Most investors shudder at the idea of having to deal with rent control laws -- especially the dreaded rent ceiling, which limits the amount of rent you're able to charge tenants. However, before you swear off investing in one of these areas entirely, it's important to have a clear picture of what you're facing.
To that end, here's a primer on rent ceilings, including their history, where they're most common, and what they look like today.
So what is a rent ceiling?
Put simply, a rent ceiling is a form of rent control that regulates how much a housing provider can charge for a rental property. In particular, a rent ceiling regulates the maximum amount of rent a landlord can charge a tenant. Also known as a rent cap, this type of rent control law is effectively the opposite of a price floor, a term for a government-regulated limit on how low pricing for a particular commodity can go.
Not all neighborhoods are subject to rent ceilings -- or any type of rent control laws at all. In fact, legislation controlling the price of housing is rare these days, and 37 states even have laws preventing it.
When these laws are in place, however, they are usually regulated on a municipal level. For example, while California, New York, New Jersey, and Maryland all have rent control laws on the books, they vary depending on the county or city.
That said, rent stabilization measures are most common in densely populated metropolitan areas where rental housing is common. Notably, San Francisco, New York City, and the District of Columbia all have rent control measures, which is a consideration for investors looking to purchase property in these areas.
How did rent ceilings come about?
Rent ceilings -- and rent control laws in general -- are said to date back to the early part of the 20th century. In the United States, the first wave of rent control laws took hold shortly after World War I as a result of public pressure due to increasing amounts of rent profiteering. These measures gained popularity again in response to the vast housing shortages that occurred shortly after World War II. Finally, in the 1970s, there was a third wave of measures passed in response to Richard Nixon's price and wage controls, some of which are still in place today.
However, that is not to say there are no new rent control laws being put in place in modern times. In fact, this past January, California enacted the Tenant Protection Act of 2019, a statewide rent control measure that limits rent hikes. Landlords are now only allowed to raise their rents by 5% plus the cost of inflation or by 10% of the lowest rent charged for the unit in the past year, whichever is less.
That said, while many of the early rent control measures included a binding rent ceiling, it's less common to see these in place today. Like California's Tenant Protection Act, today's rent control measures largely focus on rent stabilization, still allowing for periodic rent increases. Whenever there's a rent cap in place, the rental housing commission in charge of regulating pricing typically allows for a rent ceiling adjustment annually.
What are the economic advantages and disadvantages of rent ceilings?
In truth, economists are split on whether rent control, and more specifically rent ceilings, actually help communities. We've listed some of the most common advantages and disadvantages of this kind of legislation so you'll know where you stand on this issue and whether investing in an area with rent control measures is right for you.
One of the biggest advantages of rent ceilings and rent control laws is they provide affordable housing for those who need it. Particularly in high-priced markets like New York and San Francisco, many people cannot afford market-price rent. Price control measures ensure the housing market is accessible to a greater number of people, protecting their interests against unscrupulous landlords.
In addition, some economists argue affordable housing plays a key role in neighborhood stabilization, theorizing a tenant in a rent-controlled apartment is far more likely to stay in place long term than one subject to regular rent increases. By extension, the longer a tenant stays in place, the more likely they are to invest in the betterment of their neighborhood and local community.
From an investor's perspective, it's easy to see the disadvantage. In this scenario, there's a limit to the amount of profit you can make from investing in communities where rent control measures and rent ceilings are prevalent. As a result, many landlords there are disincentivized to make improvements to their buildings, which leads to substantial deterioration of the quality of housing.
However, on a broader scale, rent ceilings tend to throw off the demand curve. Since more people can afford housing when rent is lower, there is a greater demand for rent-controlled units. In turn, this lowers overall supply and creates a surplus of available renters.
Finally, experience has shown rent control measures may actually give rise to a black market. For example, a prospective tenant might agree to pay extra for a rent-controlled apartment if chosen by the landlord. However, as you might expect, that excess is typically paid under the table and kept off the books.
The bottom line
For most investors, rent ceilings are not usually something to worry about, since they were more common in past iterations of rent control laws. Today, many states and municipalities even have laws in place that outlaw implementation of rent control entirely. However, if you are thinking of investing in a market with rent control measures, make sure you're well aware of what these measures entail and what that means for your bottom line before making a purchase.