Laws on Residential Rents in Lebanon. 2015-By Paul Mourani
شاهد الجدول كاملا
These proposals call for the creation of a fund by the Ministry of Finance that will subsidize drastic increases in controlled rents (rents initially contracted before 1992), eventually completely liberalizing them. Once this is attained, the subsidies would presumably stop. The extent of these subsidies that are expected to reach hundreds of millions of US dollars, and the rent increases, will be determined by committees set up by the state.
One set of committees would estimate the value of the rent-controlled apartments (estimated to be around 150,000 in number) as if vacant. This would create around 150,000 cases and files. Appeals and counter appeals would dramatically increase the complications in the management of these files. Rents would then be increased over a period of 6 years, to 5% of the estimated value of the apartments.
A second set of committees would look into the tens of thousands of income declarations (if there are any) of the tenants who are applying for subsidies. The level of the total household income per rented apartment will determine whether there would be a subsidy, and if so, whether the subsidy will completely cover the rent increases or only partially so.
Subsidies will be paid directly to the owners.
Broad evaluation of the proposals
1. The true beneficiaries of the subsidies
The fund is supposed to help tenants in the lower income brackets. The truth of the matter is that the owners will be the sole beneficiaries of these subsidies as the government money will go directly into their pockets (unless the tenants decide to vacate the premises), whereas the “subsidized tenants” will pay the same rents or more until the end of the subsidy program, at which time their contracts are eventually terminated and they are faced with eviction.
Tenants whose total household income is more than three times the minimum wage ($448) will fully pay the drastic increases in rent which could easily reach a twenty fold (2000%) increase over 6 years. This category of tenants comprises the lower middle class and above and represent the most dynamic elements in society. The new law will go a long way to eradicate them.
2. Fiscal and economic burdens of the proposals
The subsidy deception has another socially unjust consequence, as these subsidies will be financed through additional taxes that, in the highly regressive Lebanese system of taxation, will put a greater burden proportionately on the poor and the productive classes. These taxes will also hit people who are neither tenants nor lessors in order to resolve a conflict that in no way concerns them.
Inequitable allocation of government resources
The use of public resources to finance the subsidies program is a discriminatory measure. There are people who are poorer than these tenants, some with much greater need for help. Why doesn’t the government also give them subsidies, grants and donations? Or is it that it acts as a welfare state when it benefits only the idle rich?
Most importantly, can the government find the hundreds of millions of dollars needed to pay for these subsidies? The government is incapable of paying long overdue increases in wages and salaries in the public sector. Its ratio of debt to GDP is among the highest in the world. It is incapable of providing water to its citizens, the infrastructure is in shambles. No money to pay the workers and no money to improve essential public services, but money can be drawn from the pockets of the poor, the lower middle classes and the productive sectors to give to the idle rich. A revealing set of priorities for our rulers!
3. Bureaucratic nightmare.
The Law initially stipulated that the decisions of these committees were not subject to appeal, but the Constitutional Council declared this to be unconstitutional.
This decision will add even more administrative complications to the state bureaucracy that the implementation of the new law will create. The process of estimating prices of more than 150,000 apartments will create recriminations, counter-estimates, appeals, conflicts, abuses and administrative chaos.
The committees estimating incomes will have to evaluate tens of thousands of files in order to determine who qualifies to receive subsidies. Given the tribalism, nepotism and corruption that have plagued the public sector, and the high proportion of undeclared income in the country, one can imagine the abuse, favoritism and mishandling that will occur in the implementation of this process. The bureaucratic aspects of the proposed law are simply nightmarish.
A deeper look at the old system of rent laws
1. Evaluation of the Constitutional Council’s report on the new rent law.
The Constitutional Council (CC) characterizes the old system of rent laws as a “special law” (loi spéciale) rather than a law of exception, “..because of its continuity after starting exceptionally after the second world war, as a result of the scarcity in residential housing and the reduction in supply; this explains why the tenant was considered the sole and absolute victim, at the expense of the owner, and why the property owners abandoned rental housing and moved instead in the housing sales market.” (Official Gazette, Supplement to issue No. 34, 19/8/2014, page 5).
