Legal issues Rental housing can be simply defined as a property owned by an individual other than the resident or by a legal entity, and for which the resident pays a monthly rent to the owner. In “rent-to-own” schemes, whose ultimate goal is to favor homeownership, the status as a tenant is limited to the period needed for the household to build down-payment and a record of payment. Otherwise, in “pure” rental housing schemes, there is no obligation for the owner to sell or for the resident to buy the occupied unit.It is simply a formal or informal contract between the tenant and the landlord to rent the dwelling for a certain period of time at a predetermined price.
Ownership and management There are several types of entities that can be involved in the ownership and management of residential rental real estate. The first is comprised of individuals who own a small number of units; some call them “amateur” landlords. This is the main segment of rental housing in emerging markets where these small entrepreneurs often operate in the informal sector. It is also the prevailing model in most European countries: in France, units owned by individuals are 95% of the private rental sector and 54% of the whole rental sector; in Germany, the share of individuals is 67%. The second are large scale institutional investors and owners.Most residential rental real estate in the United States is controlled by large corporate entities.
The third type of ownership structure is “social” rental housing. Here, the rules are not determined by the market (supply and demand), but rather by criteria such as maximum income, specific target groups and specific modes of allocation, and, usually, maximum rents.The commitments that define social housing may hold for a short or long, or even indefinite period, and can be imposed by law or result from a contract. Social rental housing generally serves targeted populations such as poor people, the elderly and the disabled. It has often been publicly owned and managed. This type of structure has been common in both Western Europe and the United States, not to mention socialist economies. In the few countries which remain deeply involved in social rental housing (mainly in Central and Northern Europe) the private sector now plays a dominant role through non or limited profit ad-hoc organizations (France, Netherlands, UK) or cooperatives (Denmark, Finland, Germany, Italy) along with public entities linked to local authorities (France, UK). Public rental housing has decreased in importance in many developing countries in Africa, Asia and Latin America because of operational costs and difficulties to adjust rent levels to pay for maintenance.
In the 19th century, cities in North
America and Europe were developed as renter cities, by large land and rental
housing companies. Alternative investments were very limited and supportive
were the emerging mortgage banks that financed both land and construction with
long-term loans. As the value of currencies was pegged to gold at the time,
interest rates were extremely low. Rental law standardizing contracts was
almost absent and eviction, a short process.
With the First World War, which absorbed massive capital
resources, housing investment came to a halt. Under the high levels of
inflation rates in the aftermath of the war, rents increased massively.
Governments sought to combat both shortages and rent increases by a combination
of rent controls imposed on the still abundant private rental stock, and by
promoting a new form of housing social rental housing. Governments also encouraged
home-ownership. In some cases, rental housing was even discriminated against:
an example is the exclusion of both multi-family and rental housing from
eligibility for the US public mortgage guarantee system set up in 1934 by the
Federal Housing Administration.
Most of the Middle-East countries and some in Africa
and Asia also introduced rent controls in the middle of the 20th
century, often in their hardest form: until recently in Morocco, no rent
increase was allowed if significant improvements had not been carried out; in
Egypt rents were brought down in 1952 to 65% of their 1944 level and, 15 years
after their decontrol, 40% of the rental stock in Cairo is still under this
heavily contributed to urban decay and the demise of the rental sector in
Western countries and pushed the sector into informality in emerging economies.
In the UK, France, Germany, Austria, Benelux and Scandinavia, public rental
housing flourished in the aftermath of the Second World War as large subsidy
and funding programs were set up in response to housing shortages and strongly
growing populations. Some countries, most notably Germany, also subsidized
private rental housing, mostly via tax mechanisms, and saw generally high
rental housing tenure.
Towards the end of the 20th century, a
number of countries have tried to catch up on private rental sector
development. In the mid-80s, France introduced generous tax incentives for
individuals investing in newly-built rental housing. Britain after her mortgage
market crisis in the 1990s embarked on an ambitious program which saw new
rental laws, a strengthening of housing associations (at the expense of
directly publicly owned housing) and later the private buy-to-let market. Spain
has failed so far with comparable initiatives, however.
