There is a housing topic I've written about perviously that I want to re-visit, because when I shared news of it a year ago its details were so completely ground-breaking it was guaranteed to become a national, if not global, “must read” case study.

Every person engaged in the branch of knowledge known as “economics” will be looking upon it to pull lessons from – or to hold it out as the ultimate “I told you so.”

I'm talking about the extreme rent controls passed in St. Paul, Minnesota in November, 2021.Never had any known U.S. municipality or state, much less a well-established city with a population of +-300K, passed such a limiting price control.

Today we’re going to peek in on it and see what’s happening in St. Paul today.(I LOVE whenever we can skip over “theory and opinion” and look at an actual real-world outcome.)With no further ado, let’s hop on the teleporter and beam over to St. Paul, MN, to look at what’s going on with their new law.

Let's quickly recap...

Rent controls are legislation at the city or state level that put a ceiling on the rent amount that can be charged for a housing unit, and/or cap the amount the rent can be raised each year.

If you recall, rent controls were on our radar and in the blog post about a year ago because the People First initiative had a measure proposing them for Bellingham.(Local voters defeated that People First measure by a 1%-ish margin, and they did not re-appear on the 2022 ballot.)In the same blog post where I reported that outcome, I shared the following on the national headline-making St. Paul, MN’s rent control measure:

We're about to have the ultimate rent control case study in St. Paul, MN, a city with over 300,000 residents.Voters there just approved one of the strictest rent controls on record:

A 3% annual cap on rent increases -- EVEN IF the tenant changes.

The measure applies to:

• All rental properties in the city

• Regardless of size or age

• Whether they're mom-and-pop owned or hedge-fund owned

• And (very unusually) it even applies to brand new construction.

The measure (also very unusually) does not account for inflation.

I mean...... *&%$@#!!!!!!!!!!!!!!!This is gonna be WILD to watch play out.

Here we are, in charming St. Paul, 1 year later.

What rent controls are meant to achieve

On the surface, limiting rent increases seems like it will help tenants by keeping their housing affordable.

Materially raising rents, many argue, is a form of price gouging – or taking advantage of (often extremely) limited supply FOLLOWING or DURING an emergency, a disaster, or a CRISIS.(Remember the term “housing crisis” from like 2 seconds ago?)On average, evening during normal real estate markets, rents increase much faster than wages do.

Nationally, average annual rents have increased a reported 8.85% every year since 1980.In 2021 – peak-housing-shortage-crisis – that number hit almost 20%.Wages, however, have increased a reported annual average of 3.12%.Ten years ago, the average renter paid 22.85% of their income towards rent.

This year, nationally, the average amount of income paid towards rent was 45%.Affordability is therefore mathematically fleeting -- and I fully acknowledge that that is a problem for many, many renters.

Hence, rent controls

Tenants and policy makers naturally want to solve this problematic gap, and the simplest solution is usually the best, right?

So layering on some legislation that dictates what landlords can charge and how much they can increase rents is an easy answer.

Plus, in terms of out of pocket expenses, it costs a municipality basically nothing up front to implement.

No government buildings to construct.

No subsidies to fund.

No new departments to staff up and pay.

It’s just a new rule – and it feels good to voters and politicians because it is (seemingly) helping people who are legitimately having a harder and harder time affording their housing.

So St. Paul went all in

And I mean, ALLLLLLLLL IN.

In November 2021, St. Paul, MN, policy makers and voters decided that if a little rent control is good and helpful, then more must be a lot better!As I mentioned earlier, voters there passed by a hefty (6%) margin an annual rental increase cap of 3% for any and all buildings, with no provision for inflation.3% is just below the average annual wage increase, so in theory tenants might over time not only continue to afford their rental, but might be able to put a little money away even.

No one can begrudge any person of that possibility.But when news of the measure’s passing and its specific details spread, a category of people collectively sprayed their sip of coffee across the diner.

Those people included:

• Developers

• Lenders

• Investors

• Builders

• Landlords

• And economists

This headline appeared shortly thereafter:

That was within the first 24 hours after the measure was passed.Although it was not made clear initially, it was eventually released that the new law would take effect on May 1, 2022.

In the financial equivalent of getting one last breath of oxygen before floodwaters fill your living room to the ceiling, landlords predictably sent out (often significant) rent increase notices to their tenants.

It was their last chance to get rents to market rate and to try future-proofing the inevitable "operating at a loss" that a 3% increase cap would result in

While that took place with existing rentals, those people involved in creating new rental properties stomped on the emergency brake.

The city’s planning and permit center reported a decline in year-over-year building permit applications of a staggering 80%.

With all due respect to the concerns and opinions of some who are angry at the increased cost of housing, this wasn’t merely a matter of simple greed on the part of developers and investors.

