Rental Housing Policy Strategies and Best Practices for Emerging Markets

1. Rental Housing Policy Strategies and Best Practices for Emerging Markets

2. Preface: Why Rental Housing?

3. Demand Factors � Shelter for the Young, the Mobile, the Poor & Access to Finance The rental sector creates strong utility for specific groups. Young households are the main private renter class (ownership ratios at retirement broadly similar); Insufficient rental supply discourages mobility and encourages migration abroad (e.g. Romania). Rental landlords provide implicit access to finance to the poor: operate analogous to mortgage lenders (borrow short, lend long); Rental = low-cost temporary tenure option (no downpayment, almost no transactions costs); Self-targeting to the poor. Relative subsidies (owner-rental) have strong demand impact.

4. Supply Factors � City Structures &Infrastructure Policies, Coordination Issues In the West, countries with dense cities and tight infrastructure policies feature a strong rental sectors, and vice versa. US 1920/30s: Robert Moses & Levittowns determined homeownership ratio more decisively than FHA-Fannie Mae-System. �Italian� city concept & greenbelt policies created dense rental cities in Europe (France, Germany, Russia). ? Feedback effect on housing finance system: corporate (Germany) vs. retail (United States) finance dominance. Yet, there are countries in Asia with high ownership ratios in multi-family stock (China, Korea). At the same time, micro-privatization of apartment stock in transition countries largely failed (no maintenance) ? What is the relevance of objective coordination problems vs. cultural issues?

5. Rental Sector Development Issues & Overall Strategy

6. Rental Sector Issue Hierarchy definesStrategy Scope & Sequencing

7. Our Focus Today: Issues & Best Practice Solutions in 4 Key Strategy Areas 1. Rational legal framework (legal formalization) 2. Rational tax treatment (economic formalization) 3. Sustainable & diversified investor & funding base, efficient collection & maintenance (institutions) 4. Rental subsidies

8. 1. Legal Framework Rent decontrol Liberalization of new rental contracts; De-grandfathering strategy for old contracts. Reformulation of rental law, tenant-landlord relations Definition of tenure forms and termination options; Rent setting & adjustment rules (�soft� rent controls); Contract enforcement options. Conflict settlement, contract enforcement infrastructure.

9. Who lives in Rent Controlled Units? Poor and Rich alike! Prague/Czech Republic

10. Horizontal Equity and Rent Controls: Rent-to-Income Ratios in Cairo/Egypt

11. Intergenerational Distortions from Rent Control: Ramallah, West Bank

12. Efficiency: Rent Control Blocks Housing Demand, Filtering Down of Housing Units

13. Rent Decontrol Strategies TYPICAL DECONTROL SITUATION: New contracts are fully liberalized (due to rental shortages); (Old) contracts closed prior to law grandfathered (bequeath often possible); In extreme cases whole building cohorts remain grandfathered (New York). BEST PRACTICE: Move all contracts quickly to operating cost coverage (incl. necessary capital repairs); Condition right to bequeath to raise in rent to cost-covering levels, or at least significant rise; Further adjust rents gradually, with quid-pro-quos (higher rents against landlord investment); Identify and support needy tenants.

14. Case Spain: Treatment of NEW Contracts

15. Case Spain: Treatment of OLD ContractsDe-Grandfathering

16. Cases Russia/Latvia/East Germany/Poland: Phased Decontrol Process First phase: move existing contracts swiftly to operating cost coverage (incl. repairs); Support tenants with excess burdens by rent allowances; Second phase: quid-pro-quo further rent adjustments against landlord investments: East Germany: assisted by soft modernization loans by public agency KfW and housing allowances. Third phase: reference rate system or indexation.

17. Rent Decontrol Process Visualization

18. Rental Tenure and Termination Options TYPICAL TENURE FORMS IN EMERGING MARKETS �Liberalized� (e.g. Colombia). 1 year with symmetric termination options (landlord, tenant). Problem: creates short-termism (long-term demanders move to ownership) and price volatility Analogy: adjustable-rate mortgage. Permanent tenancy (e.g. most transition countries); Severely contrains landlord termination options, e.g. use by own children, redevelopment; breach of covenants & contract; Rent adjustment rules � periodic and upon new investments � likely to cause mismatch with landlords; Analogy: callable fixed-rate mortgage. ALTERNATIVE 3, 5 years default tenure is a reasonable middle ground (e.g. Russia): Period long enough to provide certain tenure security (short of ownership); Short enough to deal with market risk and options purely contractually. Analogy: roll-over short-term fixed rate mortgage.