In emerging and transition economies rental is
seldom on the agenda. When it is, the main concern is the legacy of the past
(rent control). In a few cases however, the misuse of the existing stock
(Morocco), the evidence from the crisis that a large and sometimes growing part
of the population would not have access to long-term credit (Mexico), led
governments to consider revitalizing the rental sector.
the development of a healthy formal rental housing sector is indeed important
for a number of reasons:
First, the rental sector is a natural outlet for
households that do not have sufficient income to afford buying a home, or have
not saved enough to meet down-payment requirements for ownership, or do not
even have access to credit. Young adults and the poorer fractions of the
population fit into these categories.
Second, vibrant rental markets are necessary for
workers’ mobility as, because of transaction costs linked to purchase and
mortgage loan, ownership entails higher fixed costs, which amortize on a longer
Third, a robust rental sector is needed to give
households a larger choice for asset investment. In most countries, housing as
an asset has the two drawbacks of being indivisible and relatively illiquid,
which affects the way households can manage their portfolios. Among low-middle
income households in particular, the main residence is usually too large a part
of their wealth.
investment, rental housing generates a source of income that complements other
income sources. In some countries it can also be a substitute for insufficient
or volatile pension systems, thus being a critical element of welfare
improvement for the elderly.
Obstacles often met There a
several obstacles to the (re)development of a formal rental housing market.
They range from a quasi cultural bias towards home-ownership to the absence of
a formal property management system. Laws and administrative systems for
eviction are often biased towards the tenants against landlords, which creates
significant repayment risks. This situation caused investors in the formal
rental market to fly away in countries as diverse as India and Mexico (see case
sector often has to overcome the consequences of past behaviors and policy
choices such as rent controls. Based on exaggerated and highly publicized bad
cases, investors see tenants as moving too
often, not paying their rents, not maintaining the property, hard to evict,
etc. On the other side, greedy landlords such as Charles Boycott are famous.
Governments have a large share of responsibility in the bad image of the sector
for their poor management of public housing, their reluctance to enforce
courts’ decision concerning eviction of defaulting tenants and, above all, in
imposing rent controls that resulted in lack of maintenance of the existing
stock and absence of new investment. These dire consequences justify the
statement that “in many cases rent control appears to be the most efficient
technique presently known to destroy a city—except for bombing” ().
Lindbeck (1972), “The Political
Economy of the New Left” (New York: Harper and Row).
As rental housing is, or is seen as, an unprofitable
and risky investment, no finance is available for investors in rental housing
and developers do not often embark on this activity. Even if long-term credit
is available, in most emerging and transition economies, the interest rate will
be too high to produce the expected leverage effect. This is why rental
investment is often fully financed by equity, which limits the number of
potential investors and the rate of return of their investment. Institutional
investors are deterred from investing and individuals do it informally, thus
avoiding often unfriendly taxation.
many countries, lenders will be reluctant to finance rental investments by individual
investors. In spite of the expected rent payment, they know that this type of
lending is risky as, in case of difficulty, the investor will more easily
relinquish a property he does not occupy than his own residence.
In the recent years,
low interest rates and price increases helped lending for rental to develop.
Rental investments have been a significant minority of sub-prime lending in the
United States in cities like Miami. In France, lenders easily finance individuals
investing in new rental housing because investors benefit from important tax
subsidies (above) provided that the property is rented and a rent is really
paid during six years minimum. It may be more difficult to finance a rental
investment in an old building if its location or quality is questionable.
Lending for multifamily
rental projects is very different from retail lending for ownership or rental.
