LANDLORDS PREDICT RENT HIKES UP TO 51%
The Effect of Deregulation on Rents and Economic Activity in New York City

A new housing study, commissioned by the Rent Stabilization Association (RSA), a landlord group, finds that if rent regulations were abolished, rents in stabilized apartment buildings would rise by up to 51% on the Upper West Side and 13% citywide.

Serious questions are being raised regarding the assumptions and methodology of the study where the purpose was ostensibly to allay fears of even greater rent increases, the study as portrayed by the major news outlets, may have actually fueled the fears of many tenants.

But even in an effort to remain credible, the study may have actually substantially understated the impact of rent increases if NYC rent regulations are allowed to expire on June 15th. However, even if the figures quoted by the landlord study proved to be accurate, tenants across the city are expressing fears of inability to absorb the new rent demands and the ensuing evictions that would occur on a scale not seen in 25 years.

Much of this public hysteria has been fed by the mainstream media's emphasis on the Pataki/Bruno call for the end of rent regulations altogether. And this study, as it was released to the media, feeds the notion advanced by many Democrat politicians that Republican politicans alone are responsible for the threat to NYC tenants' homes. It's almost as if the landlords and the Democratic leadership want the public to believe that Republicans alone hold the keys in this crisis and that Democrats have no responsibility.

In the last week, statement after statement has come from Democratic politicians stating that tenants must set their sites on Republican Senate Majority Leader Joseph Bruno. However, many tenant leaders are recognizing that the real key is Assembly Speaker Sheldon Silver who can decide the real question in this fight: not whether or not rent regulations will continue to exist, but how much will the Democrats allow the system to be further weakend and undermined.

According to the study, rent increases by neighborhood would be:

Outside of Manhattan, the report predicts that rents would rise 8%, with increases ranging from from 0% in Staten Island to 19% in certain Queens neighborhoods. Charts and tables referenced in the text below are available on the TenantNet web site at http://tenant.net.

The author of the study argues that the fear of large rent increases following deregulation is "ill-founded" since this "ignores the power of the marketplace to adjust supply and demand in ways that take account of many factors including the income level of tenants, housing alternatives, quality and condition of apartments and their locations." The study maintains that rent regulation has caused substantial deterioration of housing in New York City and wrongly subsidizes higher income households not in need.

According to the author, although regulated rents may be low, "tenants are only getting their money's worth" since regulation has resulted in deterioration of the housing stock. Following deregulation, substantial upgrading of the stock will occur. Tenants will "forego some other expenditures to pay higher rents following improvements" but "many units will see little or no increase [in rent] and a full range of affordable housing will be available for families at every income level."

The study attempts to estimate the impact of deregulation on the New York City and New York State economy. It predicts that deregulation will stimulate economic activity, creating jobs and additional tax revenue.

However one needs only to look at the effects of Vacancy Decontrol in New York City the last time this "grand experiment" was tried in the 1971-1974 period. Mass evictions and harassment became so commonplace that it was the Republicans themselves who reinstated rent regulation with the 1974 Emergency Tenant Protection Act.

According to a knowledgable source, landlords have even stated privately that this time they will do away with protections "little by little". Although the spectre is being raised of the complete and sudden end of rent controls, the real strategy appears, from both sides of the political aisle, to be something much more subtle and nefarious.

THE EFFECT OF DEREGULATION ON
RENTS & ECONOMIC ACTIVITY IN NEW YORK CITY

Prepared for
RENT STABILIZATION ASSOCIATION OF NEW YORK CITY, INC.
MARCH 1997
by
Charles W. de Seve, Ph.D.

