Friday, 29 May 2015

Rental rationing equilibria?

The only way I can make sense of Lee Suckling's renting experience in Auckland is that we're in a rental rationing equilibrium.

What does that mean?

In credit rationing models, too high an interest rate will only attract bad borrowers. When the lender can't tell enough about the borrower's creditworthiness, he'll ration credit: charge a bit less interest and give the loans to the most credible borrowers. Demand for loans will exceed supply at the going rate, but nobody does better by increasing interest rates to clear the market. Tyler and I discussed these models a while back; the implications for market efficiency aren't as clear-cut as you might think.

What does that have to do with the price of rental accommodation in Auckland?

First, note that it can be hard for landlords to evict bad tenants. Or, at least, lots of landlords believe that to be the case. Here is one recent horror story. Another another; the government has a hard time with it tooOne property management company lists a best-case of a 7-week process to evict a tenant that has stopped paying rent.

Now here's Suckling's account:
At every viewing you'll be one of at least 20 people. You'll wait patiently outside, eyeing up the competition, then will line up like sheep, shoes off, ready to file in five-at-a-time.

The reality is never as good as what TradeMe presents - especially if the listing used overexposed real estate photos, complete with fisheye angles that make 50 square metres look like 80. If you're looking in a city-fringe suburb, you will be met with grottiness. Auckland landlords, you seriously need to have your houses professionally cleaned. Last time we checked, $500 a week didn't buy us mould.

Still, such filth seems not to deter most. Four or five people will fill out applications then and there, before greasing up to the agent to find out how they're going to "win" this grubby, fungus-friendly house.

The answer? Be a white couple (yes, it seems race matters in agents' eyes), not a group of potential flatmates. Come with no kids, no pets, your own whiteware, and full-time jobs in a stable industry like law. Good references are vital, and you can't have a current lease - you need to be able to move in, well, tomorrow, so the landlord doesn't lose any money.

If such qualifiers are not already ridiculous enough, you'll also need to be flexible on your budget. I started with a price range the $450-$500 vicinity. Every week, my husband and I renegotiated the ceiling on our accommodation allocation. Last week, the budget had reached $600 per week.

Oh, and you'll need $3500 in the bank to give away as move-in costs to seal the deal - inclusive of the ever-ridiculous "letting fee", which seldom exists outside of Auckland and goes straight into the agency's pocket alongside five or 10 per cent of your weekly rent.

Viewing after viewing, application after application, your spirits will sink low. Really low. Finding a rental is like applying for jobs: you're excited and hopeful in the beginning, but come week three of rejections you think there's something seriously undesirable about you.

Rental-hunting depression is also fuelled by the sheer lack of decent houses out there - those you'd never thought you'd live in, but now, somehow, are actually considering.
Suppose you had a queue of 20 potential renters at a $600/week rent. At a higher rent, you'd have a shorter queue, but you'd have a worse pool from which to draw and less ability to be selective. So keep the rent lower and pick-and-choose.

If your basic model is that landlords are trying to eke out as much in rent as possible and that they'll hike the rent at any chance, why aren't they charging more if they're getting queues of dozens of potential tenants? A rental-rationing equilibrium could explain part of it.

Sure, maybe they're lowballing things to draw in a bigger pool for the at-house auction, but the additional anecdotal hurdles are all characteristics-based, not offer price. The tenants' expected financial stability matters a lot more when it's hard to evict non-paying tenants.

The rental-rationing story is also consistent with other odd accounts you'd hear, like that longer-term tenancies induce the landlord to charge more rather than less. If the rental-rationing story is right, a long-term tenancy subsequent to a short-term tenancy would be preferred by the landlord who's then learned tenant type, but the initial request for a long-term tenancy is riskier because you have fewer opportunities to be easily rid of a bad tenant. I don't know whether that's the case: I'm neither a landlord nor a tenant.

On the other side, Tenancy Tribunal decisions are already publicly searchable; landlords can find out about the riskiest tenants. This limits the extent of any rental-rationing equilibrium by knocking out the tenants who've recently had judgements against them and who are applying for your place under the same variant of their name that they used at their last place.

Potential solutions?

Making it easier to evict problem tenants can help, but that comes at the risk of empowering bad landlords.

Best solution would be to allow sufficient increases in housing supply that landlords had to compete a bit harder for tenants - while also making it fairly easy to evict bad ones.

I wonder too whether some of the grottiness and lack of upkeep is explained not only by the tight market for rentals but also by regulatory uncertainty around zoning. If you think the unitary plan might let you bowl a run-down property in a couple of years to put up townhouses, why invest in upkeep?


  1. Your links seem to me to establish that it can take many weeks to evict a bad tenant (during which time they may be able to do substantial damage), but not that it's hard. I don't think that really affects the rest of your post, but "lengthy" and "difficult" are different things.

    In fact, compared to some other Western jurisdictions, tenancy law might be said to be tilted in favour of the landlord. In New Zealand, a landlord does not require a reason if she chooses to terminate or not to renew a tenancy. In Ontario, this is not the case; tenants have "security of tenure", and landlords must have cause to terminate (or not to renew) a tenancy.

    Also, I'm not sure what that link about Housing NZ meth houses has to do with it. It doesn't mention any difficulties with evictions at all. I would the expect the situation was not so much "We are trying and failing to get this P lab removed from the property" as it was "We are unaware of any P lab operating on the property".

  2. On the long-vs-short-term tenancy issue, a similar phenomenon exists (and has long done so) in the Auckland ground lease market: leases with 21-year rent reviews attract higher rental rates than those with 5- or 7-year reviews. However, most of the lessors and lessees in this market are familiar with each other--which on the face of it makes it hard to reconcile with the rental-rationing story.

  3. Would you expect that kind of phenomenon to show up in commercial real estate in the first place? Didn't think commercial tenants had the same legal protection as residential ones.

  4. "Difficult to do quickly regardless of whether the landlord is in the right" means something similar to lengthy.

    The meth houses link is just another example of the kinds of things that landlords need to worry about -- the equivalent of the worst type of credit risk were you lending at 25%...

  5. Tenant risk is still a real risk for commercial landlords, especially when buildings etc are involved. The puzzle is that it shouldn't usually be much of a factor for ground leases, yet the rental rate 'term structure' is still positively sloped. It seems hard to explain, at least to me.