No standardized debt instruments or financing process exists and multiple
funding sources are common. As a business line, it is closer to project
finance, as it relies heavily on the examination of the cash flows generated by
each particular project. As such, it is less subject to automated procedures of
loan approvals and other refinements that have facilitated the development of
Lending to social housing In particular loans to finance
social rental housing have specific features which may pose problems to market
players. They are (very) long term, often more than 30 years, which makes it
difficult to raise matching funds. They also may have high
loan-to-value-ratios. Both factors increase the risk premium. On the other
hand, a part of the rent is usually paid by the State through housing
allowances which, on the contrary, reduces the risk to the lender. Moreover the
risk is spread over a number of properties, unlike an individual investor.
Hence the risk of such loans is often overestimated; more precisely, whereas
the LGD (loss given default) is high, the PD (probability of default) is low.
Only during the 1980s the development and liberalization of capital
markets made market funding possible for social rental housing. In the euro
zone countries, macroeconomic stability and resulting lower interest rates
allows the market to compete with the old public financing channels, at least
for organizations and programs providing sufficient guarantees. Public funding
has not completely disappeared but has often changed shape. France is the only
country in the euro zone in which the main funding source is, if not exactly
public, at least centralized at the national level. In Poland, recently created
TBS organizations also relied on public funding but public sector reform and
budget constraints now leaves them in an uncomfortable position (see case study).
In some cases, access to
private finance has been made possible by strong public guarantees (UK,
Netherlands and Finland). In addition to usual types of guarantees, providers
in different countries have been implementing for a few years innovative ways
of pooling risks, for example, the issuing of bonds via special purpose
vehicles (Austria, Switzerland).
Main Approaches to Improve or Expand Rental Housing
Expanding formal rental markets will in general first require improving the legal framework:
it should be simple and clear, allow rent increase, accelerated procedure
(arbitration committee) and property recovery by the landlord.
Improving the legal framework In Morocco, the share of rental housing in the urban stock was rapidly
decreasing and the vacancy rate was high. New investment was scarce and only by
individuals renting one floor of a house. The main reasons were: many defaults,
lengthy procedures, eviction difficult; no rent increase possible if no
improvement works; tax discrimination against rental. A new legislation has
been drafted. Its main features are:
A written lease is required, clearly stating the rights and obligations
of the landlord and of the tenant, including the cases when the owner may
recuperate the unit and those when the lease may be cancelled, the amount of
the security deposit (two months’ rent);
Rent will increase
every three years (8%);
A written description
of the premises is required when the lease is signed and when it expires;
The unit must be
habitable and decent;
Minor repairs are the
responsibility of the tenant; written agreement of the landlord needed before
rent controls Ending rent control is a
difficult move: it takes time and requires political courage as it is not
rewarding in the short-term.Liberalization of new rental contracts is rather simple; de-grandfathering
old contracts is not.
In Egypt, a 1996 law that
freed the market for newly-built and vacant units started reviving the rental
market: 80% of new units accessed in 2001-2006 were through rental. But 42% of
the housing stock in greater Cairo is still frozen under rent control:3.7 million housing units (32% of the urban
stock) are unused, either vacant or closed (see case study).
In the Czech Republic, rents of new leases (new and vacant units) in
former public flats were freed in 1994 but this deregulation was declared
unconstitutional in 2003 and became subject to tenant’s agreement; otherwise,
the rent was frozen until 2006.In 2006, the act on One-sided Rent Increase still
gave priority to free agreement; otherwise, the landlord was entitled to
increase the rent according to the formula included in the Act with the aim of reaching
the level of 5% of average regional market price.
International experience provides lessons for rent decontrol reform First, a gradual approach is recommended. Rent adjustments
need to be phased in order to create gradual convergence toward market rents
and limit the financial burden of tenants. However, initial shock adjustments
are justified when controlled rent levels are extremely low compared to
operating costs, in order to limit the losses from depreciation, which is the
case in Egypt. Moreover, some sort of support for needy tenants should be
designed. In Spain, the administrative complexities lead here to some reform
Second, the agreement of tenants to a decontrol process
cannot be obtained without a proportional service being provided by the
landlord. This is clear in the case of rents that are not sufficient to cover
current operating costs (Phase II in figure 1). However, beyond that level rent
adjustments should be permitted in exchange for capital repairs and modernizations
(Phase III in figure 1).
