How Rent Control Shapes the Future of Small Businesses

Starting a small business is one of the most exciting and admirable endeavors an individual can take on in their life. It takes hard work, dedication, grit, and a hefty dose of risk-taking to come up with an idea, secure viable funding sources, create a solid business plan, and establish a successful business for yourself. But what happens when your efforts are met by local rent control policies that seem to have been designed to bring small businesses down rather than help them thrive? This blog post delves into the economic realities associated with rent control on small business growth in order to empower entrepreneurs as they design strategies for success.

Commercial Rent Control (CRC) is a policy tool that a few US municipalities have explored or implemented to offer stable, affordable commercial spaces to small businesses at risk of displacement due to market pressures driving up rents in developing areas.

Key Takeaways

• Rent-controlled properties have significant negative effects on the housing market in their vicinity, reducing the amenity value of their neighborhoods and rendering them less desirable to live in.
• Rent control policies that are too restrictive can hinder the growth of small businesses in certain regions.
• It is important to familiarize yourself with the rental regulations in the area before signing a lease in order to be informed of any possible negative or positive situations.

Rent control policies and their effects

Rent control regulations in cities mainly limit the price increase for lease renewals, not for new tenants. This could benefit landlords because they can charge market rates for vacant apartments. However, it could also encourage existing tenants to stay put and keep paying rent on time.

Types of rent control policies

Rent control is a program where a government regulates the maximum rent a landlord can charge. This practice is enforced by local governments and not available in every city or state. Rent control policies prevent landlords from unfairly hiking the rent from year-to-year, which makes some housing more affordable for people who cannot afford higher rates.

Rent control is not a common practice in the United States. The Urban Institute conducted a study in 2019 which found that only 182 municipalities in the country have rent control regulations. This rent controls regulations are only found in five states, namely New York, New Jersey, California, Maryland, and Washington D.C.

As of February 2022, it should be noted that 31 states have laws in place that prevent or prohibit local governments from implementing rent control policies.

In the past, there were two types of rent control: vacancy control, which controls the unit’s rent regardless of whether the tenant stays or not, and vacancy decontrol, which only controls the rent while the current tenant is in the unit.

Before 1997, California allowed both types of rent control, but the Costa/Hawkins bill phased out vacancy control provisions. According to a 1990 study of Santa Monica, vacancy control protects commercial tenants by providing lower rent increases and longer stability in rental rates, but it may have discouraged investors from constructing new rental units.

Advantages of rent control

1. Tenant Financial Savings: Rent control laws limit the legal increase in rent, resulting in financial savings when trying to pay rent, for tenants year after year. As many tenants have experienced significant rent increases in the past, they generally support rent control as a way to prevent this from happening. Rent for certain properties can go up by 10% per year, potentially making it challenging for someone to afford to stay in that property without a substantial increase in salary or a change in employment.

Rent control can also offer improved financial stability for tenants. With the knowledge that their rent will not undergo significant annual increases, they can make more informed plans for the future.

2. Unintended beneficiaries: Rent control often aims to help lower-income individuals and families by ensuring affordable housing. However, it can sometimes benefit higher-income tenants who are able to secure rent-controlled commercial real estate, as they enjoy the reduced rents without necessarily needing assistance. This can exacerbate income inequality and result in a less effective policy.

3. Lack of mobility: Rent control can create disincentives for tenants to move, as they may be unwilling to give up their rent-controlled apartments for market-rate alternatives. This can contribute to a lack of mobility within the housing market and make it more difficult for people to move for job opportunities, family reasons, or other personal factors. Consequently, this could negatively impact the overall efficiency of the labor market and economy.

Disadvantages of rent control

Rent control is when the government puts restrictions on how much landlords can charge for rent. The goal is to make rent more affordable for people with low to middle incomes. However, there are both good and bad aspects to this policy.

