Rent caps undermine tenants’ housing security

Viðskiptaráð has submitted its comments on a bill amending the Residential Tenancies Act No. 36/1994 (periodic changes to rent), case no. 157 at the 158th session of Althingi.

The bill proposes further restrictions on periodic rent increases during the term of a lease. Under these restrictions, at least 12 months must pass between rent increases, and periodic increases must be tied to one of three benchmarks: an increase in line with the consumer price index, an increase by a fixed percentage of the rent, or an increase by a fixed amount. In any case, increases may not exceed the rise in the consumer price index over the period in question.

These proposed changes follow other burdensome changes, which have included a ban on indexation of short-term leases, a right to request an adjustment of the rent after a lease has been signed, and a requirement to register leases. At the same time, capital contributions to housing cooperative dwellings have been raised from 30% to 35%, and housing benefits (formerly rent benefits) have been increased by 25%.

Misguided government intervention

Rent controls, whether in the form of a rent freeze, where the rent is frozen, or a rent cap, where increases are limited to a set maximum, have been studied extensively over the years. A recent academic paper reviewing 112 peer-reviewed studies from 1967 to 2023 shows that such restrictions have negative effects on many other aspects of the housing market, apart from the rent of dwellings covered by the controls (Figure 1).[1] The research shows that the effects on the supply of rental housing, new construction, the quality and utilisation of housing, and tenant mobility are harmful.

It is therefore clear that the bill’s aim of strengthening the position of tenants and increasing their housing security will not be achieved by imposing significant restrictions on rent increases. Moreover, the strict limits on rent increases envisaged in the bill are likely to reduce landlords’ incentive to offer open-ended leases. They also make it more likely that landlords will set higher rents for long-term leases.

If the bill becomes law, it is therefore foreseeable that only tenants who already hold open-ended leases and intend to stay in the same home for a long time will be better off in the rental market. Those who need to look for rental housing in the future could face lower supply and poorer-quality housing. It could also become harder for them to secure open-ended leases, and long-term leases are likely to become more expensive. The research findings thus suggest that the bill would reduce tenants’ housing security through lower supply and unhealthy incentives.

The effect on inflation may be negative

Viðskiptaráð questions the claim that monthly changes in rent drive up inflation. On the contrary, the proposed changes, under which rents can only be adjusted for inflation every 12 months and increases are significantly restricted, could create incentives with negative effects.

First, landlords could have an incentive to offer shorter leases, given the restrictions on rent increases in longer leases. The parties are therefore likely to renegotiate the rent more often, taking account of prevailing economic conditions each time. If inflation is high when the rent is being renegotiated, the landlord is more likely to factor inflation in and price the lease accordingly. As a result, inflation persists for longer and becomes stickier on the way down.

Second, significant restrictions on rent increases during the lease term create an incentive to agree a higher initial rent. Landlords planning a long-term lease thus have an incentive to price the increases that cannot be made during the lease into the initial rent, which in turn has a negative effect on inflation.

An unreasonable restriction on freedom of contract

Viðskiptaráð has serious reservations about the bill’s intervention in free pricing. Parties entering into a lease, which is by its nature a freely negotiated contract, should be able to agree on the price and on changes to it. This restriction on freedom of contract is particularly unreasonable when it applies only to a very narrow part of the housing market, namely the rental market.

In this context, it is worth noting that the Icelandic rental market stands out in that most landlords are individuals rather than legal entities.[2] They commonly finance themselves with inflation-indexed loans whose balances rise every month, and on top of that operating costs may also rise. These increases can be unpredictable and can leave the rent insufficient to cover the cost of running the property. The new amendment would therefore only provide predictability on the tenant side of the market, while the landlord is left carrying the risk. Under the market conditions in Iceland, such restrictions are likely to reduce the supply of rental housing, especially in light of the existing provisions of the Residential Tenancies Act that limit rent increases and allow tenants to refer such increases to the Housing Complaints Committee.

Unclear why the scope of the Act is being extended

Viðskiptaráð cautions against abolishing the option to derogate from the provisions of the Residential Tenancies Act in the case of commercial premises. The explanatory memorandum to the bill that became the Residential Tenancies Act justified allowing such derogation for commercial premises on the grounds that the parties are on a more equal footing in that case.[3]

The present bill proposes abolishing this option. It does not explain why the balance between the parties is considered to have changed, nor does it offer any specific justification for the change. Viðskiptaráð considers that the circumstances of commercial leases have not changed and opposes the amendment.

Increased supply is the best way to strengthen tenants’ position

Finally, Viðskiptaráð wishes to stress that the best way to achieve the goal of housing security and strengthen the position of tenants is to ensure an adequate supply of housing. Where supply is sufficient, tenants’ bargaining position is stronger and they have a wider choice of housing that suits them. These goals will not be achieved by imposing burdensome obligations on landlords, which in the long run will reduce supply in the rental market and lower the quality of rental housing. That would weaken the housing market as a whole and hit tenants hardest.

In light of the above, Viðskiptaráð opposes the adoption of the bill.