Third, final rent control regimes need to be defined for all
rental contracts, eliminating inequitable situations between tenants.
Finally, while there is no systematic empirical analysis on
the impact of liberalization on rent levels, there is ample anecdotal evidence
of initial overshooting phases being followed by calmer periods, resulting in a
decrease of initial tenant resistance (green line in Figure 12). The rule of
thumb is that the larger the rent controlled stock relative to the total stock
is, the more pronounced the initial overshooting and the more likely a
subsequent relative decline in rents will be.
It is important that all rental contracts be treated alike.
As the Spanish example shows, second generation rent legislation after an
initial liberalization is often necessary in order to react to market failure,
to significant increases in rent and contract term volatility, or to abuses.
More importantly perhaps, in combination with de-grandfathering the regulatory
system must unify the legal framework for all rental contracts and buy
important political support for a de-grandfathering strategy by reducing
popular anger against reforms.
Figure 1: Rent decontrol process - a stylized portrayal
Source: Achim Duebel, Finpolconsult
Improving the rate of return Next, an even playing field with other investments, non residential real estate and financial products, should be createdin
order to bring the return and risk of the housing investment in line with these other vehicles. The necessary adjustments should be made through taxation and
insurance products. These prerequisites should enable investors to have a
better access to market finance.
Multiple ways can be used to increase the net (after tax and operating
expenses) rate of return:
For rental at market prices,
tax solutions (ending discrimination against rental, allowing accelerated
depreciation, etc.) should be considered first;
Subsidies such as grants,
VAT rebates or subsidized loans should be accompanied by matching commitments
(such as income limitations and/or maximum rent levels);
For low-income tenants,
housing allowances are now preferred, because they are better targeted and more
flexible but they are a fiscal and administrative burden which most emerging
countries will find too heavy.
Reducing the risk is of primary importance to lenders.
Two main families
of instruments can be used:
devised to insure the cash flows produced by the property to the landlord,
products applying to individual mortgages (aimed at primary lenders).
Among the first category, one finds insurance for rental payment for
landlords (late or non-payment, degradations, sometimes legal costs). In the
second category, mortgage insurance is the most popular product. Mortgage
insurance insures lenders against loss in the event of mortgage defaults. In so
doing, it makes capital more readily available to the borrowing investors.
There also exists credit enhancement products applying to the bonds
issued to finance the investment (aiming at achieving a triple-A rating for the
The Cases of India and Mexico: Six Reasons Why Formal Rental Markets do
cultural bias in favor of home-ownership - India and Mexico share
this attitude with all emerging economies and a large majority of
countries. The bias seems to be particularly strong in India because
privilege savings and prefer tangible assets such as real estate and
Moreover, unlike gold, the prices on the housing market are
characterized by a
constantly ascending trend and India has so far avoided the booms and
usually affecting this market; the appreciation of the property is thus
The legal framework - In India, landlords
have long been deterred from investing by the legal framework which was,
is still, extremely imbalanced in favor of tenants: eviction was
case resolution might take several years and rents were blocked at a
level by the Rent Control Act of 1947, with only recent decontrol, which
incomplete in some states.
In Mexico, the problem
is of a lesser magnitude. After rental laws favorable to tenants were
the 1970s, there has been a trend towards a more favorable treatment of
(Civil Code reform in 1994).However,
according to potential investors, the legal protection afforded to
remains a great barrier to stimulating a large scale residential real
The rate of return - Due to the scarcity of
formal investors and of data, the gross rate of return is estimated to be
close to 10% on both markets and lower in
the best locations; the net yield (after expenses and taxes) is
below this level and may be less than 5%, depending on the tax bracket
landlord. The consequences are different in India and Mexico investors in
India will prefer to keep their property vacant and thus be able to cash
capital gain any time; this attitude entails a high vacancy rate in the
stock. In Mexico the vast majority of individual landlords will rent
to avoid taxation.
