It seems like every time anyone proposes doing anything to make things the slightest bit for renters, the real estate lobby comes out opposing the proposal — not because it would reduce landlord profits, no, but because it would lead to higher rents. For example:

"So, every time you take away a right that a property owner has...well, then all that will simply mean is fewer investors in the market and rents are going to go up, it's simple maths."

This is an absurd argument. In this post we'll try to take it down once and for all. In turn, we'll discuss:

• Why the fear-mongering about high rents is disguised self-interest,
• Why 'cost pass through' is not a real threat,
• The evidence that rental reform doesn't discourage investment, &
• The evidence that divestment won't reduce housing supply.

Since when did landlords want lower rents?

In 1991, Albert O. Hischmann wrote The Rhetoric of Reaction. He identified the three arguments that reactionaries use to oppose social change. One of these arguments is 'perversity', or the argument that the proposed change will have the opposite effect to what is intended.

Fast forward to 2022 and you have real estate lobbyists arguing that anything to make life better for renters will actually make things worse. It’s the perversity argument, 30 years later. Want to end unfair evictions? It might lead to more evictions. Want to improve rental standards? It might lead to higher rents. Want lower rents? It might lead to higher rents.

So let's just scratch our chin on this one: if these lobbyists think that law changes will mean higher rents…why would they object? 

The reality is: they are lying. They oppose change for a couple of reasons, but not one of the reasons is a fear of making even more money.

Instead, we suspect the reasons are:

• Real estate lobbyists don’t actually represent landlords — they represent the real estate industry. This industry has different motivations and incentives to landlords. For example, real estate agents make money by having high tenant turnover and temporary vacancies (they charge 1-2 weeks’ rent when they get new tenants). In contrast, landlords benefit more from stable tenancies and secure income. Real estate institutes certainly don't represent the interests of tenants and, it turns out, they don't represent landlord interests either. 
• Ideological resistance to government intervention. When people oppose minimum rental standards or restrictions on evictions you have to remember that these are the same sorts of people who opposed a centralised bond office or a requirement for smoke alarms. It’s not the substance of the change they care about: it’s the very principle of the government intervening and saying what they must do. 
• Loss of power. Landlords and real estate agents have a much easier job because they know they can get away with not following the law. Property is mouldy and uninhabitable? Just rent it out until the tenants move out in disgust. Tenant asking for repairs? Evict them. Legal changes that would give tenants more power might require landlords/agents to actually do their jobs for a change, including complying with existing legal obligations. Ain’t nobody got time for that. But rather than be honest about that, why not just say it would increase rents.

'Cost pass through' isn't a thing

So we think this argument about 'reform will increase rents' isn’t genuine: the real estate lobby isn't willing to voice the actual reason that they object. But that doesn’t mean the argument is false. As such it's worth examining: will higher landlord costs mean higher rents? 

There are two ways this could happen. The most direct relationship is simply that landlords increase rents because their costs go up. This is the idea of 'cost pass through’, which we discuss here. The other idea is that rental supply will shrink, putting upward pressure on rents. That argument makes a bit more sense (although it's still wrong), and we'll discuss it down the track.

So why can't landlords just increase rents? The answer is that rents go up when vacancy rates are low, and go down when they are higher. They have little to do with landlord costs.

To help understand this, start by asking how a landlord chooses what rent to charge. Normally, they look at the rental market: how much does a property like this rent for? If they have an agent, their agent can also provide advice. The landlord doesn't consider their own costs. Instead, they look to charge as much as they can given local market conditions. If you are a landlord or an agent, you know first-hand that this is true. 

So let's say I'm a landlord and I’m charging $500 for a 2 bedroom unit because that’s what I can get in the current market. But my mortgage repayments go up, increasing my costs. Unless the fundamental market conditions have changed and the property is now below 'market rent', I can't just suddenly raise rents. Just because my costs have gone up, it doesn't mean that potential tenants are willing to pay more for the property. If I started charging more, I might struggle to rent the property out. Similarly, if my costs go down, I don't reduce the asking rent, because people are still willing to pay the amount. The rent is set based upon supply and demand, not landlord costs: "The dominant influence on real rents is the vacancy rate". Changes in costs thus affect landlord profitability, but not asking rents - as per this funky gif.

One potential exception to this is if all landlords are equally affected by measures. Firstly, this is very rarely the case. Virtually any change will affect some landlords more than others: for an interest rate rise, some landlords have fixed rate mortgages, some have smaller mortgages to begin with, and some have paid off their mortgage. The landlords whose costs go up can’t necessarily pass it through, because they could still be undercut by unaffected landlords. Even if all landlords are equally affected, it's not clear how this would increase rents, because landlords don't operate on a 'costs plus' model where they charge a fixed percentage above their own costs. A change to interest rates doesn't directly change the vacancy rate, so there's no direct effect on rents.

Look at this another way: if some landlord's costs increase and they start charging $20 more per week, it implies that the market would already have accepted this increase. If this were the case, the rent would most likely already be set at the level. The idea of 'cost pass through' is a facile canard recycled by dishonest lobbyists who oppose any attempt at reform.

