I’m a big fan of the National Business Review.

The analysts over there often have some great insights on today’s market…and aren’t afraid to call it how it is.

However, I recently read an article by Rodney Hide, a former MP for ACT, and I wasn’t impressed.

In the article titled, ‘Trivial law change naïve or cunning?’, Hide suggests that Phil Twyford’s move to ban letting fees is meaningless.

That you can call the costs whatever you want, the tenant’s always going to pay in the end.

He’s right…sorta.

Yes, now landlords will pass on the cost of letting to tenants via rent…or via some other fee.

But a significant change has been made…one that throws a wrench in Hide’s argument.

Allow me to explain…

Let’s say there are two landlords on either end of a street.

Both have apartments they’d like to rent. Both apartments are identical.

The first landlord puts his place up for sale on Trade Me for $500 per week.

The second landlord looks at that…and what does he do? He puts his up for $490 per week.

They go back and forth, lowering their prices until they each manage to hook a tenant.

That’s the competitive power of the free market…and it’s a central pillar of pricing rentals.

Now, let’s say that both have been charging letting fees to their tenants — one week’s worth of rent.

That money goes straight to the property manager who helped find the tenant, did the background check, showed the apartment, etc.

With Twyford’s new law, property managers must charge landlords instead of tenants. Let’s say they bill $450 for their services.

Both landlords want to recoup that cost, so they up their rents. The first landlord bumps his up from $450 to $550 per week.

The second landlord — what does he do? He bumps his up from $450 to $540 —$10 less than the competition.

There’s that central pillar again… [openx slug=inpost]

The landlords go back and forth lowering rent, until they lock in tenants.

In this scenario, each landlord must fine-tune their margins by balancing their competitive price-lowering strategy with the costs they bore to let the apartment.

If they wanted, they could try to charge higher rent…but then it could take longer to find a tenant, which costs more in letting expenses, and means the house sits vacant for longer.

Or…their other option is to seek less expensive letting agencies…

They might realise that, for what they’re getting, $450 is way too much. Maybe an agency down the road charges $300…or $200…or $50. If they switch letting agencies, landlords instantly have more wiggle room to compete on price.

Eventually, you’ll see this downward price spiral rewarding tenants with lower rents.

In other words, you’ll see the fluffed-up prices that letting agencies charge deflate back to competitive market prices…and both landlords and tenants could be better off.

And from my experience in the US, where letting fees have never been legal, those costs tend to be between US$20-$30. A far stretch from the hundreds or thousands that letting agencies charge today…

Why? Because now, with the letting fee ban, landlords are incentivised to seek better bang for their buck when they hire a letting agency.

A huge difference…and one that I believe Rodney Hide failed to consider in his argument.

But one point in his article did make me question my understanding of the situation. He said:

‘In the long run landlords are more sensitive to price than tenants because landlords have options for their investment dollars. They need a required return or they will quit the rental market. That means much, if not all, of the cost of the letting or tenancy fee will ultimately be borne by tenants.’

That makes sense to me…if a landlord isn’t getting the yield they want, they can sell the house and put those dollars into something with better returns, like the stock market.

That’s called ‘opportunity cost’ in economics.

But here’s the thing — tenants also consider opportunity cost with their dollars. You can pay $1,000 a week for a unit, or you can go with another unit for $500 per week and put that extra $26k per year into something else…like a future home deposit or the stock market.

By the way, the annual return from the NZX50 in the past year is about 8%. If you did choose a $500 rental over a $1,000 one, and did put that extra cash into the NZX50, you’d have a tidy $2,080 bonus cheque at the end of the year.

So both landlords and renters must consider the cost and benefit of their dollars…whether it’s tied up in the value of the home, or it’s part of one’s weekly rent costs.

What Twyford has achieved with his Residential Tenancies Amendment Act is erase a loophole which benefitted letting agencies and hurt tenants. He’s realigned the transaction so that landlords correctly bear the costs of a service provided to them…

And while that won’t mean those costs disappear, it will mean that they are now under the economic laws of competition and opportunity cost…which in the end, should bring prices down.

Best,

Taylor Kee
Editor, Money Morning New Zealand