The regulation of residential tenancy markets in post-war Western Europe: an economic analysis.

• Author: Mora-Sanguinetti, Juan S.
• Position: Report

1. Introduction

   In several European countries, the weight of the tenancy market relative to the total stock of principal residences has diminished throughout the 20 century. Figure 1 shows, using information held in public databases of the European central banks, recent evidence for 12 European countries.

   Several explanations could be provided to understand that general trend, ranging from the finance literature, which considers housing as an investment good, to the more general housing economics literature that regards housing as a consumption good (see Henderson and Ionnides, 1983 and Rosen et al. 1984 for some early references). For instance, in recent decades improvements in access to credit and significant development of the financial markets (Iacoviello and Minetti, 2003, Kumbhakar and Lozano-Vivas, 2004, Blanco and Restoy, 2007) have occurred, which may have favored the property market. Some fiscal regimes have also privileged buying over renting of residences (see Lopez-Garcia, 1996, Garcia-Vaquero and Martinez, 2005, for the case of Spain).

   [FIGURE 1 OMITTED]

   Nevertheless, it is only some specialized literature which takes into account the effects of regulations and institutions of the tenancy market (other than fiscal policies), such as rent control clauses or periods of protection for tenants. A weak tenancy market and a diminishing rate of tenancy seem to be related, for instance, to the introduction of rent control policies. In this respect, the microeconomic intuition that relates a rent ceiling with a diminishing quantity and quality of residences in the tenancy market has been supported by several theoretical explorations (Basu and Emerson, 2000, Raess and Ungern-Sternberg, 2002, Basu and Emerson 2003) or empirical analyses (Johnson, 1951, Alston et al., 1992, Glaeser and Luttmer, 2003, Sims 2007 among others).

   However, most of the research on rent control has merely examined the type of market intervention enforced in local markets of the United States (for a summary, see Turner and Malpezzi, 2003). In contrast, less analysis has been made of the specific effects of European-style tenancy restrictions. Exceptions to that are Pena and Ruiz-Castillo (1984) for Spain, by Munch and Svarer (2002) for Denmark and by Lyytikainen (2006) in respect of Finland.

   Moreover, the regulations in force in various European countries impose not only rent control clauses but also clauses of protection term (duration clauses) against eviction. Both kinds of rules may have had an effect on the diminishing share of tenancy in very different economies. At the same time partially liberalizing laws, such as those adopted in the UK (England and Wales) and Finland, may have had the opposite effects.

   The aim of this paper is to analyze the regulations specifically directed to the tenancy markets in Europe and to provide a theoretical exploration of their economic implications. The structure of this paper proceeds as follows: firstly, the paper identifies the most common market regulations affecting European tenancy contracts by analyzing the various national laws (section 2). Those regulations are then introduced in a model of tenancy markets to explore their effects theoretically (section 3). Finally, the paper draws some conclusions based on the analysis carried out (section 4).

2. The regulation of housing tenancy markets in Europe

   At the beginning of the 20th century, "contractual freedom" inspired the contents of tenancy contracts in several European countries, following the principle of the "autonomy" of private parties. (3) However, as the century progressed, "contractual freedom" was gradually restricted by the introduction of some tenancy regulations (such as rent ceilings, compulsory terms or control over the increase of the rent) which had the objective of improving the situation of tenants in the context of a shortage of rental housing stock following the First and Second World Wars (or the Civil War in the case of Spain).

   If the analysis is limited to rent control policies, one can follow the classification made by Arnott (1998) of their different types into "two generations". A "first generation" rent control would include rent freezes and exceptional upward adjustments. A "second generation" rent control would include automatic percentage rent increases linked to the rate of inflation (or similar indices). While tenancy markets in the United States were gradually deregulated, with very few cities maintaining the controls after 1950, in Europe the first generation rent controls survived longer due to the long-lasting effects of the two World Wars. Arnott (1998) identifies the surge of the second generation controls with the inflationary crisis of 1973.

