The Flaw in the Rental Market

Rent always seems to end up too high. Eventually, a city or a neighborhood becomes popular and rent inevitably skyrockets, becoming harmful to tenants. Even in places that enact protections, such as rent control, this increase becomes a problem (albeit sometimes at a slower rate). Rent increases happen because our system for pricing rental housing is inherently imbalanced in favor of landlords.

 

At its core, our system for determining rental pricing is very simple: landlords and tenants negotiate, as equals, a price for the rental unit for a given time. While there are generally some regulations around rentals, such as habitability requirements, these regulations do not directly address the negotiations themselves. Because such regulations do not address the negotiations directly, they do not address, and so cannot correct, the fundamental flaw in our system: that landlords and tenants cannot negotiate equally. A landlord can always choose to not be a landlord, but a tenant can never choose to not be a tenant.

 

Imagine buying something not a rental unit, like buying a watch from a watchmaker. You want the watch, but you don't need the watch, just as the watchmaker wants to sell it to you, but doesn't need to sell it to you at any price. You and the watchmaker can negotiate equally because both of you have about equal need for the sale – if the price isn't reasonable for one of you, you can walk away. But this isn't true between tenants and landlords – a tenant always needs a place to live, while a landlord does not always need to rent their unit because they have options other than renting their unit.

 

Because of this imbalance of need between landlords and tenants, rental prices will always favor the landlord in our current simple system of rental contract negotiations. This means, for any solution to high rent to be effective, it must create balance between the landlord and tenant in their ability to negotiate rental contracts.

 

The Solution

We can balance the needs of landlords and tenants by creating a framework for princing rental units that scales rent to income.

 

Scaling rent to income balances the natural advantage landlords have (that tenants must live somewhere). The negotiations between landlords and tenants are then be more equal because the framework creates a balancing requirement on the side of the landlord to constrain pricing, which offesets the tenant's required need for housing. This framework also maintains a market structure for renting, allowing rental prices to naturally adjust based on changes in income for individuals and the region, as well as changes to the market value of rental units. Scaling rent to income balances the benefit landlords have, that tenants must have a place to live, with a benefit to tenants, that the cost due to a landlord is constrained based on the tenant's means.

 

The Details

Scaling rent to income means scaling rent to the degree of income the tenant earns, such that tenants which earn less, pay less in rent through a consistent framework. First we need a way to measure the degree of income of the tenant. To do this, we can measure a tenant's income against the median income for the city, such as by calculating the tenant's income as a percentage of the median income. In Portland, the median income is about 65k$, so a tenant that earns 32.5k$ earns 50% of the median income.

 

Now that we have a scaled measure of the tenant's income, we need a way to apply it to the rental price. This is easy: we can apply the percentage directly against the market value of the rental. Thus, if a tenant earns 50% of the median income, then rent would be 50% of the market value of the rental. If the tenant earns 75% of the median income, then rent would be 75% of the market value, and so on. If the tenant earned the median income or higher (100+%), then the rent would be the market value of the rental.

Thus, we see that we can scale rent to income by setting rent as a percentage of the market value of the rental equal to the percentage of the median income earned by the tenant. Put another way:

rent = (tenant income / median income) * market value of rental

 

Calculating the median income and the market value of a rental can be done on a yearly basis (or at least regularly), and how they are calculated can be adjusted by the city to improve the functioning of the framework in the marketplace. The number of units used in calculating the rental market value can also be adjusted by the city to improve market performance.

1. Median Income: can be obtained from the Census Bureau, or other governmental/nonprofit agencies. Portland can also develop its own process or calculation for determining the median income.

2. Rental Market Value: the rental market value can be calculated, for a given type of unit in a given building, as the average rental price of the top 20% of units actually rented. This has the advantage of allowing different types of units in different buildings to be priced differently based on what people are willing to pay for the unit, while still scaling the rent to income.

 

To make this framework function effectively, there are a few other requirements:

  1. Buildings with four or fewer units will be exempted from scaling rent to income (although landlords can still choose to do so).

  2. Tenants that make the median income or higher (100+% of the median income) would pay the market value of the rent as they negotiate with the landlord.

  3. A tenant's income and profession cannot be requested by the landlord and cannot be a factor in approving or denying a tenant. However, a landlord can approve or deny a tenant based on other factors. For example, a landlord can confirm that a tenant is employed or otherwise has income and is not required to rent to people without income.

  4. A landlord must rent to tenants in the order they apply and are approved, to further avoid accepting tenants based on income.

  5. A landlord cannot use income as a factor in renewing a tenant's lease. A landlord should renew a lease except in cases where the tenant has a history under this lease of failing to timely pay rent, damaging the property, or creating an inhospitable environment around the rental (such as violating the law or being an annoyance to the neighbors or other tenants). Landlord should also be free to not renew leases for units that they will not rent again, such as when they are selling the unit.

  6. Landlords should have the option to reserve up to 20% of the units of a given type for tenants that pay the full market value (e.g. that make the median income or higher), once 80% of their units are occupied by tenants paying a scaled percentage of the market value of the unit. The percentage of reservable units is another factor that can be adjusted by the city to improve market performance, especially compared to the percentage of units used to calculate the market value.

