Landlords Will Lower Rents If Cheaper Rents Make Them Higher Profits. How To Do That
A blueprint for politicians who are looking for a simple way to reduce rents without new bureaucracy
David Grace (Amazon Page — David Grace Website)
[This column is an abbreviated version of a the following more detailed article:
How To Eliminate Excessive Residential Rents Without Rent Controls Or Rent Caps
Secure reasonable rents by imposing an Excess Rent Tax that removes the landlord’s financial incentive to charge an…
The Profit Motive Cannot Be Defeated
There are lots of politicians wanting to “do something” about high rents. None of their plans — rent caps, rent control, etc. — will work effectively because trying to fight the Profit Motive with bureaucratically-enforced rules and commissions is a fool’s errand.
That’s like trying to build a very expensive wall to hold back the incoming tide. It’s always doomed to failure. The tide — the Profit Motive — will always win.
What Gets You The Most Profit — Sell More At A Lower Price Or Sell Less At a Higher Price?
When more money can be made by selling more units at a lower price, the Profit Motive will cause sellers to lower their prices.
When more money can be made selling fewer units at a higher price, the Profit Motive will cause sellers to raise their prices.
In a market where there is
- (1) a limited supply of additional available product in relation to the size of the market, AND
- (2) a small number of sellers (landlords) who collectively control a material percentage of the market, OR
- (3) communications tools and specialized software that enable independent landlords to have constant access to each other’s prices
landlords will adopt a follow the leader pricing model and, like a cartel, landlords will tend to charge the same higher price, but without the illegal “meet and agree” aspects of a classical cartel.
Because the rental market’s vacancy factor is low compared to the size of the market and YieldStar software tracks rents, landlords mostly now practice the “Follow the leader, we’ll all make more money by selling fewer units at higher price” strategy.
An Example Of How The Profit Motive Drives Rental Prices UP
Consider a landlord who owns 100,000 square feet of rental property and leases 100% of it at $3/sq ft. S/he has $200,000 in property tax, mortgage, utility and other expenses resulting in a $100,000/month profit at a $3/sq ft rent.
Now that landlord learns that several other landlords are charging $4/sq ft. for similar properties. S/he calculates that if s/he increases the rent to $4/sq ft, 20% of the tenants will be willing and able to leave. But that’s not a problem because at only 80% occupancy his/her monthly profit will increase from $100,000, to $120,000.
($4/sq ft X 80,000 sq ft = $320,00 — $200,000 costs = $120,000 profit).
The Profit Motive will cause that landlord to increase the rent even though it will leave 20% of the property vacant — fewer square feet rented at a higher price per sq ft. will be more profitable than more square feet rented at a lower price per square foot.
Making Landlords Switch To The “Sell More At A Lower Price” Strategy
To make landlords switch to the “we’ll make more money by selling more units at a lower price” strategy, you have to use the Profit Motive itself to drive rent prices down. Only when landlords will make more money with lower rents will you have lower rents.
You accomplish that with an excess-rent tax that reduces landlords’ net, after-tax profits derived from high rents to an amount that is less than their net after-tax profits derived from low rents.
After subtracting the tax, lower rents make landlords higher net profits than high rents do.
How An Excess-Rent Tax Would Work
If we decide, for example, that a “reasonable” profit is $1/sq ft and we tax the landlord’s “excess profit” at 100% then 80,000 sq ft rented times $1/sq ft profit = $80,000 “reasonable profit” + $200,000 in costs = $280,000 allowable gross rent MINUS the $320,000 gross rent actually collected = a $40,000 Excess Rent Tax.
$320,000 — $40,000 tax — $200,000 costs = $80,000 net, after-tax monthly profit at $4/sq ft rent.
However, if the landlord lowers the rent back to $3/sq ft and returns to full occupancy, the landlord’s after-tax profits will increase from $80,000 to $100,000.
($300,000 rent — $200,000 costs — $0 tax = $100,000 net after-tax profit).
By lowering the rent from $4/sq ft to $3/sq ft the landlord’s after-tax net profit increases because the tax goes from $40,000 down to zero.
Even if this landlord lowered the rent to $3.25/sq ft and occupancy only increased from 80,000 sq ft to 90,000 sq ft, the landlord’s net, after-tax profit would increase from $80,000 at $4/sq ft to $90,000 at $3.25/sq ft.
(90,000 rented sq ft X $1 = $90,000 profit + $200,000 costs = $290,000 allowed rent. 90,000 X $3.25 = $292,500 actual rent— $290,000 allowed rent = $2,500 tax. $292,500 actual rent — $200,000 costs — $2,500 tax = $90,000 after-tax profit.)
So, if you want to get landlords to reduce rents, then pick a dollar amount of profit/sq ft you want to allow, multiply that times the number of square feet actually rented during the tax year, add the landlord’s actual out-of-pocket costs, subtract that total from the gross rents actually received and tax the remainder at 100%.
With this tax in place, it is now more profitable for landlords to lower their rent than to raise their rent, so that’s what the Profit Motive will cause landlords will do.
The landlords will also spend more money on maintenance and repairs because those hard costs will be subtracted from any amounts that would otherwise be subject to the tax.
No New Bureaucracy
No rent control boards. No rent caps. No new government agencies or regulations beyond the tax provisions themselves.
— David Grace (Amazon Page — David Grace Website)