Selecting the Right Rent

Years ago, I had the opportunity to ask former Secretary of the Treasury Lawrence Summers a question. As he walked in one direction and I in the other, I waited for our paths to cross and then said that I taught economics and wondered what he thought was the most important idea my students could learn. Barely pausing, he said, “the power of the market,” and continued onward.

Today I thought we could look at NYC landlords to see the power of the market.

Calculating the Rent

As a small landlord in NYC with several apartments, deciding the right rent could be tough. You can look online, at neighbors, and at nearby Open Houses to see what others are charging, Expenses like the mortgage and taxes enter your calculations as would repairs, heat, and some profit. You might care if a tenant asks for more maintenance. It could also matter if you know the person is a senior citizen on a fixed income.

Other considerations include the cost of a vacancy. An empty apartment requires repainting, refurbishing, and months perhaps without any cash flow. One landlord had to lower her price when she had no takers. First asking $2300, she settled on $2175.

Another landlord told of his “ghost” tenant who never had a complaint. Because the rent was always on time, it stayed at $2500. But then a roommate arrived and the calls began, even for a noisy refrigerator. When renewal time came, the rent went up. He asked for $4500. They negotiated and settled on $3500 and a roommate that would be more restrained.

We could say that the market pushed the first landlord to $2175. For the second landlord, they realized that $4500 was too high and $2500 too low. No one said $3500 was right. But somehow they knew.

Our Bottom Line: The Power of the Market

The market is a process through which price and quantity are determined. Acting independently, the supply and demand sides of the market are motivated by their own incentives. The supply side is affected by cost, the number of sellers, and future expectations. Meanwhile demand decisions relate to affordability, substitutes and the number of buyers.

Rather amazingly, with no one telling what each side of the market should offer or bid, a price is determined. We could say the reason is the power of the market. Or maybe it’s just Adam’s Smith’s invisible hand giving us all a nudge.

My sources and more: Thanks to the NY Times for today’s article, “How Do LandLords Set Rents?” Instead, its title could have been “How Markets Work.”

Please note that I have told the Lawrence Summers story in past econlife posts.