new rule but intended benefits are often dissipated and, in some cases, the long-term problem being addressed is exacerbated.
Currently in the US there is an executive order being considered known as “made in America,” the U.K. is considering new laws to ensure sustainable international competitiveness, France considers ways to tax digital giants, and everyone in the world outside of Texas is proposing ESG rules. We need these laws to reduce pollution, but we should be much more careful when it comes to any rules affecting real estate, as the politicians do not seem to know or care about long term implications. An old friend, Geoffrey Dohrmann, who covers institutional real estate would always end his letters with a warning to readers – “Careful out there, it’s a whacky world!”