AMERICAN ECONOMICS GROUP, INC.
1099 22nd Street, NW Suite 1008
Washington, DC 20037
(202) 328-1545 FAX (202) 4652-0594

TABLE OF CONTENTS

I. INTRODUCTION
II. RENTS AFTER DEREGULATION
RENT INCREASES TIED TO APARTMENT IMPROVEMENTS
ESTIMATED CHANGES IN RENT AND CAPITAL SPENDING AFTER DEREGULATION
III. DEREGULATION WILL ADD JOBS, INCOME AND TAXES
GAINS FOR NEW YORK BUSINESS
GAIN IN NEW YORK JOBS
GAINS IN NEW YORK TAX COLLECTIONS
IV. TECHNICAL APPENDIX

AMERICAN ECONOMICS GROUP, INC.

American Economics Group, Inc. (AEG) is an independent firm of professional economists which serves clients in business, government and the legal profession. Founded to meet the growing need for clear, concise economic analysis and presentation, American Economics Group staff have developed the technical competence and credibility to become acknowledged leaders in providing effective analysis of complex economic issues. The firm is headquartered in Washington, DC.

Previous engagements have included numerous studies for fortune 500 companies, national associations, national, state and local governments and other clients. AEG undertakes economic studies and prepares expert reports and testimony in a wide range of areas including: tax analysis and revenue forecasting, labor arbitrations, market analysis, economic loss, policy simulation and computer modeling.

AEG is set apart by the innovative and creative thinking of its staff. Their skill and judgment can be seen in a new tax plan to promote economic development; in a method to measure the fairness of wages and benefits; in the computer simulation of tax impacts; and in the design of computer drawn maps which explain the success of some markets and the failure of others. The firm has computer and color laser graphics facilities and designs effective presentations and exhibits to meet the special needs of clients.

Charles W. de Seve, Ph.D.

Charles W. de Seve directs the research of American Economics Group, Inc. Before entering the private sector, Dr. de Seve had been director of Tax and Fiscal Studies for the New York State Assembly and Deputy Director of the State's Economic Development Board. He has published extensively and has taught economics at Rensselaer Polytechnic Institute, Russell Sage College, and the State University of New York at Albany.

During his work with the New York State Assembly, Dr. de Seve was in charge of tax research and analysis, economic forecasting, state aid to localities and computer simulation modeling. As Deputy Director of the State's Economic Development Board his focus was on improving the competitiveness of New York as a location for business by recommending policy changes in state taxation and regulations.

I. INTRODUCTION

This study advances American Economics Group's previous analysis of rent stabilization in New York City by estimating the change in rents and the increase in economic activity that will flow from allowing the free market to determine rent levels. The benefits of decontrol are many, while the fears of impossibly high rents and massive dislocations of families are unwarranted. Rent stabilization has already harmed New Yorkers by depleting the City's housing stock as it forced owners to forego essential maintenance and repairs and stalled new construction. It has also cost New Yorkers jobs and income while reducing both City and State tax collections.

Fear of large rent increases is ill-founded

Part of the fear opponents of deregulation express is that rents will rise without bound afterward. This ignores the power of the marketplace to adjust supply and demand in ways that take account of many factors including the income level of tenants, housing alternatives, quality and condition of apartments and their locations. Proof of the market's power and foresight is seen in many examples of actual rents in stabilized apartments being under their legal limit, in the greater deterioration of regulated versus market-rate units, in the average number of persons living in a typical stabilized versus a free market unit, and in the longer tenure of tenants in regulated units.

Rent regulation has caused substantial deterioration of housing in New York City

In an earlier report, we estimated that about 80% of essential annual capital maintenance is left undone, causing a deterioration in quality and abandonment of properties. Neither the "Major Capital Improvement" program nor the "Individual Apartment Improvement" has proven to be sufficient to the task, and "J-51" eligible buildings produce too low a rate of return to attract sufficient capital spending. We estimated that in 1993 the annual shortfall in maintenance and capital improvements on regulated units has cost 17,632 jobs and reduced combined City and State tax collections by $100.4 million annually.

