Cap and trade, but for rent control
Is an out of fashion climate change policy the answer to New York’s housing woes? Find out in NDI’s first foray into policy entrepreneurship.
Zohran Mamdani is very likely to be the next mayor of New York City. A charismatic state assemblyman, Mamdani is running on a progressive platform with a big promise: freezing the rent for rent-stabilized units.
This is something he has the power to do. The Rent Guidelines Board (RGB) — whose members are appointed by the mayor — sets the legal limit for rent increases across New York City’s 1 million-plus rent stabilized apartments. Their contentious vote last night to raise rents was met by confident assertions that this would be the last one for four years.
A rent freeze would be a massive boon for the people living in covered units. But there are downstream consequences: economists nigh-universally oppose rent control, arguing it poorly targets people in need while driving up rents for non-stabilized units.
One issue is that rent increases can’t take individual circumstances into account. 30% of New Yorkers with rent stabilized apartments make over $100,000, but their rent goes up by the same percentage as somebody making $40,000. Can we fix some of the distortions caused by rent control without giving a blanket hike to 2 million+ rent stabilized New Yorkers?
The climate movement faced similar issues with allocating a tax on carbon, driving policy innovation. What if we tried a cap and trade system for rent increases?
A brief primer on rent control in New York City
New York’s traditional rent control system comes from the Emergency Housing Rent Control Law of 1950, which formalized wartime price controls. Tenants under this law had a level of protection unheard of today: lifetime tenure, a cap on total rent, and broad succession rights.
Only about 16,000 units in New York City maintain this system. What most people refer to as rent control today is rent stabilization, a much more limited regime. A series of late 60’s/early 70’s laws1 established the stabilization system, which has replaced the vast majority of controlled units.
Unlike rent control, which offers lifetime tenure and a cap on total rent, stabilized units cap rent increases to the amount set by the Rent Guidelines Board each year. Last night the board voted to allow landlords to raise rent by 3% for a 1 year lease, or 4.5% for a 2 year lease.
That’s a big increase, but market rents regularly climb 5% or more in a single year. Compounding over decades, the difference between stabilized and market rent units can be thousands of dollars a month. But even though rent stabilization lets millions of New Yorkers stay in their homes, the market isn’t healthy.
Rent stabilized units are rare and fought over, often requiring illegal $10,000+ upfront payments that people are willing to pay. And because rent increases are based on starting rent, stabilization acts as a subsidy to staying in your apartment as long as possible. That means you’re unlikely to move, even if you (e.g.) had a child and need more space. And even if the rent is cheap, it’s almost a cliche that landlords of rent stabilized units will do everything they can to avoid maintenance or investment.
Most concerningly, critics argue that New York’s laws2 contribute to tens of thousands of dilapidated and vacant units that require more money to bring up to code than the legal rent can cover. This is a pure waste in a city with a massive housing shortage; can we do better?
Cap and trade for rent. Seriously.
Per the Rent Guidelines Board, the average collected rent for a stabilized unit is $1,599. With an estimated 1,020,600 apartments, this year’s 3% increase in the rental guidelines board will cost the city’s stabilized renters a collective $48,958,182 per month, or $587,498,184 per year.
Today, that 3% increase is distributed as a flat 3% on each individual unit's rent. What if instead, we capped the total allowable rent increase at $587 million across all units citywide, and let landlords trade their share? Bear with me as we explore the housing market cap and trade system.
Rental Increase Credits (RICs) would be the carbon credit of rent increases: a right to raise rent by $1 that you can use, sell, or hold. Each year, landlords would receive a bundle of RICs based on how much additional rent the city allows them to charge for their stabilized units. If they want to raise rent, they need to trade in their RICs. If they don’t, they can sell it to someone else who values it more.
Say you own a stabilized unit that rents at $2,000. If the RGB sets a 3% annual increase, you’re issued 720 RICs — each worth $1 in annual increase — which together let you raise your tenant’s monthly rent by $60. Or, you could keep rent the same, sell the RICs, and find a better use for the money.
This subtle change totally reshapes how rent stabilized housing works in NYC. Today, a landlord sees only downside for not raising rent: they not only receive less income this year, they receive less income for every year in the future (both from a lower base rent and lower percentage-based rent increases).
With RICs, landlords that choose smaller increases can be directly compensated for it. For the first time in history, landlords will have the option to finance capital improvements by raising someone else’s rent.
At the same time, it also means that rent increases accrue to those most able to afford it. About 15% of rent stabilized renters have fallen behind on their payments; these landlords are likely to sell their RICs and freeze the rent for those struggling the most to pay.
New York could actually build this
You might be thinking: “how could New York City possibly set something like this up?” Well, the NY State Division of Housing and Community Renewal (DHCR) already does most of the work needed to establish the RIC system.
Landlords for rent-stabilized units are required to report the current unit rent to DHCR every year. This (annoyingly non-searchable) database of the designation and rent history of all rent stabilized apartments means that the city already has a way of tracking rent levels for all rent stabilized units, including the annual change in rent.