“The subsidy deception has another socially unjust consequence, as these subsidies will be financed through additional taxes that, in the highly regressive Lebanese system of taxation, will put a greater burden proportionately on the poor and the productive classes“
A number of comments on the CC characterization are in order:
Special laws are coercive in their nature and are in response to exceptional circumstances, and therefore, temporary in their nature. They also would normally require a higher majority for their enactment than normal legislation. The old system of rent laws does not fit this characterization as the old laws were routinely enacted with normal majorities. There was nothing coercive about them and investors continued freely flocking in this market in the full knowledge of what they were getting into. Furthermore the facts that the CC uses to justify its characterization are simply false:
1- Regulation of rental laws was not started exceptionally after the war as was claimed in the CC report. Laws regulating rents predate the war and others were started at its beginning (Decision N.213 of 12/10/1936, Law of 11/5/1938, legislative decree No. 25 of 5/1/1940, legislative decree 134 of 31/12/1941 and legislative decree 288 of 11/12/1942 are examples of such legislation).
2- There was no exceptional scarcity due to the Second World War as the CC statement claims. Exceptional scarcity and limited supply of rental units would have resulted in steep increases in real estate prices and rent levels and, therefore, in government intervention aiming at decreasing rent levels. The rent regulations during and after the war, however, aimed at increasing rents very substantially, and not at decreasing them!
3- The property owners did not abandon the rental housing market as a result of government regulations. Tens of thousands of rental contracts were initially signed after this early period. Housing sales became prevalent only after the enactment of Law 160/92 that freed all new rents from state regulation. The facts indicate that the old system of laws managed to maintain a steady supply of rental units and that it was rent deregulation that impeded the growth of residential rental housing.
In addition to its characterization of the old system of laws, the CC builds its case that the owners were victimized on the grounds that these laws were encroachments on the rights to private property and violated the principle of contractual freedom.
Deviations from these principles are legitimate. The CC readily admits this, but it maintains that measures that encroach upon them are only legitimate, if they are publically useful (d’utilité publique), and if they offer a fair and balanced solution in a situation involving two parties, and not resulting in one party abusing the other. They reject the “securité juridique” argument, and accept overturning 80 years of “constant jurisprudence” for the same reason, namely that the old system of laws was not balanced and fair.
Fairness to owners is revealed by how well they performed economically under the old system of laws, and this is measured by the calculation of their cash flows and the rates of return on their investments. The CC implicitly assumes that rent differentials are prima facie evidence of unfairness to owners. Let us now consider the validity of equating rent differentials with lack of profitability in the rent-controlled sector.
Large rent differentials do not mean lack of profitability
The compelling evidence that the controlled rent sector was profitable to owners is the fact that they kept investing in this sector when 50 laws covering a period of more than 70 years made it abundantly clear that government controls were there to stay. Owners were not coerced into leasing under these conditions. They freely chose to do so, preferring to invest in this sector rather than in bonds, equity or in furnished apartments which were not subject to the same rent controls. The explanation for this is simple.
Initial levels of the “old rents” in Lebanon were determined by the market forces, that is, by free agreement between tenants and landlords. The crux of the matter, is that owners were able to make very high profits in the regulated rent market, as a result of their ability to extract a higher initial gross yield or ratio of rent (R) to apartment value (V) than in the unregulated market, because the tenants were willing to pay a premium for the security given them by the state regulatory controls. Some data and examples will clarify this.
Data on gross rental yields
Picketty’s data shows that the average gross yield (R/V) was 5% historically, but that it had fallen in the twenty-first century to an average of 4.5% (Capital in the 21th century. Harvard University Press, 2014. Pp. 54-55). In the unregulated rental market of today, gross yields have fallen even more according to the Global Property Guide, averaging between 2.09% and 4.36% in London, and between 3.39% and 3.67% in Paris. In Beirut the same source indicates that rental yields were between 3.7% and 4.7%, but have decreased recently and now range between 2.7% and 3.5%. Rent Law of 9/5/2014 calculates fair rent at 5% of the estimated value of the apartment if vacant.