In another analysis, we demonstrated how lower rents were associated with lower turnover rates and higher rates of disrepair and deterioration of stabilized apartments. The average 6.7 years tenure in a New York City unregulated apartment rises to 9.8 years for all stabilized and controlled units. The effect of this 46.3% greater stay is a longer period between improvements done while units are vacant and fewer repairs and less maintenance during the long occupancies. This deterioration is exacerbated because many tenants withhold permission to upgrade units and equipment fearing even the reasonable rent increases permitted under the improvement programs.

Rent regulation wrongly subsidizes higher income households not in need

AEG also tabulated the perverse subsidy created because regulation reduces rents for many higher income families not in need of government protection. Frankly, many tenants in regulated apartments can afford much higher rents as proven by those of similar income who choose higher quality and better locations and who willingly pay the extra cost. Our 1994 report reveals households of similar income paying a wide range of rents in both regulated and unregulated housing. Apartment dwellers with limited means have a wide selection of both stabilized and market units that will remain affordable. Following deregulation they will continue to be accommodated by apartment selections throughout New York City having a wide variation in price, quality and location.

Examining the distribution of rents and income together shows that for households with income less that $75,000 there are significant numbers of households at virtually every combination of rent and income in both classes of apartments. For example, families with annual income between $50,000 and $55,000 are seen renting both regulated and unregulated apartments ranging from $400 per month to over $1,000. However, at incomes in excess of $100,000, those in unregulated units are generally paying rents of $1,000 or more, while similar families in regulated units in substantial numbers are paying rents as low as $500 per month.

When rents are constrained, the market reduces housing quality

Regulation constrains the market and causes distortions that reduce the quality of apartment living for many New Yorkers. It forces owners to erode their own investments by making capital maintenance unaffordable. It shrinks economic activity, reducing jobs, income and tax collections, and it virtually guarantees that tenants will pay for any rent savings by living in lower quality and deteriorated units. Deterioration begets deterioration, producing a cycle of building and neighborhood decay and lower quality of life for tenants along with lower rents.

Many regulated units rent below their legal limit

Of surprise to many, significant numbers of rent stabilized apartments actually rent below their legal limit. There are several reasons for this including a reduction in the quality of some apartments and, for higher rent units, the gradual increase of stabilized rents to market levels. Among stabilized apartments renting for $600 or more, approximately 15.6% are below their legal rent limit. Fully 24.6% of apartments that rent at $1,000 or more are priced now below their legal limit. Deregulation will have a de minimus effect on units in good condition and already renting below their legal ceiling.

For apartments with stabilized rents below a level that makes proper maintenance and upkeep and capital improvements affordable, rent regulation encourages a cycle of deterioration that lowers quality. Tenants pay less because they are getting less. This is an example of the power of the market: when it is not allowed to adjust prices competitively, it may adjust other elements of the bargain such as quality. In these cases the lower rent is the market rent given the condition of the units.

The market imposes its own limits in response to the interaction of supply and demand. Landlords do not have the power to beat the market, to charge rents above levels the market will not sustain. For many more, the legal limit corresponds to the free-market rent, in part because quality has fallen until the stabilized price is the market price given the condition of the units.

Average rent increases following deregulation will be small

In the current analysis, we find that average rent changes following deregulation will be small except where accompanied by landlord spending on upgrades, improvements and capital maintenance. Naturally, some areas of New York City will experience greater change than others, reflecting geographic differences in supply and demand. The Upper East Side of Manhattan, for example, can support higher rents, while the possibility of significant increases is quite low in the outer boroughs. It is not owners alone who determine rents; they cannot overcome the power of the free market which accounts for many other factors than their wishes to charge more.

Demand factors, including household incomes, limit potential rent increases

Remember, the demand for apartments is as important as their supply, and city-wide rents cannot rise above the willingness and the income of households to pay them. Owners who may push rents too high initially will learn from higher vacancy rates the limits of their market power. This is demonstrated by the significant number of rents already below the regulated level. To some degree demand is adjustable. Some tenants who want a higher quality or larger or better located apartment than might be affordable pool their resources. On average, unregulated apartments have 13.0% greater occupancy than regulated ones, with an average of 2.6 versus 2.3 people per apartment.