Lack of incentive for investors - There are no subsidies
provided for rental housing by the federal or state governments, except
Army; in India the public housing stock was sold to tenants in 1978; in
in a similar way,there has been no
federal program of social rental housing for 25 years and there is no
allowance or voucher program.
Lack of adequate finance - The overall financial
system would not readily provide equity capital or long term debt for
in multi-family residential rental developments. Even if it did, there
no leverage effect possible as the net rate of return is much lower than
rates of long-term mortgages.
Lack of formal property management - Unlike non
properties, there is no formal property management system for the
rental stock. Professional management is essential in multi-family
housing as the net operating income highly depends on rent collection,
and on adequate
level and timing of maintenance. This “operating leverage” is the
of the “finance leverage” mentioned above.
All these issues need
to be addressed in order to pave the way to a substantial investment in
Poland: A new Social Housing Sector to Fill the Market Gap
The homeownership rate in Poland (66%) is close to EU average
rental sector is excessively fragmented and the formal free market
underdeveloped. This situation is the legacy of evolving policy reforms
institutional framework over the past 20 years of economic transition in
The rental residential market is made of the following segments:
Municipal housing, mostly untargeted (except for “waitlist
allocations”), with highly preferential rents (of about 1.5% of the
which encourages tenants to stay rather than leave. It includes
units targeted at vulnerable households (mostly low income) with very
as municipalities have, by law, the obligation of housing the homeless;
The old (pre-1945) private stock, restituted to the previous
(when found), rented formally and governed by tenant-protection law and
taxation regime, with rents very close to the 3% replacement value limit
the law (see below);
The recent private stock: consisting individually rented dwellings,
most often informally, targeted mostly at students, migrant workers as
foreigners and companies (for employees). Rents are highly variable, but
often 5 to 10 times higher than in the municipal stock;
The system of social rental housing (TBS): inspired by the
system, it was introduced in 1995. The main operators are non-profit
housing companies owned by municipalities, but some are fully private
others mix public and private capital. Rents should not exceed 4% of the
replacement value. They are heavily subsidized (through provision of
land and low-interest loans by the State bank BGK).
However, their tenants are not the poorest but mostly middle-income
have to contribute up to 30% of the construction cost without being
right to buy in return. Moreover, the number of units produced is far
- Cooperative housing: some cooperatives offer so called “coop rental
rights”, which require some “key-money” from tenants and thus resembles
The creation of TBS aimed at filling a gap as the housing
unable to develop, largely because tenant protection was reinforced
contrary would have been necessary. The Tenant Protection Act, passed in
has been amended: the initial rent setting is free for new contracts,
increases on rents exceeding 3% of the replacement value1
exceed a complex percentage that includes an ill-defined “fair profit”
component. This formula leads to conflicts ending up in court where the
of proof lies with the landlord. The courts are also opposed to
eviction of non-paying tenants: in any case, an evicted tenant must be
with a municipal dwelling, but, given the shortage of such units, many
non-paying tenants are allowed to stay in the premises while the
landlord is in
theory eligible to compensation from the local authorities.
 An administrative parameter
of construction cost established by local authorities.
 The State cut its subsidies and
a revision of the system is under way.
Egypt's Rental Stock After 10 Years of Decontrol
Much of Egypt’s housing stock still remains
constrained by very high vacancies, as a consequence of rent control and lack
of alternative inflation-proof investment. Almost 3.7
million housing units are unused, either vacant or closed. According to the
2006 census, the total number of unused units in urban areas in Egypt reached
4.58 million units, of which 1.18 million were closed and 3.40 million were
vacant.It was estimated that more than
80% of these 4.58 million unused units are for housing use.The scale of vacant urban housing units is a
specific and puzzling phenomenon of the Egyptian housing market.
One explanation is that
the sustained rapid appreciation in value over the past 25 years or so and the
lack of alternative investment mechanisms until quite recently meant that
housing and real estate have consistently served as an inflation-proof savings
and investment mechanism, without need of the rental yield. The idea of renting
was even less attractive due to the imposition of rent control until 1996.Even now, the continued perception of
uncertainty about the enforceability of the new rental law makes many owners hesitant
to put their unoccupied units to rent.Poor targeting of government subsidized units, as well as the mostly
unattractive locations in New Towns, have also further exacerbated the problem.