Historical data on gross yields for regulated rents is not readily available, but consensus has it, and the case-study illustrates this, they were between 10% and 12% in Beirut.
Comparing rates of return (IRR) in regulated and unregulated markets for a period of 25 years, reveals that the rates of return in the unregulated market with initial gross yields of 4% and 5% only approach the IRR in the regulated market when the rate of growth of free rent levels reach the high historical average of 6% annually. The exercise assumes that in the regulated market initial gross yields are 10% and rents are nominally fixed. This underestimates profitability in the regulated sector as legislators would systematically increase controlled rents in later years.
In a case study of an apartment for which exact data could be obtained, IRR’s were calculated after deduction of expenses at between 7.94% and 9.16% depending on the estimate of residual value of the investment: the price this apartment could fetch in the market today if its rent was still government-controlled. These high IRR’s were achieved even though the calculations of the cash flows included rent levels that reached values in the last years of the war as low as $8 per annum. The IRR’s were also adjusted down from 8.94% and 10.16% respectively, to account for owners expenses.
(The reader is referred to the full-length article for detailed discussions of the various scenarios envisaged and their precise calculations).
The owners squeezed their profits in the first years of their investment, knowing fully that rent differentials would grow with time. The returns of the early years of an investment weigh more than those of later years in the calculation of profitability (IRR). That is the explanation why the owners can achieve high profitability even though their rental incomes become very low in real terms in later years. The legislators and the CC failed to take this into consideration, and this invalidates their legal reasoning based entirely on faulty economic and financial grounds.
The tenants paid a premium in higher initial yields for the security given them by 50 laws over 80 years. This security should not be denied them without proper compensation.
A simple and fair proposal to resolve the conflict between owners and their tenants
We now have the elements for the elaboration of a simple and fair solution to the residential rental housing problem.
It should be recognized at first, that there are some categories of owners that were unjustly treated in the rent adjustments made by past legislators, because the latter were fixated on rent differentials and oldness of initial contracts rather than on overall profitability to owners. This is the case of contracts initially signed in the mid 1980’s. Whereas the rent adjustments made in the 1992 law, to correct for the hyperinflation of the war years, multiplied the rents initially contracted before 1954 by a factor of 165, they only multiplied those contracted in 1984-1985 by a factor of 24, thus depriving these owners from the benefits of high early profits.
The simple way to correct for these inequitable adjustments is to return all old rents to their initial real value. A good approximation for the real value is their initial value in US Dollars, which can be easily calculated and then transformed into current Lebanese Pounds at today’s rates. These values should then be subjected to all the raises voted since 1992 that were linked to cost of living adjustments to wages. These corrected rents will be referred to as Rehabilitated Wages (RW).
The proposal can now be summarized as follows:
- RW is used as the initial current rent, and its future increases will be linked to cost of living adjustments to wages, as stipulated in the 1992 law.
- All current expenses will be paid by the tenants.
- The rented apartments share in costs of rehabilitation of infrastructure, equipment purchases, renovation, will be fully born by the tenants. They will be given, however, the choice between making a lump-sum payment for the whole amount of their share in costs, or of incurring a rent increase equal to 5% of these costs.
- In both cases above, the tenants will have the right to participate in the decisions and in overseeing the execution of the works
- Should the owners be dissatisfied with the conditions of their lease under the extended Law1992/160 applied to the RW, the proposed solution offers them the possibility of reclaiming their property against compensation. The owners can, at their sole discretion, offer the following deal to tenants: The owners will provide an estimate of the value of their apartment as if vacant. This estimate will not be subject to revision. The tenant, within one year of this offer, will be obligated to select one of the two following options: buy the apartment for half the estimated price or accept an indemnity equal to the same amount in order to vacate the premises and end the rental contract. The tenants will be given enough time to find the financing if they decide to buy, or to seek alternative housing if they accept the indemnity to vacate their old lodging.
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