The next sections of this report describe the finding of our current study and the implications for economic development and tax collections in New York. The appendix includes the technical details of the calculations of free-market rent levels and the accompanying restoration of much of the rent regulation legacy of deterioration and inadequate housing.

II. RENTS AFTER DEREGULATION

A. Many Rent Increases Tied to Apartment Improvements

Rent regulation has been in effect so long that the market has moved many stabilized rents to near their unregulated equivalents. The regulations set rent ceilings but were unable to prevent adjustments to other market-related factors, especially housing quality. Consequently, regulated apartments are in poorer condition, have more deficiencies and add to the general deterioration of neighborhoods which have higher concentrations of stabilized units. Our tabulations of the 1993 New York Housing and Vacancy Survey count high deficiencies (three or more) in 27.5% of stabilized apartments versus 11.2% of unregulated units, and fewer stabilized units are labeled in "good condition." About 89.7% of stabilized apartments are located in neighborhoods deemed less than excellent as compared with only 83% of market units.

For those apartments suffering substantial deterioration, this is a double-edged sword for tenants. On the one side, it means that after deregulation rent increases will be small on average because rents already reflect their market value given the condition of the units. On the other side, these regulated apartments are in disrepair and many have old appliances, a true penalty for tenants. Regulated rents may be low in these cases, but tenants are only getting their money's worth, and the New York City housing stock has suffered as a consequence.

Deregulation will mean the eventual improvement of deteriorated apartments

Following deregulation many owners will seize the opportunity to improve their property with the expectation that somewhat higher rents will pay the added cost and maintain a competitive rate of return. Remedies for deteriorated properties will be done over several years, and not all at once when regulation is lifted. The result will be a small immediate increase in rents overall, then a gradual rent increase in step with remedies of deteriorated condition. Of course, some prime locations, such as key areas of Manhattan, will average greater rent increases, but that is as it should be as the market takes account of the differential value of land throughout the City.

Most rent increases will be in step with apartment improvements over several years

In general, about 70% of any increase in rents over the several years following deregulation will be to pay for updates, maintenance and improvements which were unaffordable under regulated rent ceilings. Importantly, these increases will be spread over time and limited by the demand structure of the market. Except for brief periods of adjustment, market rents cannot exceed the capacity of tenants to pay them. Ultimately, incomes are a limiting factor in the rental market and exert pressure on owners via increases in vacancy rates. While a single landlord might attempt to charge rent above the market rate, there is not the possibility of large numbers following suite without paying unacceptably high penalties that force them to lower rents. (A few fans might stand up to get a better view of the game, if they all stood up, there would be no overall advantage. This is the well known "fallacy of composition" to avoid when thinking about deregulation.)

B. ESTIMATED CHANGES IN RENT AND CAPITAL SPENDING AFTER DEREGULATION

Except in certain prime locations, the capacity of owners to increase rents beyond a minimal amount depends upon their investment in maintenance and capital improvements. Rents are already near their free-market level, given the condition of regulated apartments. That means that rent increases will generally be accompanied by increased economic activity jobs, incomes and tax collections. Tenants will forego some other expenditures to pay higher rents following improvements, but the rent increases will be spread over a long period of amortization, while owners will borrow and pay for improvements as they happen. Thus, a leveraging will occur which will increase economic activity as improvements are staged, while deferring the reduced consumption of tenants over the longer period they pay for them.

Five equation econometric model used to estimate deregulated rents

We used an econometric model of rental housing in New York City to estimate rent adjustments following decontrol. We concentrated on the gradual investment in remedying the high level of deficiencies and deferred maintenance in stabilized apartments, and estimated the ensuing rent changes. In the jargon, our approach uses a five equation two-stage least squares simultaneous model which is described in the appendix. Its results are robust and give a high degree of confidence in the estimates.