The series of rent
control laws imposed by the government as early as 1944, but especially during
the 1950s and 1970s, has had serious effects on the housing market.Rent control was originally
conceived as a temporary measure in the aftermath of World War II; it was later
extended to preserve housing affordability for limited income groups. Rent
control forced housing investors to concentrate solely on building housing for
sale, which implied a focus on the upper income segment of the market.
Professional long-term investors in rental housing, such as insurance
companies, exited the market facing severe losses on their existing holdings.
At first, rent control law applied only to units built during the 1940s, but
controls were gradually extended and applied to all new construction (i.e. no
Renting is tantamount to owning, for the
insiders. Rent control prompted the application of key
money for new rental contracts or to release an old rent-controlled
agreement.A comprehensive World Bank
study on the rental sector in Cairo
found that, in practice, key money is roughly equivalent to the net present
value of the difference between market rent and the frozen rent level over the
duration of a long-term tenancy contract. In effect, renting has been tantamount
to owning in Egypt,
and households expect to have – and have had – exceptionally long leases
relative to most other rental markets worldwide.
Bequeathing rules create new generations of
insiders and perpetuate distortions. The 1996 law
grandfathered existing rental contracts, thereby allowing units to be passed on
one time to a family member (parent, spouse, offspring, or any relative of the
first degree) living in the household 2 years prior to the death of the
tenant.Indeed, this provision, although
not uncommon for rent decontrol in its first phase, is frequently abused. A
typical form of abuse seems to be children, or even grand-children, moving into
the apartment shortly before the anticipated deaths of parents or
grand-parents, just to comply with the letter of the law. Anecdotal evidence
about more serious infringements includes the changing of residence on the
government issued identification card and the name on household utility bills
to prove occupancy. As a result, about 50% of tenants in the age group 25-35
years (household heads) are living in controlled stock, paying rents usually
not exceeding 5% of stated household income.
An estimated 42% of the housing stock
remains frozen under rent control. Since the
passage of Law No. 4 of 1996 that freed the rental market for newly built and
the then-vacant units, but grandfathered existing rent-controlled units for the
duration of the contract, the rental market is showing signs of much
dynamism.The TAPRII Greater Cairo
Housing Demand Survey found that 81% of all the new units accessed in the 2001-2006
period were through rental contracts signed under the new law (only 19% were
for ownership).Yet, the TAPRII survey
also indicates that 42% of the total urban housing units in Greater Cairo are
still locked under the rent control regime as a result of grandfathering, and
that this is not necessarily benefiting the poor.This greatly constrains residential mobility,
locks a large proportion of units out of the market, causes lack of stock
maintenance, and distorts the overall housing market.
Going forward, without further action, the rent-controlled
sector will remain for another three decades. The current
situation of massive bequeath of old rental contracts to the younger generation
will likely leave Egypt with a large part of its housing stock under rent
control for a long period. A simulation suggests that it could be three decades. Even a radical reform scenario in
which bequeath would be prohibited altogether would still mean that Cairo had a
rent-controlled sector of 14% of the housing stock by 2016.
A, Malpezzi, S. and S.Mayo. 1995. “Egypt
Rent Regulation Reform Study for the Arab
Republic of Egypt”. Study commissioned by the
World Bank. Cairo.
on the TAPRII Survey, about 50% of the old rental contracts are bequeathed to
the next generation, for whom both mortality rates and conversion or
termination incentives will remain low over the coming decades.
Hans-Joachim (Achim) Dübel is an independent international consultant with 20 years of experience in housing finance. Based in Berlin, he is the founder of the financial and housing/real estate sector think tank FinpolConsult. Before founding FinpolConsult in 2004, he worked on staff of the Financial Sector Development Department at the World Bank in Washington and as a free-lancer.