19. Soft Rent Control Options: Reference Rate System Reference rates derived by rent surveys Based on rental market surveys, CPI indexation only for updating Covers rental contracts closed in the last 4 years Generates average rents and confidence bands over an apartment quality-size-location matrix. Legal impact: rent surveys are the basis for usury legislation, replaces hard rent controls Rent level 20% above the upper band limit is considered usurious. Landlord may contest in court if he is able to prove that at least 3 typical units are priced at his ask rent level. Market impact: reasonable rent definition changes with market conditions, with some lag (4 yrs); usury claims can be objectively benchmarked. Costs: surveys are done every 4 years; alternative is expert rent survey.

20. Rent Survey Methodology � Locational Quality Map Example of city of Berlin 3 classes: - Red areas � high quality - Orange areas � mid quality - Yellow areas � low quality Maps are provided online

21. Rent Survey - Typical Rent Matrix by Size/Amenities Example of city of Hamburg Mean and range of net rents (net of heating and operating costs), are provided by - age class of building - size of apartment - amenities in the apartment (bath, central heating) Individual assessments are provided online

22. Rent Adjustment after Investment � Options Decision-making Law should provide tenants with rejection option for non-essential investments: E.g. pure beautification of building Smaller investment, major repair decision of landlord alone (e.g., elevator repair); Major investments e.g. analogous to condominum laws, voting? Rent adjustment formulae: Max statutory interest rate, or market interest rate, TIMES investment (minus subsidies); Amortization, e.g. 10 year schedule, of investment (smaller investments = sunk). Increases beyond a certain threshold are usually capped by law (as interest caps); exceptions can be made for major repairs.

23. Confict Settlement and Contract Enforcement TYPICAL SITUATION IN EMERGING MARKETS: Disputes courts only; Eviction not practiced; Rental investment deterred. BEST PRACTICES: Mediation as a low-cost mechanism can settle smaller disputes, e.g. repairs, and declog court system; Local gov housing offices (ideally those that do rent surveys) can offer independent opinions over usurious rent levels; Substitute housing to cater for evicted tenants (private or public rental).

24. 2. Rental Housing Taxation Tax system should be: Tenure neutral and otherwise non-distortive; Neutral among rental investor classes; Budgeted and transparent; Supportive to investment rather than confiscatory. Relevant tax classes: Income tax; Capital gains tax; Property tax; Value-added tax.

25. Income Tax Treatment SITUATION IN EMERGING MARKETS: Gross rental taxation system; No deduction for investment costs, or costs exceeding certain % of gross rents; High levels of tax-informalities. BEST PRACTICES: Make investment model of taxation available for individual landlords, I.e. Deduction of main expenses from income tax maintenance; interest paid; economic depreciation. Netting of losses from rental with other income, e.g. labour or business. Carrying forward of losses from rental to future incomes; Simple administration (may imply flat cost deductibles in certain cases). 

26. Rental Investor Tax Situation: Case Egypt

27. Investment Good Model for Rental � Basic Mechanics

28. Other Taxes SITUATION IN EMERGING MARKETS High tax rates (property, capital gains tax, sales tax) Tax base loopholes (primary residence, units intended for children); Sometimes inconsistencies (value-added tax on rental income), definition problems (commercial vs. residential). BEST PRACTICE Broaden tax base (including, in principle, primary residence); Lower tax rates For property transfer taxes: keep rates low to reduce loads of housing investments vs. other investments For property taxes: burden on cash flow as gross rent taxation; tax deferral model? For capital gains tax: floors of tax-free gains addressing inflation (cold progression); For value-added tax: treat mortgage interest rates and rents similar.

29. Internal return of a new rental investment under different tax policy scenarios, Case Egypt Purchase in t=0, sale in t=21. 20 years rental payment stream. Long-term IRR rests on heavy assumptions (fixed rental growth, fixed interest rates), to be repeated with shorter terms, scenarios.