Recognizing the interplay of several important market influences, we estimated separate equations for tenant's demand, for owner's supply, for the condition of units, for their number of occupants and for the length of occupancy. We drew a large number of descriptors of the apartments and of the tenants from the 1993 NYHVS. We then estimated and solved the model and used the results to calculate the impact of deregulation.

Rather than believe all deficiencies would be cleared, we assumed that the deregulated units would be upgraded to the same general level now found in free-market units, no more, no less.

Rent impact is greater in Manhattan, lower in the outer boroughs

Figure II-1 summarizes the impact of deregulation on average rents in each Borough. The table shows the full multi-year impact following the completion of all improvements anticipated. City-wide this full-measure rent increase, not to be confused with the small immediate increase expected, averages 13.2% for all tenants in the 979,026 stabilized apartments.

Not surprisingly, the largest change will occur in Manhattan, a 22.3% hike amounting to an average of $175.35 in reflection of that Borough's hot real estate market and higher current rents. Many Manhattan areas will experience much lower rent increases as the more detailed table in the next section reveals. Importantly, the average City-wide increase is only 8.32% when Manhattan is excluded from the calculation. This represents an average increase of $44.25 per stabilized apartment.

Figure II-1: Long term borough impact of deregulation on rents

Except for Staten Island which has only 9,455 stabilized apartments, the smallest change will be in Brooklyn, which will see a 5.2% rise amounting to an average $27.64. Increases in the Bronx will average 6.0%, about $24.71, while in Queens, rents will increase 16.4%, about $96.73 on average. Again, it is important to remember that these increases will not be immediate, but will occur over several years in step with apartment upgrading. Many units will see little or no increase and a full range of affordable housing will be available for families at every income level.

Geographical impact of deregulation is dispersed

Figure II-2 presents more geographical detail on the estimated multi-year rent changes. As expected, the diversity in Manhattan is apparent with large increases of 51.4% in the Upper West Side and 29.7% and 29.9% in Greenwich Village/Financial District and the Upper East Side, respectively. The Harlem districts and nearby Bronx areas will experience only a 5.3% increase averaging $26.46.

Virtually no change will occur in the Crown Heights, East Flatbush and Prospect Heights areas of Brooklyn, while other areas of that Borough will average between 2.3% and 9.9% in rent increases which accompany apartment improvements. The Bronx shows a wide diversity of impacts, which includes a 12.6% increase in Kingsbridge, Riverdale, Williamsbridge and Baychester districts, while areas including Pelham Parkway, Throggs Neck and Co-op City will see a smaller 4.9% rise. Increases in Queens reflect substantial deferred maintenance, which after being corrected will be paid for with rent increases averaging between 13.7% to 19.4%.

Figure II-2 Geographical impact of deregulation on rents

Rent Increases will largely cover deferred maintenance and capital improvements

The level of spending on apartment improvements and upgrades is tallied in figure II-3. City-wide the total anticipated level of spending to bring stabilized apartments up to the level of their market rate counterparts is $4.0 billion over several years.

Manhattan will see spending of about $2.2 billion to bring its units up to nearby market units of similar composition. In Brooklyn spending will be $675.2 million, while in Queens it will be $636.7 million and $499.9 million in the Bronx.

This spending will generate $5.3 billion of net new economic activity in New York after adjusting downward for the loss of tenant spending relating to rent increases and upward for the added rounds of economic activity stimulated by purchases of materials, supplies and labor. The next section shows industry by industry how this spending produces sales and jobs in most major New York industries.

Figure II-3 Anticipated Spending on Improvements

III. DEREGULATION WILL ADD JOBS, INCOME AND TAXES

A. GAINS FOR NEW YORK BUSINESSES

Expenditures on capital maintenance and improvements are a vital component of New York's economy. The maintenance and repair construction industry is the prime supplier of labor and most visibly benefits when remedial construction is done. But the work involves many specialties outside construction and requires components and materials produced by a wide array of other industries, many of them located throughout New York State.