1. Reduced housing supply: Rent control may lead to a reduction in the supply of rental commercial real estate as developers and landlords may find the controlled rents to be too low to cover costs and generate an adequate return on investment. This could discourage new construction and investment in rental properties, exacerbating the long-term affordability issue.
2. Lower maintenance and quality of housing: When there are rent control measures in place, landlords may be less motivated to take care of and upgrade their properties, which could lead to subpar living conditions for tenants due to reduced investments in maintenance and repairs.
3. Inefficient allocation of resources: Rent control can cause commercial property resources to be allocated improperly. This is because some tenants may occupy bigger or more desirable units than they would under market conditions without rent control, due to the price being artificially low. As a result, this can make it more difficult for other people to find suitable accommodation, leading to longer waiting lists and more competition for available units.

The relationship between rent control and small business growth

Impact on start-ups and entrepreneurs

Rent control worsens this disparity by providing disincentives for builders and landlords, ultimately discouraging them from offering new rental units to the market.

The already-dated rental stocks suffer further from this issue, leading to a decline in the tenants’ standard of living. Ownership of rental properties entails recurring maintenance, management expenditures, and, most importantly, surging property taxes.

When landlords are prevented from increasing the rent to keep up with the escalating costs, it often results in a lack of investment in their properties. Over time, this can cause the properties to become neglected and increasingly run-down. Maintenance halts, repairs cease, and upgrades come to a standstill.

When landlords prioritize maximizing rent over property upkeep, the result is often run-down buildings infested with cockroaches and a lack of access to the capital needed for improvements, thanks to rent controls. Ultimately, this situation leads to unaffordable living conditions, leaving everyone feeling the impact.

Positive impact on small business growth

There is no real ‘Positive‘ impact on small business growth with rent control.

According to Bloomberg, Rent control is often one of the first lessons in undergraduate economics. The purported goal is to help low-income families gain access to affordable housing. However, when analyzed, we see that such programs can frequently backfire.

Bloomberg reported that while rent control is taught in undergraduate economics as a way to provide affordable housing, it often backfires, especially for low-income families.

Throughout the years, rent control has earned a formidable reputation among economists. It is a law that sets a cap on the amount a landlord can charge for rent and is often designed to protect low-income tenants and prevent displacement. However, the efficacy of rent control is the subject of intense debate among scholars, policymakers, and advocates alike. Some argue that it reduces the supply of rental housing, undermines property values, and discourages new construction.

As Assar Lindbeck, the esteemed Swedish economist who presided over the Nobel Prize committee for many years, reportedly claimed, it can be equivalent to “destroying a city through methods other than bombing”. Nevertheless, rent control remains an aggressive issue, as advocates point to its success in protecting vulnerable populations and providing stable housing options in increasingly unaffordable cities.

Are issues like labor markets, minimum wage effects, and highway expansions too complex to be explained by basic economic principles?

To provide answers to complex questions, data holds the key. Recently, economists Rebecca Diamond, Timothy McQuade, and Franklin Qian conducted a study that explored the effects of imposing rent control in San Francisco, a city known for its excessive housing costs. Their findings align with the predictions made in economics textbooks.

This study is truly unique because of its precise use of comprehensive and accurate data. Diamond and her team tracked the addresses of all San Francisco residents dating back to 1980 (yes, even the ones who left the state!) using a private company’s records.

From this extensive analysis, they were able to examine how a change in San Francisco’s rent control policy impacted the city. Specifically, they found that since 1995 only small multi-family buildings built after 1980 were exempt from rent control.

Unsurprisingly, the implementation of the rent control policy caused a decrease in the number of renters moving out — between 8 and 9 percent over the medium to long term.

The new policy didn’t benefit all renters equally. Landlords were incentivized to convert rental units into condos or demolish old buildings to build new ones. It caused existing tenants, especially younger renters, to relocate. As a result of the 1995 policy, landlords lowered rental unit supply by 15%.

Being compelled to move can be a traumatic experience, and not just because of the expense involved. The displacement also separates people from their communities, especially those who are already vulnerable and at risk. Often, it means moving to less-affluent neighborhoods with limited access to education and job prospects.