   However, rent control is only one of the market regulations introduced in the European tenancy markets. In fact, "compulsory terms" are a mean of temporarily protecting the tenant against eviction. It is also possible to classify those regulations by their severity: the protection could be permanent, therefore rendering the duration of the contract subject to the will of the tenant, or temporary.

   In this section, a detailed analysis is provided for Spain, as a benchmark, Italy, UK and Finland (the last three providing examples of countries that introduced relevant reforms in recent decades) and an overview of the most recent regulations for a multiplicity of European countries (see Table 1).

   2.1 Spain

   The tenancy market was not deeply regulated in Spain prior to 1931. Only some partial decrees limiting the duration of the tenancy contracts and rent therein were passed for specific situations and in particular cities during the 1920's. (4) The Spanish Civil Code (1889) was mainly liberal: Article 1255 thereof stated that private parties were free to agree any terms and conditions in a contract as long as they were not contrary to "Law, morality and public order".

   In 1931 (5) the limitations to contractual freedom introduced in the previous decade became permanent. However, the first complete piece of regulation of tenancy markets did not occur until 1946, with the "Ley de Arrendamientos Urbanos" (Urban Tenancy Act). (6) Since then, a Law of this kind has always remained in force in Spain (the aforementioned law of 1946 being the first, and later, the Laws of 1964, 1985 and 1994). The restrictions introduced by the 1946 Law were a reaction to the profound changes undergone in Spanish society before the Civil War, such as the rural exodus, and, after 1936, the shortage of housing caused by the Civil War. In any case, more general populist reasons also influenced these early initiatives which were a mean of winning support for the newly established political regimes (firstly, the Second Spanish Republic, and after 1939, Franco's dictatorship).

   The Law of 1946 rendered the principles of the Civil Code almost inapplicable (Rodriguez-Aguilera and Pere, 1965), introducing, among other restrictions, a "compulsory duration clause" and a "regulation of rents". At this stage, the interventions were severe. The tenant's protection against eviction was unlimited. Even close relatives of the tenant were able to succeed him as tenants in the same dwelling and benefiting from the same conditions. With respect to rents, the Law established fixed one-time increments in the rent paid for apartments leased before 1939 and freezed the rents in respect of all new contracts.

   In 1964 the Government adopted a new Law through a new Decree (7) which compiled several partial amendments to the old legislation (including the Law of 22 December 1955 among others). The new Law, which remained in force until 1985, maintained the rules governing the duration of the contract (indefinite extension thereof). However, a timid change in the rules governing the rents was introduced. The Law allowed an increase of the rents in contracts signed after 1956 after the fifth year of renewal of the contract. The increase was linked to an official index related to the "cost of living" published by the National Statistics Institute (INE).

   The statistical information available on the tenancy market in Spain was very scarce, although following the census (1970 and 1981), the proportion of principal residences in the rental market diminished from 30.1% to 20.8%. As a consequence of this weak proportion, the Government decided in 1985 to liberalize the tenancy market by removing the requirement of compulsory extension for all tenancy contracts concluded after that year ("Decreto Boyer") (8) However, the rents were still linked to the Consumer Price Index (CPI) and the Decree was not applicable to all of the contracts signed before 9 May 1985.

   The censuses suggest that the effects of the new rules were quite limited: the census of 1991 showed a further reduction in the weight of the tenancy market (15.2%) although the pace of reduction had also slowed compared to previous decades. (9)

   In 1994, the Parliament enacted the most recent Law. (10) On the one hand, it aimed to reduce the instability caused by the very short duration of the contracts regulated by the "Decreto Boyer". On the other, it aimed to address the problem of the coexistence of very different types of contracts (the "new" contracts concluded after 1985 and the "old" contracts which were rigidly regulated). Thus, the Law reintroduced compulsory durations for a limited period of 5 years and maintained a rent control that tied rental increments to the CPI. However, it removed the principle of the unlimited extension of contracts signed before the reform of 1985 (such contracts could therefore no longer be transferred to other members of the family, leading to their extinction in the medium term).

   Thus, following the classification made by Arnott, rent control in Spain partially transformed into a "second generation" type during the 1960's. However, modernization of the regime of compulsory extension of tenancy contracts did not occur...