With this data, the DHCR will know exactly how many RICs to issue to each individual landlord. This can be set up and managed through a RIC eXchange (RICX), which tracks ownership, transfers, and usage of RICs for rent changes.
When a landlord reports rent increases to DHCR, they also need to cash-in adequate RICs with it. Landlords who raise rents without RIC coverage would face fines and lawsuits from the city and their tenants. These punishments don’t even need new laws; tenants today are already entitled to 3x damages for illegal rent increases.
What’s the value of a dollar in rent?
Given that RICs are interchangeable — one RIC is one dollar of rent increase — they would almost certainly trade at a market price. How would you value one?
At a basic level, a rent increase isn’t just for that year — that additional dollar is paid every year under the new higher base rent. At a 5% discount rate, that $1 hike is worth $50 in today’s dollars as a growing perpetuity.3 That’s probably close to the fair market price for the average RIC — but it could be worth more to the right buyer.
A likely reserve buyer is the owners of those dilapidated and vacant apartments, who claim that the stabilized unit rent is too low to justify the investment to bring these units up to code. Today, these units are depreciating assets with $0 cash flow.
A sufficient rent increase to justify capital improvements means they could rent these units out; once at code, owners would get more than $1 in rent for each RIC used if that increase gets them from $0 in rent to $2,000. If these owners really need to charge a higher rent to make their units habitable, we should let them — if they directly pay to freeze the rent for other tenants in the city.
Of course, these aren’t the only likely buyers. Rent stabilized buildings tend to sell for 6x-8x gross annual rent, an arbitrage that soon-to-be sellers will absolutely take advantage of. We may start to see a systemic behavior difference between long time holders and those looking to sell their building.
I can acknowledge that there’s room for abuse here. A vindictive landlord who wants to evict their tenants to condoize a building could spend $50,000 on 1,000 RICs, raise rent by $1,000, and force an eviction. Sure that landlord is freezing a bunch of other people’s rents, but that’s cold comfort to the person getting the hike.
You might try to solve this through other interventions — cap the RICs per unit, etc — but you’re never going to be able to stop every loophole. Maybe the answer is to not build the market purely for building owners. If landlords can trade rent increases, why shouldn’t tenants be able to as well?
Using RICs to empower tenants
In addition to giving you the right to raise rent, what if RICs could be used to negate an increase?
Say my landlord scrapes together 400 RICs, letting them raise my rent by $400 annually. If I really value keeping my rent the same, I can go out and buy 200 RICs myself. If we both decide to use them, my annual rent only goes up $200 instead of $400.
More likely, my landlord agrees to back off and sell his RICs on the open market — preserving the landlord-tenant relationship with the help of securitized rent adjustments.
This totally transforms the market for RICs, making both tenants and landlords potential participants. With the ability to bid against your landlord for the right to raise your rent, prices for RICs will generally increase — which means that only the highest value rent increases will make financial sense.
Of course, not everyone has thousands in savings to spend on a game theory transaction over their apartment. You could imagine tenants unions creating some kind of rent stability insurance (RSI) to share the risk.
Imagine you’re living in Astoria and want to minimize rent hikes. You start paying $50 per month into an insurance pool with other tenants. When the RGB guidelines come out, the tenants union could purchase some RICs to insure against rent increases. If your landlord comes at you with the $400 raise, the RSI will offer you 400 RICs to counteract it — unless your landlord agrees to negotiate or back off.
This is a new source of tenant power, but probably one that will lead to new inequalities. The most organized tenants will be able to push back on rent hikes, while those without the ability to organize will eat greater rent increases.
What does a mature market for RICs look like
The Rent Guidelines Board has a lot of power to shape this market. Their annual vote directly sets the supply of RICs for the year. More RICs act as a direct subsidy to landlords of rent controlled apartments, who now have more instruments to use or sell. At the same time, RICs (and rent increases) become cheaper as more supply is created.
With this variability, we’d likely see the creation of RIC futures to lock in the price for a RIC before the true supply for the following year is known. This financial market puts the RGB as the supply setters, the landlords as the sellers, and rent-stabilized landlords and tenants as the buyers.
But the market doesn’t end there. Much like carbon markets today, you’d likely see the entry of outside speculators who want to benefit from mispricings.
Speculators might buy RICs right before the rent guidelines board vote, hoping that a low rent increase year could increase demand for their credits. Trading desks would spring up to offer futures to let investors lock in prices for RICs long term, or options to let investors bet on price changes through Robinhood. Maybe even an ETF that lets investors (and pension funds?) get economic exposure to RICs.
Most people will probably absolutely hate the idea of speculation on rent increases. But every RIC being traded is a RIC that isn’t being used. Speculation that increases the price of a RIC means more RICs are sold, fewer are bought, and fewer are redeemed into rent hikes. Speculation actually helps tenants by reducing the total rent burden increase across the city.
RICs would also give tenants new exposure to the financial world. A lower interest rate changes the discount rate of future cash flows, meaning that RICs will become more expensive. A higher interest rate increases the discount rate, making RICs cheaper.