30. 3. Sustainable & Diversified Investor & Collection Base Who is the optimal rental investor? Equity investor with long-term savings (collection) horizon E.g. savings for retirement: can be small individual, or large pension fund; Investor with institutional social or non-profit agenda, e.g. funded by endowments; NOT developers (short-term funding) Rents are usually fixed or slowly adjusting. A leveraged investor needs to manage rent / interest rate mismatch and rent collection. Who is the optimal rental collector? Two models: At arm�s length collection (e.g. individual renting out single apt) Professional collection (like mortgage lender, can serve large apartment stock), usually combined with maintenance.

31. Types of Rental Investors TYPICAL SITUATION IN EMERGING MARKETS: Subsistence and small private landlord rental housing; Employer housing. Some (limited) public rental housing efforts (often failed). MISSING INVESTOR AND COLLECTION AGENTS: Small businesses (10-50 units); Supported by financing and risk management model (developing e.g. in Poland and Lithuania, UK buy-to-let market, Germany); Institutional investors in housing (pension funds, insurance co�s); Non-profit housing associations, foundations and cooperatives: Defined as risk-taking investors, not beneficiaries; Supported by financing and risk management model (e.g. Poland); Property management companies (e.g. Poland). Also: PPP models between developers and public housing companies;

32. Rental Investors and Their Support Needs

33. Public/Non-profit Rental Financing & Risk Management Models

34. Two-Tier Model of Non-profit Rental Housing Finance � United Kingdom First tier: Housing Associations. Second tier: The Housing Finance Company; initially direct (co-)financier, now administrator for securitization deals, bond and commercial paper arranger.

35. Public, Private or PPP Rental � which route to go for Poland? Rental in Poland is not marginalized as elsewhere, but also badly targeted. Cost rent system creates strong incentives for richer households to remain in public rental (in good locations). There are working management structures, but also problems. Non-profit system TBS caters middle class (new construction, leasing & key monies); Gminas cater the low-income sector, developers push new (risky & costly) PPP model; Restitution created private rental, yet many poor private tenants that do not receive sufficient public assistance .

36. PPP for Rental Construction � Proposal for Poland Developers builds into public-private SPV, which issues debt to commercial lenders and pays the developer. Local government services debt and purchases properties held by SPV in installments. Central government counter guarantee. ? Problem: PPP (laws) usually foresee limiting government risk, yet in practice often shift risk to government.

37. 4. Rental Subsidies Direct assistance to support rental tenants may take three main forms: Allocation of (new) public rental unit; Rental allowances/vouchers in the private stock: to protect against rental shocks following decontrol; as permanent housing cost support for the poor, elderly. Purchase of occupancy rights from the private rental stock (i.e. gov subsidizes rent temporarily) Indirect assistance to landlords via soft funding, tax support.

38. Choice of Subsidy Approach in Rental � Vast Fiscal Cost Differences: Latvia 2005

39. Choice of Rental Subsidy Approach � Avoiding Poverty Traps

40. Rental Allowances TYPICAL SITUATION IN EMERGING MARKETS: There is a social allowance system in some rudimentary form (welfare); System collects targeting information that could be used for housing. BEST PRACTICES: Targeting via unified system, local government level control; Applicable rents to be capped to avoid poverty traps and excessive fiscal costs. CASES: Latvia, Poland introduced rental allowance systems; East Germany used rental allowances to absorb payment shocks as rents were massively decontrolled.

41. East Germany � Housing Allowances do NOT Mean that Rental Burden will not Change

42. East Germany � Housing Allowance Expenditures during Shock Decontrol Phase

43. East Germany � Targeting: Share of Households with Housing Allowances by Quintile

44. Occupancy Rights for Social Tenants TYPICAL SITUATION IN EMERGING MARKETS: Housing programs limited to new housing provision. Alternative: creation of housing solutions for the poor. BEST PRACTICES: Existing housing stock provides much cheaper rental solutions than new housing; Needs combination with eviction protection (e.g. to mobilize units built for later use by children); Occupancy rights will be limited in time (3, 5, 10 years); landlord can choose among a choice of tenants offered by local government; Local government will top-up affordable rent level; collection by landlord.

45. Should Rental Investors Receive Tax Subsidies? US Low-Income Housing Tax Credit System: Swap 10 year-tax credit against 30 year commitment to house x% low-income tenants. Make tax credits tradeable in order to expand investor base. Problems: New & high standard housing unaffordable for the poor ? additional subsidies Tax subsidies not under direct control of subsidy provider (state).