#289 Newton’s Third Law and Landlords

Newton’s Third Law is worth considering before any sweeping policy changes go into effect.

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Resources Mentioned on this Episode:

https://www.forbes.com/sites/garybarker/2019/11/28/supply-and-demand-the-leaking-ship-of-landlords-and-tenants/#687fe8453d36

https://www.behavioraleconomics.com/the-three-laws-of-human-behavior/

https://rentprep.com/podcast/263-minneapolis-landlords-push-back/

https://rentprep.com/podcast/274-nyc-micro-apartments-exposed/

Show Transcription:

Eric Worral: (00:00)
Hey everybody! Welcome back to another episode of RentPrep for Landlords. This is episode #289. I am your host Eric Worral. And today we’re going to be talking about Newton’s third law and why I think it applies to the real estate markets and different kinds of restrictions that you’re seeing being placed on landlords and in not only the US but outside of the US as well. We’re going to be covering a lot of recent stories from 2019 and what the fallout is and why Newton’s third law applies here. So we’re going to get to that right after this.

Voice Over: (00:36)
Welcome to the RentPrep for Landlords podcast and now your hosts Steven White and Eric Worral.

Eric Worral: (00:42)
Now I don’t want to get too heady on today’s podcast because I don’t want to lose people cause I’ll probably lose myself as well. But I looked up, you know, got on the old Googles and looked up Newton’s third law just to make sure I had it correct. But Newton’s third law is basically for every action there’s an equal and opposite reaction. I know I’ve touched upon this on podcasts in the past, at least the concept of it without directly naming it. But I wanted to just do an episode dedicated to it because I was looking up content. And typically what I’ll do is I’ll look up content that’s trending in the last week, get ideas for the show. And I started reading one and I was like, wow, this is really interesting.

Eric Worral: (01:20)
I’m surprised I didn’t hear about any of this. It turns out it’s actually in Britain. So that made sense. But it kind of made me realize that Britain’s kind of going through a lot of the same things that we’re going through in the United States where you see actions happen, whether it might be restrictions that are placed on landlords or new regulations that are handed down. And then there is an equal and opposite reaction. So how about I read you some of this Forbes article to kind of give you an idea of what’s happening over there and then relate it to things that I’ve seen happening in the United States and Canada. And seeing how that there is this similar kind of connecting thread of Newton’s third law. So the article comes from forbes.com and the title is supply and demand, the leaking ship of landlords and tenants by Gary Barker.

Eric Worral: (02:04)
So I’ll try to summarize some of this, but what Gary said is that he prophesized that the industry was going to have an issue. And he did this about six months ago since the government enacted something called the tenant fees act on June 1st. And again, this is in the UK. A United Kingdom reports are steadily been coming in that rents have been on the increase as more and more landlords are choosing to exit the market. So he said it’s a little comfort to see my earlier prediction takes shape as this is the one thing I would have loved to be wrong about. The writing was on the wall from the get-go, that the burden’s being levied against property agencies and landlords would have a detrimental knock-on effect to tendencies in both cost and supply. So opening up his earlier prediction. He was talking about rules and regulations, what agents and landlords need to know.

Eric Worral: (02:51)
So what happened in the United Kingdom was that tenant fees bands play on June 1st, 2019 and aims to ensure that tenants will be able to see at a glance what a given property will cost them. And the advertised rent with no hidden costs. That means that deposits will be capped at five weeks rent or six for tendencies that cost more than $50,000 a year. And agents and landlords will be banned from charging fees for anything other than contract changes. Council and utility taxes changes to tendency and issues for which the tenant is at fault. The tenant fees ban is set to affect both landlords and agents who won’t be able to pass on the cost of activities such as inventories, tenant referencing and credit checks to tenants. So if you are a landlord who lives in New York state or Minnesota specifically Minneapolis or other areas that have recently had regulations handed down this may sound kind of familiar.

Eric Worral: (03:46)
So, for example, in New York state you cannot look at eviction data anymore. They handed down that you cannot charge more than $20 for a background check. And there’s a, a lot of other regulations that have been handed down in Minnesota. I covered this on, I believe episode 274 actually 263, Minneapolis landlords pushed back. So what happened out in Minneapolis is they’re putting restrictions on not being able to look at criminal data and also not being able to just deny somebody a if they had below a 500 credit score. What I brought up on that episode was that it was kind of interesting in the fact that what landlords were doing, at least it’s rumored doing, is that a lot of them were just increasing their rents there as well. Or they were making it harder to get the apartment because you had to have an even higher credit score or something like that.

