Question my MBA professor asked me, looking to surprise him

17 Replies

Suppose now that the proposal before the City Council contemplates imposing a price ceiling on apartment rentals, but not on house rentals. Would owners of rental houses in this city be likely to support this proposal, or would they prefer the status quo (i.e., no price ceilings)? Provide the economic rationale for your answer. (In answering this question, you should ignore all supply-side considerations. In other words, just assume that supply adjusts fully to accommodate demand.)

This is a question in my MBA business finance course. I figured I would bring it to BP and see what professionals think, and I will copy, paste, and of course cite them with a link to BP and maybe get a chance to teach my teacher a thing or two while he is teaching me! who knows maybe he will become a fellow BP member if he isn't already

@Andy Rousch , I'd hardly call myself a professional in this area but I'll try and answer for fun.

Based on the limitations of the question it would probably depend on what rental SFH owners value more-- an increased ability to increase gross rents or the risk to SFH home owners of increased property taxes (which would decrease net rents).

The impact of rent control on apartment owner net income  which would presumably necessitate an increase in property taxes on SFHs to maintain property tax revenue collections (assuming the city doesn't leave taxes on SFHs the same and instead increase them on a group that doesn't contribute to reelection campaigns).

This would limit future growth in the apartment market. Possibly shift growth into SFH market, this could drive up house prices and make them more unaffordable for entry home owners.

Commercial property is valued upon income. Limiting income keeps values from growing which could limit longterm economic growth. Why would anyone want to invest in building apartments in this area when they can build in other areas with no caps?

Whatever answer might be given is useless.  In real life, you can't just say, "...ignore all supply-side considerations...".  Any answer you might give, would be useless in real life, once the real world introduces the "...all supply-side considerations...".

Have you ever seen the movie, "Back to school" with Rodney Dangerfield?

@Andy Rousch

I personally would not support the proposal as if the city imposed that rule on apartments, it is a much easier task for them to do the same to other housing types next year. Generally speaking, in my experience the more governments exercise their power, the more power they want to exercise in the future.

Thank you everybody for the responses! Excited to see what my professor thinks. Of course it’s only class and not real life. I feel as it can go either way where it would prevent apartment owners from being able to update and keep them nice, increasing the appeal of a nice house rental. At the same time the low price could be a pain for house rental owners. The fact that the government is stepping in on the apartment ceiling rate would def scare me as a house rental owner too though cause like kris said they will probably get their hands in that next and mess everything up

You made it a price cap on SFR at the same time when you said ignore supply side considerations.

If apartment rent is stuck at say $500 and the market will supply unlimited apartments for $500 (that means building brand new ones) how much can you rent your “used” house for if I can rent the same size/bed/bathroom brand new apartment for $500?

@Andy Rousch , assuming that this is still pretty early in the semester and that this is a business finance class-- it's a pretty good question to introduce the economics of price control.

For the market to adjust to meet demand, the ceiling would have to be at a level where it creates no housing shortage for renters. That either means that the price is set above the apartment supply/demand equilibrium price (i.e. no impact on rental demand for apartments), or that SFH supply will meet the apartment demand shortage (so there's no deadweight loss).

My guess is that the things your prof brings up in discussing the risks of price control (black market, shortages, queues,limits to government ability to predict demand, etc...) won't be too much different than posters here bring up. Economists are generally pretty skeptical about the effectiveness of price control. 


I would look at some case studies of what happened in areas where rental ceilings were implemented. Illinois has no ceiling, so in theory, I could raise someone's rent from $500 to $1,500 upon new lease, and there is no law stopping me. In Chicago, this likely happens often in areas that are quickly gentrifying. If there was a limit, areas would improve more slowing.

@Andy Rousch answer him with a question or two of your own.

1. How many pieces of real estate do you own?

2. How many have you owned?

Number 2 is because most likely he/she hasn’t owned much more than their primary residence. In the off chance he/she has in fact invested in real estate, you’ve got to go with the single. Prices will appreciate much faster than multis if the apartments are capped. No one will want them. Only when the market is substantially depreciated would it be beneficial to swoop in and grab all of them. At a reduced price and in bulk, a decreased rent may still work out to the margins needed to be profitable.

