The flipside of rental regulations

Since May 2021, a Dutch law limits annual rent increases in the private market to 5.5%. The measure was introduced to curb excessive rent during a period of high inflation and is currently under review for an extension until 2027. There are good arguments in favor of rental regulations -- as was recently echoed by a UN policy advisor -- but is it smart to further restrict the rental market when supply already seems to lack?

Typically, prices reflect supply and demand. The Dutch rental market is tight, and so rents increase. However, when rents are capped, demand grows instead. Rather than higher rents, we can expect to find longer waiting lists – as we see in the social housing sector. But at the same time, something different is happening as well. There is a way for markets to avoid the restrictions. Maximum price increases are no longer in effect once tenants change. The interplay between tight markets, price restrictions, and possibilities to undermine these restrictions leads to interesting outcomes, as can be seen in the picture below. Rent increases when tenants change are above 10%, on average, while rent increases for homes where tenants remain are just 2%, on average. This has important implications.

• First, we can expect a redistribution of welfare. Households with fixed rental contracts benefit from capped rent increases, while those without contracts or with a need to move, face heightened competition and limited supply.
• Second, the regulation disrupts the incentives of property owners and tenants. Normally, owners benefit from happy renters. Changing tenants brings additional costs, and so it is better to avoid it when reasonably possible. However, once the difference between market- and real rents exceeds transaction costs, things change. Suddenly owners do profit from changing tenants now and then, while the opposite is true for tenants who face increasing reallocating costs.

The extra rent increase when tenants change is not solely caused by the 2021 law, as can be seen in the figure. However, restricting the market might stimulate this gap to widen even further.
In real life, we can already observe anecdotal evidence suggesting that demand outgrows supply. For example, there is the emergence of rental bidding competitions – a phenomenon new to the Dutch market. Moreover, we see a rise in temporary lease contracts. The temporary leases allow owners to swap tenants when they see fit, but give little security to renters. While legislations hinder owners from providing repeated temporary contracts, markets effectively undercut these with dubious fixes, such as temporary contract interruptions, households swapping locations, and using different members of a household to sign consecutive yearly lease contracts.

So are price restrictions favorable? The ones with fixed lease contracts and that are not planning to move, might agree. However, those on the move are paying for it.