Adapted from Timothy Clark
Voters in the United States considered a Universal Basic Income (UBI) for the first time in several decades. The most mainstream proposal is the central piece of Democratic presidential candidate Andrew Yang’s platform. Yang’s ‘Freedom Dividend’ would guarantee each American $1,000 dollars every month. A plan like this would undoubtedly kick off an unprecedented transformation of the economy. However, a UBI has never been implemented on a national scale before, so naturally there are lots of questions about exactly what would change. Right now, the United States in the middle of a rental crisis. Wages for most Americans have barely increased since the 1970s, while home prices have rapidly grown past most people’s ability to buy. Rent is increasing too, and that powerful combination has lead to record numbers of people who pay more than 30% of their income on housing. Considering the apparent imbalance of power between renters and landlords, some are concerned that giving everyone $1,000 dollars a month could quickly turn into a subsidy for those landlords and leave most people without much money left over. With our current economic knowledge of how the real estate market works, we can gain some insight into how rents might be impacted.
How Rent Prices Work
Rents are often fairly opaque to renters. They seem to rise without justification, and vary widely from neighborhood to neighborhood. However, there’s a few simple principles at work that defines how much a landlord can charge. The formula below tells us the maximum amount a landlord will typically be able to charge.
Rate of Return
The rate of return here refers to the percentage of property value the owner collects each year. In Thomas Picketty’s landmark book, Capital in the 21st century, he analyzes income from all kinds of capital. Picketty observes that real estate has a remarkable stable rate of return. In developed countries as far back as the antiquity, land has nearly always enjoyed a 4–5% annual return. That trend is remarkably durable, and holds true in today’s economy.
Another way of saying expressing the same idea is that it takes 20 years for a property to pay back its value. If I were to buy a house for $100,000, and I rented it out for $5,000 per year (a 5% return), I would pay back the original cost in 20 years. Even though the types of real estate has changed dramatically, the return has remained reasonably stable over decades. This suggests that the housing market has a rough equilibrium around how long investors are willing to wait to recover the original cost of their investment. To frame it another way, If I wanted to sell a property that I was collecting $10,000 yearly, I would want to sell it for at least $200,000. I know that buyers in the market are willing to buy a house with a 5% return, so pricing it lower than $200,000 would mean leaving money on the table. If I price it much higher, no one would want to buy it because it would mean accepting a lower rate of return. 5% yearly happens to be the level at which the desire to sell high, and the desire to buy low balance out.
Picketty explains the link between property value, rate of return and rent very effectively:
“For example, in 2010, a large apartment in Paris, valued at 1 million euros, typically rents for slightly more than 2,500 euros per month, or annual rent of 30,000 euros, which corresponds to a return on capital of only 3 percent per year from the landlord’s point of view. Such a rent is nevertheless quite high for a tenant living solely on income from labor (one hopes he or she is paid well) while it represents a significant income for the landlord. The bad news (or good news, depending on your point of view) is that things have always been like this. This type of rent tends to rise until the return on capital is around 4 percent (which in this example would correspond to a rent of 3,000–3,500 euros per month, or 40,000 per year). Hence this tenant’s rent is likely to rise in the future”
Returning to our formula, obviously a UBI wouldn’t change the denominator since the number of months will stay the same. It also seems unlikely that a UBI would increase the rate of return. The basic logic that a property that takes 20 years to pay off is a decent deal, and owners wouldn’t sell properties that take only 10–15 years to pay off when they can command a higher price for them. Even a social program of this scale wouldn’t fundamentally challenge the dynamic that leads land to generate a 4–5% return per year, especially considering the trend has persisted through vastly different economic systems over history. So the question is fundamentally about whether or not a UBI would lead to an increase in property values.
Property Values are governed by the principles of supply and demand. If there are more renters and less housing, prices will increase. If there are fewer renters and more housing, prices will decrease. So how would the supply and demand change if every person suddenly had $12,000 more dollars per year?