Weirdly, this means that rent stabilized units would start to look more like the owned housing market. A lower interest rate increases the cost of a RIC, making it less likely that someone will burn their RIC to raise your rent. Much like variable rate mortgages go down with lower interest rates, rent increases will be lessened due to the greater speculative value for RICs. The RGB might need to go beyond real estate and start tracking Federal Reserve Board meetings in their annual rent decisionmaking.
The political economy of capped and traded rent increases
RICs would absolutely impact the political dynamics of New York City. Here are a few immediate ideas:
NIMBYs
NIMBYs, who famously oppose new housing development in their neighborhood, often arguing that new buildings will raise prices in the neighborhood and force out long term residents.
Sometimes, builders can appease existing tenants through adding affordable units or investing in the neighborhood. With RICs, they can do one better and make an agreement with their landlords to buy their credits — literally paying to freeze the rent of existing tenants long term.
City Control of Rent Stabilized Units
Politicians could find ways to control landlord behavior by utilizing RICs. Frequent violators of city laws could face reductions in future RIC issuances instead of a traditional fine, directly tying your ability to raise rent to how well you treat your tenants.
RICs could even revive the entire stabilization system. Today, new rent stabilized units are somewhat rare; last year just 14,898 net units were stabilized, or 1.4% growth. That sounds ok, but this was the first net positive year since 2018 — and only 3 of the last 21 years have seen a net addition of rent stabilized units.
Nearly all new stabilized units today are created through very generous tax incentives under the 421-a program, at a cost of $550,000 per unit on average. In a world with rent control cap and trade, RICs would act as an indirect annual subsidy for new buildings entering stabilization.
At an average rent of $3,105 for new buildings entering stabilization, it pencils out at a $18.6k annual subsidy per 1% rent increase. Alongside other incentives, it may move the needle on marginal buildings that otherwise wouldn’t convert to stabilization.
The Rent Guidelines Board
The Rent Guidelines Board, despite criticism, seems to be made up of mostly good eggs: think a nonprofit chair, a housing expert, a policy analyst, an NYU professor, and a lawyer.
With more attention on the board, you might start to draw a different kind of candidate. Financial speculators might try to join, citing their expertise in RIC markets. Greater attention might attract ambitious politicians seeking a stepping stone to higher office.
And with the ability to directly bet on their regulatory decisions, issues like insider trading become imaginable. It’s going to be an interesting news cycle if the RGB freezes rent right after a board member bought thousands of RICs.
Official idea rating
4/5. The existing system of rent stabilization benefits incumbents at the expense of everyone else. This can correlate with income, but doesn’t entirely; we all know of high earners paying far less rent because they moved to New York 6 years ago instead of 4.
Still, there are 2 million-plus New Yorkers living in rent stabilized units. The system is going to stay, and it probably should in some form — I don’t think mass evictions is the right way to fix rent stabilization in New York.
Cap and trade might resolve some of the most egregious externalities of the system. But this has never been tried before to my knowledge, and there are 100% going to be unexpected consequences; I don’t think a new mayor running on a bold platform is going to want to take this kind of risk for a market based solution.
So while I’m waiting on a call from Zohran’s policy team, I think he’ll probably just freeze the rent. But if you happen to be on his team — or are the mayor of a midsized town trying to make a splash — my DMs are open.
The stabilization system came into existence with the Rent Stabilization Law of 1969 (RSL), which applied to buildings built between 1947 and 1973. The system was formalized by the Emergency Tenant Protection Act of 1974, which stops NYC from adding new buildings to the rent stabilization scheme involuntarily.
The phenomenon of empty units that can’t be rented out is often blamed on the Housing Stability and Tenant Protection Act (HSTPA) of 2019, which (among other things) made it harder to remove rent stabilization from units or raise rents to pay for maintenance.
Mea culpa: a commenter on Reddit corrected me that as a growing perpetuity, this would be $1/(0.05-0.03) = $50, and not $7.73 over a 10 year period. This does assume that the 3% increase continues every year, so in reality it may have an uncertainty discount.
I could be wrong about this but I believe there already is a trading style system for new construction in NY, where developers who are required to build x% affordable units will sometimes not build those units in their fancy new development but instead give the money to some non-profit developer to build the units somewhere else. There's also famously a sort of cap-and-trade with air rights in NYC. Between the two feels like the city government ought to already have some familiarity and expertise in this zone
The idea that the tenants can negate the increases with their own RICS is deeply destabilizing. How are you supposed to be able to finance a building if you don't know what your increases are going to be?
Ultimately, the free market is a good thing. Price increases serve to efficiently allocate apartment product to the right end user. Allocating to the right user allows productive labor to be close to productive office nodes. It allows nice restaurants to open up next to people who can actually afford them. It allows nice schools to open up next to affluent families that can afford the taxes necessary to hire nice teachers and staff.
Getting in the way of that is bad.
RGB is bad but at least that system provides some level of predictably so you can underwrite these investments. This is more volatile and similarly inefficient.