The most compelling argument against rent control is that there are more effective ways to shield vulnerable renters. One proposed approach, supported by Diamond and other experts, is a comprehensive government social insurance system for renters across the city. Households dealing with rent hikes could qualify for tax credits, welfare payments to offset the increase, or vouchers for relocations.

The initiative’s finances would stem from taxes on landlords, facilitating cost-sharing amongst renters and landowners instead of imposing a burden on the vulnerable population.

Negative impact on small business growth

Reduced commercial property investment: Rent control may disincentivize property owners to invest in maintaining and improving their commercial spaces, leading to a decrease in quality and availability. This can make it difficult for start-ups and small businesses to search for suitable locations.

Displacement of businesses: Rent control policies may unintentionally contribute to gentrification as landlords seek other options to increase their profits. This may involve increasing commercial rents or converting commercial spaces into more lucrative residential units, displacing small businesses from the locality.

Rent control and business location decisions

Rent control policies can indirectly impact where businesses choose to locate. Although primarily aimed at regulating residential rentals, rent control can still affect the broader economy, housing market, and commercial real estate sector. Here are some ways rent control could affect business location decisions:

1. Availability of workforce: When a city or region implements rent control policies, it can increase the availability of affordable housing options and rental commercial properties. This can attract a broader range of workers, making the location more desirable. Consequently, businesses may opt to establish their operations in areas with rent control to access a more diverse pool of skilled workers.
2. Consumer purchasing power: Lower housing costs can increase the disposable income of residents, which may lead to higher expenditure on goods and services. This may be a factor that businesses consider when selecting a location since greater consumer purchasing power can result in higher demand for their products or services.
3. Cost of commercial properties: Rent control policies can affect the commercial real estate market in indirect ways. If there is an increase in demand for housing in a certain area due to rent control, this could potentially increase the value of nearby commercial properties. Furthermore, landlords might try to compensate for possible losses from rent-controlled residential units by charging more for commercial spaces. Hence, some regions might become less appealing for businesses because of the higher costs.
4. Competition for commercial space: Rent control policies could result in a limited number of commercial properties as landlords may prefer to convert these spaces into residential units due to the benefits provided by rent control policies. Accordingly, businesses may struggle to find appropriate locations, which could impact their operations.

Influence on small business expansion

The conversation on whether to expand or enact rent control provisions has been reignited in many of the US’s large, productive cities, as steadily rising housing rents continue to pose affordability challenges. This has put pressure on state lawmakers in Illinois, Oregon, and California who are actively considering measures to repeal laws that have hitherto limited cities’ abilities to pass or expand rent control.

Notably, rent control measures can take many forms, with a cap on the percentage of rent increases being the most popular of such provisions. However, beyond this, in certain cases, there are also some restrictions on evictions. All in all, rent control measures are seen as one of the potential solutions to improve housing affordability and combat homelessness, but experts also note that there are some potential drawbacks to the approach, such as making it less attractive for investors to invest in property and potentially leading to the deterioration of the housing stock.

New research offers important insight into how rent control affects tenants and housing markets. While rent control may offer short-term benefits to current tenants, in the long run, it may lead to negative consequences. Studies show that rent control can reduce the supply of available housing, reducing affordability and forcing people to live in overcrowded conditions. This can fuel gentrification, driving property values up and pushing long-term residents out of their neighborhoods.

Additionally, rent control can have negative spillover effects on surrounding neighborhoods, leading to a decline in property values, increased crime rates, and a decrease in the overall quality of life for those who live nearby. These findings highlight the need for innovative approaches to addressing housing affordability issues.

Case studies

Cities where rent control policies hindered small business growth

Rent control policies are a complex and controversial issue. While they can help protect small businesses from steep rent increases or displacement, they can also have unintended consequences, such as limiting the supply of available commercial spaces or discouraging new development. Here are two examples of cities where rent control policies may have hindered small business growth:

1. New York City, New York: While the city has a long history of residential rent control and stabilization policies, these same policies may have indirectly affected small businesses. The limited supply of affordable housing has led to increased demand for commercial spaces, which can drive up commercial rents. Additionally, strict zoning regulations and a lack of new development can further constrain the supply of commercial properties, leading to higher rents and making it difficult for small businesses to find affordable spaces.
2. San Francisco, California: Like New York City, San Francisco has a history of residential rent control policies that may indirectly affect small businesses. High housing costs and a limited supply of commercial properties can lead to increased demand and high commercial rents, making it difficult for small businesses to thrive. Additionally, the city’s stringent regulations and permitting process for new developments can further constrain the supply of commercial spaces.