The demand for housing would not change. This may seem like a bold proclamation, but it makes intuitive sense. While there certainly is a small number of people who would choose a home free lifestyle even if housing were free, we can safely say that just about everyone has a need for shelter of some sort. Housing has inelastic demand, meaning people will seek to buy it whether it is cheap or expensive. However, changes in the rental market may occur. As rents rose over last few decades, many renters gave up on buying a house. At the same time, 80% of renters are still interested in buying a home at some point. There are currently over 45 million renters, and the biggest regret those people have is not being able to buy a house. Many Americans would suddenly be in a position to move out of the rental market and into a mortgage, decreasing demand in the rental market. Some people may choose to move to higher quality homes with their increased income, which would shift demand towards more expensive properties. This may come with an overall increase in the average rent paid, but it also would decrease demand for more affordable housing. At the same time, there are currently at least 550,000 homeless people who would now have an income, and presumably look for a place to rent. The overall picture shows lots of processes moving in many directions, but very little reason to think affordable rent will become less available due to changes in demand.
Is there enough housing supply to provide for the changing demand? There are certainly reasons to be optimistic. It is probable that very cheap housing would face the largest shortage of supply, since 550,000 homeless people will enter the market. Those buyers would likely look for their first housing to be fully covered by their Basic Income, so that sets a limit of $500 per month. Looking at data from the Census’ 2017 American Housing Survey, there are currently 4.53 million units for rent, and 20% of those units have an asking price of under $500 per month. This implies there would be about 900,000 rent-able units for this part of the market. There certainly would be inefficiencies in getting people into housing, due to limited information and the possibility of units not being near where people currently live. But it is at least possible to house everyone without placing critical stress on existing supply. Developers would also be interested in capitalizing on this market segment by creating new housing at price points that would appeal to new renters, if only due to the scale of the increase.
As for people looking to rent at other price points, the Census data shows that even more vacant units exist at each other price range. Prices would not increase across the board due to lack of supply. There might be exceptions in localized hot markets, like San Francisco, Seattle, New York, etc. But those places have structural housing issues that drive cost increases independently of whether a UBI exists, and that holds true for other markets as well.
At this point I’d like to remind you of Picketty’s explanation from earlier. He observed that “large apartment in Paris… rents for slightly more than 2,500 euros per month… which corresponds to a return on capital of only 3 percent per year,” and then goes on to say, “this type of rent tends to rise until the return on capital is around 4 percent… Hence this tenant’s rent is likely to rise in the future.” This example brings up a curious case. If it is so unlikely for housing to have a return higher than 5%, what could account for landlords collecting a lower amount? It turns out that it is difficult for landlords to constantly adjust their rents to match market conditions. Obviously, a landlord can’t raise rents in the middle of a lease, so there’s a small buffer period there. In addition, most places have specific rules for raising rents on existing tenants, sometimes including regulatory approval. At minimum it requires advance notice, which creates another challenge for assessing market conditions effectively.
If a landlord raises rents too aggressively, they even risk a backlash from their tenants. This could range from the tenants moving away (and leaving a vacancy that accrues no rent), to organizing tenant unions and rent strikes. With the extra financial security and resources, renters will be able to exert more influence over the terms of their living conditions and demand better prices. It is also well established that affluent people have more access and influence in government. Renters with a UBI may be empowered to lobby their governments more effectively for rent controls and other housing initiatives.
A Universal Basic Income would likely have a muted effect on rent prices. Social programs don’t change the rate of return. If one examines closely, they find that the supply and demand effects are also marginal. It is unlikely that a UBI would drive property values significantly higher. None of the three terms in our formula (property value * rate of return / 12 months) are abnormally impacted by a UBI. If rent does go up, it will probably be due to other factors. Renters will also have the benefit of more resources and leverage at their disposal to negotiate with sellers for better prices. As the first graph at the top of this article demonstrates, when wages don’t grow with rents, the number of cost burdened renters increases. However, it also shows that the rise in wages since the 2008 recession relieved a notable number of people from that burden. A UBI would act like a large wage increase, causing a marked drop in homelessness, more first time home buyers, fewer cost burdened renters, and more leverage for renters over the market than ever before.