Eric Worral: (04:43)
What I’ve found in a lot of these cases are right, and here’s another one. Episode 274 we talked about New York city micro apartments exposed. So this is where somebody was turning all these apartments into micro-apartments. But another thing that we’ve heard about is that New York City, due to the rent control laws that went into place, that a lot of apartments were moving people to different apartments and then rezoning apartments. So they’d take two rent-controlled apartments that were next to each other, knocked the walls down, and then create a new apartment that was rent-controlled. And what they were doing is they were pushing people out of, or at least incentivizing them out and actually reducing the amount of rent-controlled units that were on the market. Another example of Newton’s third law in a, a case study, and I’ve talked about this recently, is California.

Eric Worral: (05:34)
Recently Institute of Rent Control, but they did not get the two-third majority vote there was required to make it happen immediately. So what happened in California was I think it was a 90-day delay. Don’t quote me on that, but like three months delay. When the announcement came down to when it was actually implemented, which actually just happened recently when I was talking to Steve, he was telling me that you got an email from the NAA PBS national association of public or professional background screeners. So what happened in that instance is that a lot of these landlords felt like they had a 90-day window. So what they did is they jacked up the rents in a lot of situations where they thought the rents were going to be controlled soon. So and the shocking thing is that the tenant advocacy programs were shocked that this happened, which seemed a little naive to me in that situation.

Eric Worral: (06:27)
So again, for every action, there’s an equal and opposite reaction. I’m not saying the reactions are correct or right. But I’m saying that when these regulations are handed down, it’s naive to think that there isn’t going to be reaction. So going back to the original story about what’s happening in the UK what they said is that they found, and they call them letting agents, right? That’s just like real estate agents who are doing tenant placements. It said that the latest private rental sector report from an R L a property Mark reveals that nearly six and 10 58% of letting agents have seen an increase in rent in September. And this is up from 31% of agents back in September of the previous year. So nearly double the amount of rents went up and why that’s happening in the UK according to this article, as a lot of restrictions are starting to be handed down and placed on landlords.

Eric Worral: (07:20)
So what are landlords doing? A lot of them are saying, I don’t want to be a landlord anymore and they’re selling their property was not always landlords that are purchasing the properties. A lot of times it’s home buyers. They’re seeing actually more and more homebuyers in the UK. If I scroll down, I think I can find the stat here so that nearly 64% of households are owner-occupied as 2018. But this is a drop from 9.9% registered in 2008 but it said that the last 10 years, a steadily increasing house prices in dwindling supply following the recession at Forrest potential buyers to stay within the rental market. That puts a squeeze on rental demand, which in turn drives up prices further. So you’re just kinda kind of seeing, he talks about that demand can’t fly through a supply bottleneck.

Eric Worral: (08:05)
So the supply of rentals in the UK is diminishing even further due to restrictions being placed on landlords who no longer want to be landlords. And what you’re seeing is that these restrictions that were handed down to help renters, you know, making sure they’re not getting gouged when they’re applying for rental properties or maybe they’re these exorbitant fees being placed on them to run a background check or something like that. And now the reaction Newton’s third law is that you are actually seeing rents go up because demand or the supply of rental properties is going down as people are jumping ship because they don’t want to be landlords anymore. If I’m being honest 100% when I sold my rental property, it definitely factored in a little bit where I was looking at what was happening in New York state with the all the regulations being handed down and not, that was like even more than like a few percents maybe of the decision of why I decided to sell.

Eric Worral: (09:00)
But it definitely factored in the back of my mind where it was like, okay, it’s getting harder and harder to manage this property so I’m going to sell. And in my case, I sold to an owner-occupied landlord where I took essentially two units that used to be in the market and North Buffalo where my rental was and then it just reduced to one unit. So you could say in that particular case that you were removing one potential rental property or a rental unit, I should say out of the market in that particular case. And if the reasoning I did that was specifically due to New York state regulations, you could make an argument for that. So that’s a pretty weak argument I’ll admit in that case. So I thought it was interesting. And I was curious about Newton’s third law and how it applies to human behavior.

Eric Worral: (09:45)
So I did some Googling and found this a pretty cool website, behavioraleconomics.com. The title of this piece is called The Three Laws of Human Behavior by Aline Holzwarth. And she specifically talks about Newton’s third law three laws and she lays the third law out of, and she talks about if you were to take his third law for every action, there’s an equal and opposite reaction. But look at it through the spirit of behavioral economics basically human behavior. How would these three laws apply? And she says that basically law number three is that for every decision made there are tradeoffs and the potential for unintended consequences. I think that really puts the button on. What I’m trying to say here is that for every decision made, there are tradeoffs and the potential for unintended consequences. So in the case of California, the decision made was rent control, but there are trade-offs and potential for unintended consequences.