 

 

The Advantages

 

There are numerous advantages to scaling rent to income, most of which are because scaling rent to income corrects the underlying problem, rather than patching symptoms of the problem as common remedies, like rent control, do. Here are a few of the advantages:

 

1. Scaling rent to income maintains a flexible marketplace, which means rental units can still be valuable assets and offered to tenants. The actual paid price of units still can fluctuate with the value of particular rental units and changes in the market. This allows rental units to be profitable without the negative effects of the current marketplace structure. Different units will still be able to comand different levels of rent, and so there is incentive for both nicer and simpler units. This framework ensures that rental units will be a profitable business, and so rental units will be made available in the marketplace, just based on a different baseline profitability scale than currently used. We want landlords to offer rentals, and this system provides them a balanced incentive to do so. And because the framework is knowable, businesses can calculate their expected income and value, allowing them to have security in their business and plan how best to develop,

 

2. Scaling rent to income has a low cost to the City. The costs would include covering a small expansion to the housing bureau, such as for staff to collect and maintain lease data and publish regularly the numbers necessary to calculate the scale (like the median income, market value of a unit type in a building, and so on). But this framework avoids the large sums of money needed to build government housing, or subsidize housing, for example.

 

3. Scaling rent to income provides multiple levers for the City to use to ensure the housing market is working well for both landlords and tenants, with little effort. For example, the number against which income is scaled can be readily managed by the City. We can scale income to the median, as proposed, but analysis after a few years of implementation may show that the income average is a more appropriate number, or that income should be scaled to 110% or 90% of the median income. The number of units used to calculate the market value and reservable for median-income residents can also be readily adjusted to ensure housing is both affordable and profitable. The scaling framework includes tools for the city to work with landlords and tenants to improve the marketplace without passing new regulations or making major changes to the system.

 

4. Scaling rent to income provides relief quickly and across the board. It does not rely on finite resources (e.g. a limited amount of money for subsidizing housing), and so can help a broader swath of people struggling with rent, from the working poor to middle class renters, from students to retirees.

 

5. This aligns the interests of landlords and tenants in the economy. As tenants do better, landlords will do better, and vice versa.

 

 

The Transition

Transitioning to a housing marketplace that scales rent to income does require recognizing that current landlords have invested in property based on a different expectation of return. This means they have loans, mortgages, that may not be affordable based on scaled prices. This will not be a problem in the future, because businesses can value buildings, land, and construction based on scaled rental income, but this can be a problem now for landlords already invested based on the old system.

We should work with landlords to ensure this transition is possible and affordable for them while maintaining their business. One possible option would be to provide interest-free loans to replace current mortgages on qualifying rental buildings.

UPDATE - Effects on the Rental Market

One valuable trait of my proposal to scale rent to income is that it modifies the parameters or the framework of the rental marketplace without controlling or eliminating the marketplace. The proposal is that rent would be determined per tenant per unit type as a percentage of the market value of the specific unit equal to the percentage the specific tenant earns of the median income (or other income target), up to 100 percent. Let's consider what this means for business on the landlord side.

 

If we're looking to purchase an apartment building, we'd look at the estimated revenue, the average rent we can expect to receive, compared to the cost to purchase and run the building. If the expected revenue is enough to likely generate profit (either now or in the future as loans are paid down) compared to the cost to purchase and operate, we'll buy the building. If the revenue isn't enough, we won't buy the building. If the cost of the building (or costs to operate) is too high compared to the expected revenue from renting the apartments, the value of the building will go down.

 

It doesn't matter how we get to the estimated revenue, just that we can estimate the revenue. Right now, the structure of our rental marketplace is very little to none – landlords can set their rate however they see fit, with the risk that it'll be higher than enough people will pay. The purpose of this video is to show that tenants don't have the ability, ultimately, to drive down the price by simply not renting because they can't really walk away from bad deals. Housing is a necessary good – everyone must live somewhere. If you think this isn't true, try roaming a metroplex talking down an apartment to where you can afford it while facing a deadline when you won't have a place to live because your current lease is ending.

 

Instead, my proposal to scale rent to income keeps the marketplace but with a formula for how rent is determined. Revenue can still be estimated, but through the formula scaling rent to income. This is likely to be a lower amount than current prices, which will reduce the value of rental properties. But that doesn't mean the marketplace has no room for profit, just that costs to purchase and operate must be re-scaled to a new formula for rent. This is what is meant by balancing the needs of landlords and tenants. The marketplace still exists with room for landlords to have a say in pricing, but it adds that tenants have an actual say as well, with neither party having complete control.

 

Moreover, the formula includes the market value of the unit. So, the value of the units is still driven in part by negotiations between landlords and tenants, just not entirely.

 

This describes how scaling rent to income affects the marketplace once implemented, but it doesn't address landlords that have taken out loans based on our current system (loans which helps drive our current high prices). Landlords that purchased a decade ago or more, before prices spiked, are unlikely to have a problem with adjusted rent providing sufficient income to cover their loans and operating costs. But more recent acquisitions may have trouble, being fully leveraged based on the current exorbitant rents. We must work with such landlords to help them transition to the new system while continuing to provide housing that is now affordable.

 

Scaling rent to income balances a marketplace that has never been a system with equals on both sides of the contract. It uses both the market value and the income of the tenants together, through a known formula with statistically predictable results, to create this balance. The transition to this system requires working with landlords and tenants both.

Fair Housing

​We can do more to make housing affordable by scaling rent to income, up to the median income, for Portland.

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FAIR & AFFORDABLE HOUSING FOR PORTLAND

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