I own only houses, and I would not support such a proposal. Price controls never work as advertised, and the government makes a mess of just about everything they stick their noses in.

@Andy Rousch

Since an apartment buildings value is based on (5 unit's and greater) NOI (net operating income) by caping the income (rents) would actually decrease its value since expenses would increase as they typically do, while potentially income would max out. An example would be if my NOI is 100K and my cap rate is 7% my property value is 1,428,571. If expenses increased 5% and income stayed the same my NOI is now 95K and my value is 1,357,142. The value of my investment decreased 71K. Why would someone invest in this type of product unless the rent control was very favorable to the owner, which is very unlikely. This will reduce the investor to make improvements as the incentive to increase the viability of his property has been lost. The end result is slum landlords. No one wins in this scenario.

Good Luck.

The only unspecified item in your question; What defines an apartment? For my response, buildings with four or more units will be defined as apartments. Single Family Rentals (SFR) Duplexes and Triplexes will be exempted from the rule because 20 to 40% of two and three family homes, (depending on location) are owner occupied.

1. All owners of apartment buildings will give maximum and immediate rent increases to existing residents on month to month agreements before the laws effective date. If possible the same will issue maximum notices of rent increases for those residents whose leases are renewing within the timeframe prior to the laws effective date.

2. Any included utilities or services will be terminated and the residents will be charged seperately as  soon as practicle. Submetering of water, sewer, gas and electric will become a more common occurance. Freebies like cable TV or internet will be removed from all renewing lease agreements.

3. Sales of Apartment units will stagnate over the next few years as the demand will subside due to government restrictions.

4. Apartments damaged and destroyed by losses covered by insurance will not be rebuilt. Vacant land reduces the city's RE Tax revenue. If the city does not have a good tax and demo ordinance in place unscroupulous owners will quit claim the properties to a non existent entity and walk away from the hazardous 

5. Vacancies in Apartments will be almost non existent since the residents know they are in a better position than in a SFR. Residents will thumb their noses at the apartment owner and try to get the owner to commit an infraction for which legal or civil action can be commenced in order to recieve a payout or get free rental.

6. Single Room Occupancies (SROs) will increase. As the apartment housing stock becomes unavailable due to shrinkage, SROs will become an alternative. Large two story duplexes will be converted into SROs where the owner pays for and monitors all utilities. All second floor kitchens and common areas will be converted into bedrooms. Since this is NOT an apartment individual rooms will rent for $300 to $1,500 a month depending on the location. 

For the rest of this article go to the Illinois REIA web site and check out our blog post

Good Luck and Good Investing.

@Andy Rousch just to qualify my response, I own only rental houses. In my experience the rental needs of a person renting an apartment versus single family home are usually different. In other words I don't see apartments as my competition. For that reason I wouldn't expect economic impact. Theoretically they are both housing, but a motor cycle, car, SUV and truck are all transportation. Arguably each serves a different sub market. Of course rent price caps could reduce supply of apartments, which may make houses a more appealing substitute.

I would oppose such legislation mainly under the "slippery slope" premise. Anyone in business understands that government controls like this only increase in scope over time. So I would know that although house rentals are not part of the regulation today, they are likely to be added in the future. 

Originally posted by @Dennis M. :

@Joe Villeneuve

I would tend to agree with joe on this . How can you simply ignore the supply and demand metric in this scenario ? I would question the good professors understanding of real estate and economics .

 Ever see the movie, "Back to School" with Rodney Dangerfield? I think I know who the Professor might be.

Originally posted by @Andy Rousch :

Thank you everybody for the responses! Excited to see what my professor thinks. Of course it’s only class and not real life. I feel as it can go either way where it would prevent apartment owners from being able to update and keep them nice, increasing the appeal of a nice house rental. At the same time the low price could be a pain for house rental owners. The fact that the government is stepping in on the apartment ceiling rate would def scare me as a house rental owner too though cause like kris said they will probably get their hands in that next and mess everything up

This question he asked you was supposed to get YOU to think. I am curious what YOUR answer is. Better learning experience IMO if you give your answer and ask us to critique it rather than simply getting us to give you answers.

 

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