Eric Worral: (10:43)
The unintended consequences was that the rent control was not introduced immediately after the bill passed and the gap in time that was created creating an unintended consequence of landlords increasing rents or evicting renters or making drastic changes to try and improve their financial situation before rent control went into place three months later. Now again, forgive me if it wasn’t exactly three months from kind of going from memory on there, they go into a little bit more detail on this. And I’ll, I’ll link to both the Forbes article on this behavioral economics article along with previous podcasts and I mentioned on this episode, but it said that trade-offs, it says that there are costs and benefits attached to every decision. We may actively weigh the pros and cons of a decision at times and other times we may not, or regardless of our attention to trade-offs inherent to any decision, there are often losses suffered in one area when gains are made in another.

Eric Worral: (11:40)
For example, when you say you’re considering starting a multivitamin, you might say, sure, it may very well be a placebo or what are the downsides? Well, the cons could be that you’re taking a multivitamin which costs money and she kind of goes down a rabbit hole here and how those costs can add up. But the concept of what are all the things I’m giving up if I do X is known as the opportunity costs. And I’m sure you’ve heard of opportunity costs before and it’s a type of trade-off that we often ignore. One way to weigh trade-offs like these is to classify the potential pros and cons of a decision and then weigh them a method called signal detection theory written by Daniel Arielli. When situations are complex and an involve a degree of uncertainty, we can use this method to consider the trade-offs of a particular decision.

Eric Worral: (12:28)
Because our time and resources are unlimited. We have to choose how to spend them wisely. So it’s kind of getting into the weeds a little bit. And then it talks about unintended consequences. It says that they are related to trade-offs. Just like the pros and cons of every decision that we don’t see. There may be some unanticipated effects caused by the decision when making a decision. We may not predict future effects that negate or undermine the positive aspects of that decision. A classic example of this is crowding out or overjustification effect were a positive behavior like exercise as initially boosted with an extrinsic incentive. So for example, a financial reward but that positive effect disappears and may even retreat to a level lower than before. The incentive was introduced as soon as the incentive is discontinued. Rewards like this can increase behavior in the short term but undermine the motivation in the longterm.

Eric Worral: (13:21)
Now I don’t know if you follow the same train of thought is me on this, but like I think of section eight in that a little bit, right? Cause they’re always kind of tweaking and thinking about how to introduce section eight and how to make that program work. And I, I think that going through this article would be a really good read for policymakers before they hand down a policy because a lot of times they may not be thinking about all the unintended consequences, which is hard to do because they’re unintended. But knowing that there is a reaction for a lot of this, I’m not a guy who pretends to have the answers, but I do think it is interesting to make the connections and start seeing how regulations and policy changes have these unintended consequences. And it kind of approaches that Newton’s third law and even seeing it playing out in other countries where you’re seeing regulations handed down in the UK and that the rental supply is getting even lower because of it and that rents are getting jacked up.

Eric Worral: (14:19)
And the entire reasoning for these regulations was to help runners and it may actually be hurting them by increasing rents. And we’ve talked about this before too, where there are some people who argue that rent control actually hurts the economy in that market. Because people who want to perhaps build new buildings, maybe they were planning on building a, an apartment complex, say they don’t want to do it. And they said that I remember reading this in Oregon where they had rank control. I think there might’ve been the first date that did it, that they had to kind of put certain provisions in there thinking about people who might be new builders who might do some new construction and try to give them incentives that the rent control wouldn’t apply to them in the same way because they were worried that, you know, people wouldn’t want to build there.

Eric Worral: (15:10)
So what happens when new construction doesn’t happen? New apartments complexes don’t go up in your state. Well, there are then again, less rentals and when there are less rentals, there’s less supply. And when there is less supply and the demand outweighs the supply rents go up if they can, you know, if you don’t have rent control in there, in there, but you kind of get the idea and landlords then have more power because the supply is so high, or excuse me, the demand is so high and the supply is lower. So it’s an interesting conundrum. Definitely takes a lot of thinking to think of all the unintended consequences that may come from Newton’s third law. And again, don’t claim to have the answers, but I think it’s stuff we’re thinking about before policymakers kind of jump to conclusions and think that they’re doing the best thing for landlords and tenants that they may have some unintended consequences.

Eric Worral: (16:02)
So yeah, if you’re in a state where, you know, you’re seeing some of this coming to fruition I’m sure you can rationalize with it. And if you’re not you, it’s only a matter of time, right? There’ll always be changes. Things will always be changing in the future. So it’s stuff to think about and be aware of as you’re even seeing they’re happening across the pond. But before I go on another tangent, I’m going to let you guys go this week, but I appreciate you guys listening and yeah, let me know what you think. Hit me up in the Facebook group or on in the email, eric@rentprep.com and yeah, I appreciate you guys listening and I hope you have a great week. Take care.