It should be remembered that the connection between rent control policies and the growth of small businesses is not a simple one and can differ depending on the policies and the local situation. Although certain policies may obstruct small business growth in some cities, they may produce dissimilar effects in other cities.

Alternative solutions for small business growth and affordability

Cities can implement different solutions to promote small business growth and affordability. These solutions aim to create a supportive environment for small businesses and address concerns like rent stability and access to affordable commercial spaces. Some potential solutions include:

1. Business incubators and co-working spaces: Encouraging the development of business incubators and co-working spaces can provide affordable and flexible workspaces for small businesses, reducing the need for long-term leases and large commercial spaces.
2. Community land trusts (CLTs) and nonprofit ownership: CLTs and nonprofit organizations can purchase and manage commercial properties, ensuring that they remain affordable for small businesses. This can help stabilize commercial rents and provide long-term stability for small business tenants.
3. Technical assistance and business support: To help small business owners or property owners overcome issues related to rent, leases, and business operations, they can benefit from receiving technical assistance, training, and additional resources.

Rent Control on Small Business Growth FAQs

How does rent control impact start-ups and entrepreneurs?

Rent control policies can have significant impacts on the housing market, particularly for start-ups and entrepreneurs. While the intention of rent control policies may be to provide affordable housing options, the reality is that these policies often create negative externalities for nearby neighborhoods. Rent control can lead to a decrease in the quality of housing and a reduction in the overall value of the surrounding area, making it less desirable for individuals and businesses alike.

For start-ups and entrepreneurs, high-quality office spaces and affordable housing options are critical for success. As such, rent control policies can limit the availability of these options and make it more challenging for businesses to thrive in these areas.

Can rent control policies influence business location decisions?

It is true that rent control policies can affect business location decisions. If a city has strict rent control regulations, businesses may find it expensive to locate there and might be discouraged. However, if a city offers incentives or more flexibility with rent control policies, it could encourage businesses to choose that location.

Are there cities with successful rent control policies for small businesses?

According to urban.org, If rent control is judged on its ability to promote stability for people in rent-controlled units, evidence has generally found it to be successful. Research on rent control’s effects on the broader housing market (whether on rents, construction, or conversion) has yielded mixed results. However, evidence is also mixed for rent control’s ability to promote economic opportunity or reduce racial disparities.

How can rent control policies hinder small business growth?

Implementing rent control policies can negatively affect the growth of small businesses as they may struggle to afford prime locations or generate sufficient profits to facilitate their expansion. Furthermore, if the regulations regarding rent control are excessively rigid, landlords may become hesitant to invest in upgrading their properties, which could result in subpar residential and work environments.

What are some alternative solutions to support small business growth and affordability?

Various alternative solutions exist to support the growth and affordability of small businesses. One example is that governments can give tax incentives to businesses that meet specific criteria, like investing in innovation or creating job opportunities in underprivileged areas. Another example is that cities can implement zoning regulations that ensure affordable housing options and commercial spaces for start-ups.

Conclusion

When it comes to balancing the needs of small businesses for affordable rent and the interests of landlords, rent control can be an effective solution. Although increased regulations place restrictions on how much a landlord can charge tenants, they also help to ensure that those tenants are not overburdened with fees. With careful consideration and the right set of policies in place, cities, and their governing bodies can facilitate the growth of small businesses while accommodating the needs of landlords. 

I know that you may feel overwhelmed with all of these pieces of information, so If you’d like to know more about how rent control policies may impact your business, or if you’d like assistance navigating rental regulations, I encourage you to call or schedule a free consultation with me. I’m here to answer any questions you have!