Regulations don’t affect landlord behaviour

But 'cost pass through' isn’t the only concern. If landlords can’t pass on costs, their business becomes less profitable. This could cause them to sell, leaving the rental market. As the argument goes, this would reduce the availability of rentals and thus increase rents. 

There are two parts to this: firstly, that regulations would drive out landlords, and, secondly, that this would increase rents. So let’s start with the first part: would regulations drive out landlords?

Well, we can see that all over the world this is not the case: generally, decent tenancy regulation exists alongside a growing private rental sector (PRS). In fact, a fairly typical pattern is that tenancy rights become stronger as the PRS grows: with more people renting, and renting long-term, it becomes more important to safeguard their homes. 

The evidence confirms this. Past experience shows no impact from tenancy reform legislation on reducing the supply of private rental housing. One smart person asked landlords whether landlords who threaten to sell do actually sell and found that, after 12 months, only 17% of landlords who said they would sell had done so. In addition, researchers ask landlords about their investment decision-making, and a consistent pattern is that investors, when being honest, don't connect tenancy law and their decision-making. As one study found:

"...investors simply do not consider tenancy issues when investing for the first time...in this study it was almost impossible to get investors to engage on tenancy law as an issue, let alone an important factor connected to investment decisions."

This actually makes a lot of sense. Imagine you have an asset worth $800,000, and the capital value is increasing by 5-10% every year. Are you really going to make a sale decision with hundreds of thousands at stake simply because your tenant no longer needs your permission to put in furniture hooks? 

And this is probably also an important point: while some tenant protections might impose costs on landlords (for example, a requirement to pay for safety inspections of gas appliances), many of them are procedural protections that don’t impose direct costs, like changes around minor modifications or the right to have a pet. These changes can make a big positive difference for renters, but they really have negligible impact on landlords, and it makes no sense that they would drive investment decisions. In fact, the evidence shows that investment decisions are far more influenced by changes in capital and financial markets and lifestyle factors such as age or lifestage. 

What happens if landlords do sell?

So it's implausible that tenancy reform would factor into investment decisions, but let's entertain the argument. Let's imagine that Mr Rich Wyatt just can’t handle the thought that some renter somewhere might be overcoming depression with the help of a pet cat. What happens when Wyatt sells?

Well let’s be clear on one thing: the property remains in the housing market. The overall supply of housing remains the same. The property could be bought by another investor, and remain in the rental pool. Or it could be bought by previous owner-occupiers, creating another available property elsewhere. Or it could be bought by people moving from the private rental sector into ownership. In this case, a property leaves the rental sector, but a household does too, leaving the supply/demand relationship roughly the same. 

The fact is, that landlords don’t supply housing, they simply buy the income streams from existing properties. Because rental investment isn’t productive — it doesn’t actually generate anything — rental disinvestment doesn’t affect production either. Landlords are like ticket scalpers. They buy up all the tickets the moment they go on sale, then sell them at inflated prices. But guess what? If the scalpers aren’t there…the tickets still are! Just as scalpers don’t put on shows and produce tickets, landlords don’t provide housing. 

And let’s think a bit more: if property investors do sell up, is that so bad? The landlords who sell because they don’t want to comply with the law are probably pretty shit landlords to be honest, and we’re better off without them. Tenants are better off if landlords and agents have the attitude, resources and professionalism to take their responsibility seriously. Don’t want to shape up? Please, ship out. 

And if they are selling to first home buyers: is this a bad thing? Most governments love the idea of increasing home-ownership rates by helping first home buyers. If it were to happen, pushing out investors and making things easier for owner-occupiers would seem to be an unintended positive effect of rental reform.

So how do the economics actually work?

So, to bring it together, our model of the rental market is this: most landlords charge as much as they can. This amount has little to do with their own costs. Instead, it’s what the market will accept. Past evidence suggests this is linked to vacancy rates (supply) and wages (demand). Landlord costs are then subtracted from this rental income. Landlords can reduce their cost: for example by refinancing to a better rate, or self-managing and cutting out agent fees. Any such cost reduction will increase landlord profits and not reduce rents (just as any such cost increase will reduce landlord profits and not increase rents).

Conclusion

It’s pretty hard to develop an accurate understanding of how rental markets work. This is because the people with the biggest platform are deliberately lying and spreading misinformation to serve their own agenda. Fortunately, with a bit of effort it’s pretty easy to see through these lines.

Rental reform is unlikely to have the perverse effect of increasing rents because rents are set by supply and demand in the rental market, not by landlord costs. Landlords are pretty blase about tenancy law and evidence suggests that it has little impact on investment decisions, which are far more about personal life circumstances and market cycles. 

More people are renting in Australia. More of these people are renting long-term, renting with children, renting in retirement. The growth in the number of renters is directly caused by property investors who purchase properties that would otherwise have gone to owner occupiers. Governments have a responsibility to improve tenancy laws to ensure that people who rent can have stable, affordable, and healthy homes. They can do so confident that this is unlikely to have perverse effects on the rental market, and can instead mean better homes for over 7 million people in Australia who rent their homes.