Middle East Rent Controls Harm Property Investment

  • 16 years ago
  • Uncategorized
A report examining the effects Rent control in the Middle East has concluded that such measures are generally harmful for property investors.
 
In December 2007 Dubai’s government toughened up its 2005 Rent Law and reduced the maximum 2008 rent increase to only 5%. Abu Dhabi has likewise capped 2008 rent hikes at only 5%. 
 
In neighbouring Qatar, a rent freeze has been implemented while the government is determining the new rent increase cap. For the past two years to February 2008 rent increases were limited to 10% annually
 
In adopting rent control the Gulf has moved in the opposite direction to the rest of the world. Elsewhere, rent control regimes have generally been dismantled or softened since the mid-1990s.
 
Rent control has been removed in most of Eastern and Central Europe. Asia has also followed the trend: China, Japan, Malaysia and Singapore have lifted rent controls since the early 2000s.
 
The Gulf measures have dismayed landlords, and alarmed property investors. 
 
In an extended research article published today, the pros and cons of rent control regimes in about 40 countries are reviewed by the Global Property Guide (http://www.globalpropertyguide.com), an international research firm.
 
 
“We believe that rent control is generally harmful,” says Prince Christian Cruz, senior economist at the Global Property Guide.
 
“But rent control can be benign, if: 1.) it is implemented so that its market-restraining effects are modest; 2.) it helps to defuse public protest about high rents; and 3.) it assists landlords and tenants by providing an agreed framework for contracts,” he continues.
 
“Most of these conditions are not present in rent control measures in Qatar and UAE. If rent control persists in its current form, the property market boom might grind to a halt,” Cruz notes.
  
In defence of rent control
A common (and much abused) justification for rent control is the right to housing, which is sometimes protected by the constitution.
 
Another justification is to correct market inefficiencies such as information asymmetry and high transaction costs. Because of the high cost of moving, tenants can arguably be pressured by landlords to accept rent increases. Tenants may also be unaware of the real condition of units until they move in. If the tenant complains, the landlord may threaten to increase the rent.
 
Standard contracts perform a service to both landlords and tenants. In many cases in modern society, the state intervenes in contractual relations between individuals in order to provide simplicity, clarity, and order. 
 
Both landlord and tenant are helped if standard provisions exist, for instance, which determine what should be agreed on – the initial rent, rent adjustments, date of payment, penalty for delays, conditions for eviction and such. These can provide both flexibility and security.
 
The problem with rent control
The principal argument against rent control is that it tends to distort economic incentives, leading to inefficient distribution of resources.
Rent control reduces the incentive of landlords to supply rental units. Rental units tend to be in scarce supply under rent control. Ironically this leads to an escalation of complaints against the landlord class. Vacancy levels tend to be relatively low and available units tend to be rented only under strict conditions, again aggravating relations between landlords and tenants.
Rent control discourages landlords from maintaining and repairing units till the end of a tenancy.
There is also an incentive for landlords to discriminate against tenants likely to stay for a long time, like retirees or couples with children.
In some countries, landlords collect key money to offset the losses occasioned by rent control.
Rent control tends to lead to bullying and illegal behaviour by landlords. If rent increases are allowed between vacancies, landlords will try to evict tenants in any way possible. This will likely translate into demands for government protection for tenants, i.e., into a further layer of bureaucracy and policing.
Tenants in tenancy rent controlled units are less willing to move to other places, despite the possibility of earning higher wages.
 
According to a study by economists Basu and Emerson, “he removal of rent control can not only increase efficiency in the rental market, but can also lead to a general lowering of rents, making all tenants better off.” 
 
Lessons for rent control
When might rent control be desirable? Where it will help provide all parties with contractual certainty.  
 
Global Property Guide believes that rent control can be harmless or even (in some cases) mildly beneficent, where it occurs in the context of standardization of contract structures, designed to increase market certainly and to provide guidance for citizens.
 
However as noted before, rent control should be minimalist.
 
1. The rent control scheme should be simple.
It should be easy to determine if the unit is covered by rent control or not. It is generally easier to determine if the unit is covered by rent control if the basis is the actual rent, and not property value or construction cost. Using furnished vs. unfurnished for rent control delineation can also lead to confusion.
 
2. The basis should be transparent.
Using the CPI or inflation as the basis for rent increases is generally desirable, because it is transparent. Most central banks and statistical agencies regularly report inflation.
 
Using a formula that only the rent tribunal can understand and configure creates abuse and corruption.
 
3. The rent control system should allow capital recovery.
The rent increase structure must allow landlords to recover their investments and certain costs. Without this basic precondition, private housing investment will grind to a halt, with all the attendant evils mentioned earlier.
 
4. The scheme should be predictable.
If the allowable rent increase is changed annually, then the government must announce it early to allow landlords and tenants to negotiate and evaluate their options.
 
5. The rent control scheme should be easy to implement and enforce.
Decisions must be easy to execute and implement. Given the cyclical nature of the rental market, prolonged litigation and eviction proceedings can lead to substantial losses for the landlord and/or immense distress to the tenant.
 
6. Special courts can help
The legal system is an important variable. In most countries in Europe, and countries with English common law systems, a rent tribunal or rent board hears complaints regarding rent adjustments. The decision can only be appealed to the tribunal itself. The process is usually swift and efficient.
 
In many other countries, on the other hand, cases related to rent adjustments are handled by generalized courts and can be appealed to the highest courts – which usually means a cumbersome and expensive process 
“Qatar and UAE can learn a thing or two from Canada,” says Cruz. “Although the laws appear to be pro-tenant, the system is not entirely disadvantageous to landlords. Allowable rent increases are based on each province’s CPI, allowing regional disparity,” he continues.
A landlord can usually petition for a rent increase above the “rent increase guidelines” set for the province. Landlords doing so have to apply to that province’s rent authority. Landlord-tenant disputes are resolved by the provincial (small claims) court system, or through a tribunal/arbitration system. The system is very efficient.

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