Construction projects require financing, and lenders have criteria that help ensure the borrowers will be able to repay the loans well beyond year one.

Repayment of those loans is made possible by revenue generated by the asset.

See where this is going?

Here’s a simple example of that criteria: Debt Coverage Ratio, or DCR.

A lender might have a DCR requirement of 1.2.That means, if the total debt service (mortgage payment) is $100,000 per year, then the lender wants to see the asset generating $120,000 per year in net operating income – or 1.2 times the debt service.

When rents are so strictly capped while the owner or landlord continues to experience un-capped increases in operating expenses like taxes, insurance, utilities, maintenance, management, and so forth, the lender or private investor has no choice but to say, “Sorry, we can’t do this loan.”

No loan, no construction project.And that’s just new construction.

With a 3% cap on annual rent increases – and remember, that stands even if the tenant moves out and a new one moves in – the city of St. Paul would very quickly begin to see another undesirable effect take place:

Landlords of existing buildings would stop maintenance on them, and in some cases would eventually shudder them, removing them from the housing pool altogether.

That’s what has happened in New York.

Rent controls have been in place in New York City since the 1920’s.In 2019, however, a reform to the laws there removed an allowable 20% increase during a vacancy, and limited renovation expenses that a landlord could recapture with rent increases to just $15,000 over 15 years.

That's an allowed $1000 per year in rent increases for necessary renovations.(How much "renovation" could YOU do for $1000?)The unintended consequence of this policy?

A reported 43,000 vacant-but-uninhabitable (read: shuddered long-term) apartments that landlords can not economically justify renovating, so they just leave them vacant, in a city with a reported 60,000+ nightly homeless people.

Voter popularity aside, economics operate much like the laws of physics, independent of opinion, whether we like them or not.

And no matter how many times it's been tried, rent controls squeeze supply.

When demand is high and supply is diminished, what happens to price?

This, reported in August, 2022:

Back to St. Paul…

Despite its margin of victory at the polls, the actual landscape created by the unprecedented 3%-across-the-board rent increase caps was rather quickly identified as entirely unsustainable.

It did not take long for public officials to recognize the over-tight restrictions' damaging consequences.

With obvious frustration from those who fought for, supported, and voted for the measure, St. Paul government officials made the following amendments, which are scheduled to take effect on January 1, 2023:

• Upon a vacancy, the landlord can increase rents by 8% + CPI inflation (most recently reported at 7.7%)

• New construction and buildings up to 20 years old are exempt from the rent controls.

• Landlords, while still being held to the 3% cap, are also entitled to a “right to a reasonable return on investment.”

• This means the landlord can apply for an exemption to the 3% if there is an increase in operating expenses, e.g. property taxes, utilities, cost of necessary renovations, etc.

• There is also new language requiring “just cause” before a landlord can terminate a lease or evict a tenant.

The less-than-one-year-in reforms have understandably created outrage, as referenced in this article.

People are naturally angry...

The simple truth is that the St. Paul rent control law should have never even reached voters.

Not as it was written, and passed, last November.

An hour of research and reading, of looking at other municipalities who have experimented with rent controls, should have sufficiently informed St. Paul public officials that they were teeing themselves up for an outright disaster.

St. Paul news sources wrote:

“...Activists told the council they’ll remember them voting to gut the ordinance when they’re up for re-election next year.

“The ordinance [reform] goes directly against the democratically passed policy and completely subverts the will of the people, sowing distrust, disdain and contempt for this elected body.”

While last fall, voters were buying rounds for the public officials who represented their fair city as this law was passed.

Those same voters now want the local government's collective head on a stake.

Conclusion, and a question

Let me conclude my report by acknowledging once again the endless complexity of the issue of housing availability and affordability.

I support laws requiring “just cause” for lease terminations, which is state law in Washington, as long as there are provisions and protections that require and allow enforcement of reasonable care for the property.

There are also rent controls in place in other states and municipalities that take real world economics into consideration, things like inflation and rising operating expenses, and that give landlords the ability to achieve "market rate rent" following a vacancy.

I have not done a deep-dive on those more moderate laws, but I will continue to study this issue.

I completely understand the frustration that exists, especially with the growing gap between wage growth and cost of living across all categories, housing included.

What is beyond perplexing to me though, is this, and I invite conversation on this, please:

How does a city government in a place as established and sophisticated as St. Paul, MN, allow such a completely non-functional-in-any-way measure as a 3% straight cap on rental increases......to ever, EVER, reach the ballot and pass into law?

For those Bellingham public officials who read this blog post, both current and past, or any readers who have knowledge or an opinion on this, can we talk about it?

Am I being naïve? 

Thanks again and again for reading... and please do email or call if you want to talk about the topic above.