In fact, thirty-five major industries in New York City and State derive substantial sales from capital and maintenance outlays on apartment buildings in New York City. They include construction; chemicals and refining, fabricated metal products; electric and electronic equipment; stone, clay, and glass products; lumber and wood products; paper and allied products; textiles; wholesale trade; transportation; and miscellaneous small manufacturing.

The revenue which contractors and suppliers receive and pass through to their employees and suppliers circulates through the economy, expanding sales and incomes in thirty-five of thirty-eight major New York industries. Measuring this flow requires an elaborate matrix which describes the connections among industries, what each purchases in materials and services from each of the other for every unit of its output produced. This matrix, built upon what is known as 'input-output" analysis, can also keep track of the flows within New York State and across its borders.

American Economics Group contracted with the U.S. Department of Commerce, Bureau of Economic Analysis, for special tabulations of its Regional Input-Output Modeling System (RIMS II). We used the data to construct a New York State Input-Output simulation model to measure the production and the jobs involved in supplying New York City's rent regulated housing with its capital maintenance needs. The model enables us to calculate the impact of maintenance outlays on each of thirty-eight major industries and on households within the State. We also constructed an elaborate tax matrix which tracks the taxes paid by each industry and worker to the City and the State as a result of maintenance outlays. These are described in the next subsections.

Deregulation will bring added sales to most New York industries

Figure III-1 documents the full impact of the new spending on apartment upgrades and maintenance. The $4.0 billion in initial spending circulates through the economy and eventually produces $5.3 billion in sales for all industries. This is after deducting the shifted consumption of tenants following rate increases, about $1.2 billion.

Figure III-1 Sales by New York State Industries

Figure III-2 Total Jobs in New York State Industries

The table shows the largest gain by firms performing maintenance and repair construction, $2.8 billion. Wholesale and retail trade each benefit by about $225 million each. Other large beneficiaries are real estate firms, metal fabricators, business services and chemical producers and distributors.

B. GAIN IN NEW YORK JOBS

The economic activity generated by apartment improvements and described above will create 66,528 jobs during the construction and related work. As figure III-1 shows, about 26,065 of these will be in the maintenance and repair construction trades. However, jobs will also be produced across many other industries including manufacturing of stone, glass, metal and chemical products, trade, real estate, food and finance.

C. GAINS IN NEW YORK TAX COLLECTIONS

Increased economic activity brings with it increased well-being, incomes and, of course, taxes. The existing state and city tax structures will produce $563.5 million in added revenue as a result of landlord spending on apartment upgrades and improvements and the spin-ups it produces.

Of this, $360.9 million will flow to New York City and $202.6 million to the coffers of New York State as shown in figure III-3. For the City, much of the gain will be in the real property tax, about $179.7 million, and it will recur annually even after all construction and upgrading is complete. The sales tax will benefit by $55.7 million, while the City income tax will see a $45.3 million increase.

New York State's $202.6 million will flow from: the State income tax ($97.7 million), the sales tax ($52.4 million), corporation franchise taxes ($17.6 million), and $34.9 million in other taxes.

Figure III-3 Additional tax collection from apartment improvements

IV. TECHNICAL APPENDIX

The five equation two-stage least squares econometric model used in this analysis recognizes several key differences between regulated and unregulated apartments including the condition of the unit, the neighborhood, the tenure of tenants and the number of occupants. The table in figure A-1 is the output of a probit analysis on the binary variable "market," a dummy equal to one for unregulated apartments, zero for stabilized units. (The name and description of each variable is given in figure A-2 ).

Notice that each variable in figure A-1 is significant, all at the 95% level except the "gdcondx" variable which is lower, but still significant. Free-market apartments are seen to be in better condition, be in better neighborhoods, have tenants in residence for shorter periods and contain a greater number of occupants on average. Each of these results is expected as described in the body of this report. The five equations of the model estimate these key factors from sets of variables relating to supply, demand, condition, occupancy and length of tenure. The equations were used in a simultaneous simulation model to estimate the effect of rent decontrol under different circumstances.